Conditions seen worsening for majors until late 2016

Fundamental business conditions for integrated oil and gas companies will worsen before signs of improvement appear late next year, according to a Moody’s Investors Service assessment based on reduced expectations for crude oil and natural gas prices (OGJ Online, Aug. 7, 2015).

Moody’s expects earnings before interest, taxes, depreciation, and amortization (EBITDA) for the global integrated oil and gas industry to contract by 20% or more this year and to recover only modestly in 2016.

“This view is based on our expectations of revenue and cash flow declines and a negative free cash flow profile for the industry in 2015,” the firm says. “We expect the industry’s free cash flow to remain negative in 2016.”

Free cash flow is the difference between cash flow from operations and investments.

Moody’s expects total free cash flow for the integrated companies it rates to be negative by as much as $80 billion this year, compared with a negative $26 billion in 2014.

“The cash flow gap at recent pricing levels should ease somewhat in 2016 to the area of $55 billion,” says Moody’s. The firm assigned the global integrated oil and gas industry a negative investment rating, indicating expectations for worsening business fundamentals during the next 12-18 months.

Companies rated by Moody’s are ExxonMobil Corp., Chevron Corp., Royal Dutch Shell PLC, Total SA, Statoil ASA, BG Energy Holdings, BP PLC, Eni SPA, OMV AG, and Repsol SA.

Capital spending

The ratings firm expects cuts in capital spending by integrated companies next year to be larger than the 10-20% reductions this year. Because some companies, including Total and Chevron, continue to invest heavily in large projects, Moody’s says, “if oil prices continue to fall, the industry’s negative free cash flow profile could increase in 2016.”

Still, cuts in spending and operating costs as well as asset sales will cushion the effect of lower oil prices.

Moody’s notes that full-cycle costs rose to about $50/boe for the companies over the past 4 years, while the ratio of per-barrel cash margins to 3-year average finding and development costs—a metric called the leveraged full-cycle ratio—has fallen from 2.54:1 in 2011 to 1.56:1 in 2014 and 1.25:1 in the 12 months ending in June.

Costs are falling, however, in response to spending cuts and overcapacities in drilling and other service industries (OGJ Online, Sept. 15, 2015). The big operators are renegotiating and canceling rig contracts, improving supply-chain management, and standardizing project design.

“We expect the benefits of lower costs to fully show up towards the end of 2016, bringing upstream margins and returns more in line with lower oil prices,” Moody’s says.

Asset sales

Most of the integrated companies are increasing asset sales “to cover negative cash flow, improve capital discipline, bolster cash, and support disciplines,” the firm notes.

The companies it tracks divested more than $35 billion of assets in both 2013 and 2014. The total could reach $40-60 billion in 2015-16.

The price assumptions Moody’s adopted in August for West Texas Intermediate crude are $50/bbl this year, $52/bbl in 2016, and $60/bbl in 2017. Its Brent assumptions for those years are $55/bbl, $57/bbl, and $65/bbl.