Oil & gas credit quality stagnates
The recovery in credit risk across the global industry has slowed, due to several sources of disruption
The long-promised recovery of the global oil and gas industry appears to be sputtering. When viewed from the perspective of credit analysts at the world’s largest financial institutions, the industry was showing signs of improvement throughout much of 2018 and into early 2019. But the risks on the road ahead are proving too big to ignore.
The credit analysts are right to be concerned. The industry is confronted on every side—from a volatile geopolitical environment, technological changes, concerns about climate change and significant investment into renewable, cleaner sources of energy. Meanwhile, larger-than-expected supplies have consistently driven down prices and crimped earnings growth for large producers.
Given these factors, bank credit analysts—whose job it is to predict the likelihood that a corporation will default on its debt obligations—have been a prescient source of intelligence on the long-term fiscal health of the industry.
Credit Benchmark evaluates that sentiment by creating a proprietary consensus estimate of credit risk drawn from the views of over 40 of the world’s leading financial institutions. By looking across all of these analysts’ estimates for the global oil and gas industry, it is possible to chart the recent reticence among credit analysts to fully commit to recovery.
Tracking the credit trend
The phenomenon is best conveyed in Figure 1, which depicts the three-year trend in credit quality for US, EU and UK-based large oil and gas companies. Across all three global markets, the period between December 2015 and March 2017 was marked by a steep deterioration in credit quality, followed by a promising recovery that stalled in early 2019.
Specifically, the data points plotted on this chart illustrate the consensus probability of default metrics for bank credit analysts. Looking at US-based large oil and gas firms, for example (red line), credit quality deteriorated more than 80pc between December 2015 and March 2017. There was an inflection point where credit quality started to improve by roughly 50pc between April 2017 and December 2018. Since then, however, the trend has been flat-to-deteriorating, unable to climb back to the levels reached back in 2015.
The trend has been similar in Europe. UK oil and gas firms (blue line) took a credit nosedive between December 2015 and June 2017, before starting a recovery. However, the UK has struggled to match the rate of recovery shown in the US. From the trough in November 2017, over the following two years the credit quality for UK firms improved by 6pc. This compares with an improvement of 28pc for US-based oil and gas firms over the same time period.
For EU-based oil and gas companies, the moves have been less dramatic than those witnessed in the US and UK, but the overall trend has been similar. Since hitting a trough in credit quality in April 2017, credit quality for EU companies has steadily improved by 17pc, edging closer to the levels seen in December of 2015.
The global oil and gas industry finds itself at a crossroads where it is simultaneously being squeezed by disruptive technological and geopolitical factors, yet also more in-demand than ever before. The industry—and the analysts and investors who watch it—simply cannot ignore the impact that hydraulic fracturing, electric vehicles, drone and exploratory data analysis and concerns about pollution and climate change are having on future growth. However, with no immediate, significant tech-nological replacement for fossil fuels, demand continues to grow.
Successfully navigating that challenge will require a deft balancing act in which industry leaders successfully manage a transition to clean energy alternatives without compromising the reliability and accessibility of their legacy operations.
This tight rope walk is exactly what credit analysts are watching closely when they determine the credit quality of the underlying firms that make up the industry. It also explains why credit risk volatility levels have been so high over the last three years.
The current business environment for these firms is one in which a single stroke of the pen from a regulator—or even a tweet from a prominent politician—can have a swift, material impact on growth trajectory and strategy. Expect continued credit volatility in the sector as analysts update and refine their models based on the multitude of potential disruptions that will continue to affect the industry.
David Carruthers, Head of Research, Credit Benchmark