S&P Global Ratings (S&P) is considering downgrading the credit ratings of nine of the world’s largest oil companies in a move that analysts said could deter them from investing in greener forms of energy or help accelerate spin-offs of their renewable energy businesses.
S&P — the largest of the three ratings agencies — last week warned companies including Shell, ExxonMobil, Chevron and Total, as well as some subsidiaries, their credit ratings could be downgraded within weeks amid concerns about increased risk due to the energy transition.
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Also on the list are Shell Energy North America, ConocoPhillips, Imperial Oil, Australia’s Woodside Energy, Canadian Natural Resources and Chinese companies China Petrochemical Corporation, China Petroleum & Chemical Corporation, CNOOC Ltd.
S&P also revised its assessment of the oil and gas industry to “moderately high risk” from “intermediate risk”.
Meanwhile, the agency revised the outlooks for both BP and Suncor to “negative” from “stable”, which could be a factor in future ratings downgrades but does not mean it plans an immediate review of their credit ratings.
Downgrades likely, within weeks
“S&P Global Ratings believes the energy transition, price volatility, and weaker profitability are increasing risks for oil and gas producers,” said S&P, adding the downgrades could come within a few weeks.
A ratings downgrade would almost certainly increase the cost of borrowing for the companies, which have been grappling with how to maintain profitability amid falling oil demand as a result of the Covid-19 pandemic while also delivering on society's needs to reduce carbon emissions to limit global warming.
Western oil majors have cut spending by billions of dollars and booked huge impairments on upstream assets after reducing their long-term oil and gas price assumptions in the wake of the pandemic.
'Obvious blow' to the sector
Per Magnus Nysveen, head of analysis at Norwegian consultancy Rystad Energy, said the move was an “obvious blow” to the sector, which will “add more pressure on big oil to invest comfortably within operating cash flows”.
“It could also deter them from investing quickly in renewables where capital cost is the key driver for profitability,” he said.
“These oil companies have a solid base cash flow, as costs have dropped together with prices, and plenty of flexibility to protect dividends by reducing capex.
“Lowering costs and efficient capex is the way to attract dividend-hungry pension funds.”
Accelerated spin-offs possible
Biraj Borkhataria, co-head European energy research at RBC Capital Markets, said: “Looking forward, moves like this could accelerate the spin-offs of the majors’ renewable businesses, allowing them to issue debt within these structures, potentially linked to sustainable/low-carbon targets.”
Borkhataria noted the “huge disconnect” currently between the equity market and debt markets when it comes to the oil majors.
“We’ve seen ExxonMobil trading at a 10% dividend yield, while the company has been able to issue long-term debt very successfully at extremely cheap levels. The distortion is driven in large part by central banks and policy, but this could signal something. At the very least, it could give management teams a bit more pause for thought around share buybacks in the near term, and they may choose to pay down debt instead."
Energy transition pressures
S&P said it was considering the move due to “significant challenges and uncertainties engendered by the energy transition, including market declines due to growth of renewables. This included “pressures on profitability, specifically return on capital, as a result of high dollar capital investment levels over 2005-2015 and lower average oil and gas prices since 2014; and recent and potential oil and gas price volatility”.
“We are placing on CreditWatch those ratings in which we see industry risks as having the greatest incremental impact on credit quality,” S&P said.
“These include some of the highest ratings in our oil and gas portfolio, as these companies bear the burden of sustaining the strongest credit quality over time, in the face of current and future industry uncertainties.
“Our view is that the challenges the sector faces are more important for these ratings, at this point, than the precise strategic adaptations and choices the companies make. Also, in general, we do not see materially different dynamics for producers of oil compared with gas.”
S&P said it did not anticipate downgrades of more than one notch as a result of the industry risk review alone, but did not rule out a combination of the industry risk revision and “other material factors” leading to a two-notch downgrade.
“Especially given the potential for negative surprises after the Covid-19 impacts in 2020," it said.
BP and ExxonMobil are due to report fourth-quarter results on Tuesday, with Shell reporting on Thursday.
Chevron posted a $665 million loss in the fourth quarter of 2020 on Friday as the oil demand destruction caused by the coronavirus pandemic hammered revenues.