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IOCs put on show of strength in bond markets

Majors have issued bonds and cut expenditure in equal measure, ensuring a buoyant market for their debt

Recent debt issuance by IOCs could be seen as a muscle-flexing exercise as much as a move to bolster balance sheets.

Italy’s Eni became the latest company to approve the issue of bonds on 23 April, worth up to $4.3bn, while revealing a 30pc reduction in capex for 2020 and a 30-35pc cut for 2021. The dividend issue was kicked down the road, with the company saying it would provide an update in July.

BP, Spain’s Repsol and Shell had already issued bonds in April, with an RBC research note suggesting BP could spend the next 20 months reducing a debt-to-capital ratio that reached 36pc in the first quarter. ExxonMobil and Chevron have eschewed the debt markets so far this year, although the latter has been boosted by the sale of assets in Azerbaijan.

A report from bank HSBC Global Research published on the same day Eni approved its bond issuance stated that none of the IOCs have what could be considered excessively levered balance sheets and that there was no reason to believe the big oil companies were ready to cut dividends yet.

Indeed, ExxonMobil’s management has recently reiterated its commitment to maintaining its dividends by reducing expenses. But, at the very end of April, Shell broke ranks and announced that it was reducing its dividend from 47¢/share to just 16¢/share, effective from the first quarter on 2020. It is the major’s first dividend reduction in 75 years.

Balance sheet gearing

BP and Shell had year-end 2019 net debt-to-capital ratios of 31pc and 27pc respectively, note Morningstar analysts Preston Caldwell and Dave Meats. They also observe that both companies have large downstream operations that, although they are also experiencing difficult market conditions, help cushion the blow of lower upstream revenues. Repsol’s year-end 2019 net debt-to-capital ratio was 32pc, whereas Eni’s was 20pc.

1.1x Average European IOC five-year debt coverage

Research house Bloomberg Intelligence analysis suggests European IOCs have the liquidity to cover maturities for the next five years by a factor of 1.1x. Eni can cover its five-year maturities by 2x with cash and credit lines, reflecting its sensitivity to Italian country risk and local funding conditions. Total is the only peer with hybrid debt (which contains an equity component) and Bloomberg Intelligence includes its first call dates as maturities, although these could be extended at the  company’s discretion.

However, the HSBC report authors also predicted that average balance sheet gearing would continue to creep up in 2021/22. It noted that BP already has above-average balance sheet gearing as a result of previous cash outflows for its Deepwater Horizon liabilities and 2018 purchase of onshore US assets from Anglo-Australian producer BHP. Likewise, Shell’s relatively high debt levels—plus the added cost of its share buyback programme—make its financial framework more susceptible to sustained lower crude prices than many of its peers.

According to financial data analytics company Credit Benchmark’s monthly oil and gas aggregate for April, credit quality for large US and UK oil and gas firms is now in its worst position in more than two years, with the average probability of default for US firms up by 8.6pc from the same period in 2019 and up by 4.3pc for UK firms.

Credit Benchmark calculates the average probability of default among US oil companies is now at its highest point since May 2018, while the average probability of default for UK oil companies is at a peak not seen for just over two years. By contrast, EU-based oil companies saw their credit quality improve by 4.4pc year-on-year, with their average probability of default less than half that of their US counterparts.

Bank of America Global Research’s stress test analysis—with oil prices down to relatively low levels for a longer period—suggests there is not really a liquidity crunch at any of the European IOCs. Rather, they have used market conditions opportunistically to underline their strength, according to Christopher Kuplent, head of the bank’s European equity research team for oil and gas.

“From my vantage point, looking at some of the healthier and more stable balance sheets at the higher-rating end of the IOCs, it could be argued that some of those that raised debt during April did so almost to show the market that they could even in this stressed environment,” he says.

Kuplent adds there is no reason to suggest the oil companies he covers—which include Shell, BP and Eni—have performed any worse than their non-oil peers from a debt perspective this year. “The sectors and sub-sectors that would face issues include smaller caps and oil services companies,” he adds. “What would be a source of disappointment to investors is the fact that the supermajors are still behaving pro-cyclically even though they are designed to be counter-cyclical.”

“It could be argued that some of those that raised debt during April did so almost to show the market that they could” Kuplent, BofA Global Research

Debt will dictate how boards behave over the next three-to-six months in terms of how they think about dividends in particular, according to Christyan Malek, managing director and head of the oil and gas team at bank JP Morgan, who observes that recent and proposed debt issuances by the IOCs he covers—BP, Shell and Eni—are designed to provide more liquidity to manage their working capital.

These moves are more about the ‘active’ parts of the business and have been led from an industrial rather than a fiscal perspective, designed to position them competitively from an operational standpoint.

Malek believes more issuances are possible and is confident there would be a healthy appetite from investors, but he adds that more issuances are likely only if the oil market remains depressed and there is no line of sight on improvements in demand.

The possibility that IOCs could have their credit ratings downgraded will further strengthen their focus on balance sheet strength.

Mitigative measures

“There will be mitigative measures, whether these are industrial in the form of capex and opex or fiscal in the shape of additional liquidity, reviewing dividend policies or scrip,” says Malek. “When IOCs are accessing an NOC’s oil, their credit rating is vital since it provides assurance that they will be able to finance future projects.”

There remains plenty of appetite for high investment grade quality debt, agrees Jason Gammel, equity analyst at investment bank Jefferies, noting that the likes of Shell, ExxonMobil, BP and Total are all single-A credits or better and their latest debt issuances were over-subscribed.

“When you are dealing with high investment grade quality credits there is not necessarily a specialist market for energy companies, and there would be interest from across the market in any new debt,” he says.

Some IOCs are on negative watch—which raises the possibility of their debt being downgraded. An energy company on a triple-B rating with a negative outlook might have some problems, but this is not yet an issue for the majors.

Gammel also refers to the cancellation of share repurchase programmes and an average capex reduction of 20pc across the sector. “ExxonMobil made the largest capital expenditure reduction [30pc] reflecting the fact that it also had the highest cash burn,” he concludes.

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