Oil markets on the rise
The oil-price recovery has helped to improve the outlook for oil and gas capital markets
Capital raised by oil and gas companies reached $530bn in 2017. Although a partial recovery from 2016's nadir, this remains low compared to recent historical levels and is around 70% off the peak we saw in 2014. In 2017, all sources of capital—loans, bonds and equity—came in at lower than the five-year average.
While access to capital has undoubtedly improved, a host of other factors are also at play. Internal cash generation has recovered along with commodity prices. In parallel, capital discipline and efficiency measures have reduced the sector's capital intensity to some extent, and alternative sources of capital such as forward sales or divestments to private equity are also increasingly having an impact.
The recovery in oil prices has helped improve the financial health of oil and gas companies and boosted investor confidence. Many US independents and large-cap oil and gas companies—most of whom were impacted by the oil price downturn—recovered in 2017 and started to deliver positive returns on capital. While distress persists in smaller and highly leveraged independents with weak balance sheets and low ratings, moves into financial restructuring have significantly declined.
Total bankruptcy filings in the oil and gas sector nearly halved from a five-year peak of 62 in 2016, to 30 in 2017. Similarly, total liabilities recorded at initial filing declined from $42bn in 2016 to $19bn, according to Capital IQ financial services firm. Declining repayment defaults have also helped stoke investor confidence, resulting in a narrowing of high-yield debt spreads and a weakening of protective covenants.
Against the backdrop of a growing industry consensus that oil prices have bottomed out, the outlook for oil and gas capital markets is improving. According to our 18th Capital Confidence Barometer, 99% of oil and gas executives think that credit availability is stable or improving. The capital markets are expected to receive a boost as companies return to growth and their capital needs increase as they resume investments.
The annual report of quality assurance firm DNV GL, Confidence and Control: the outlook for the oil and gas industry in 2018 , highlights that two-thirds of more than 800 oil and gas executives surveyed plan to maintain or increase capital expenditure in 2018. Portfolio transformation continues to be the top priority for boards of oil and gas companies. We anticipate that many companies will likely use divestments to fund existing operations, as well as mergers and acquisitions.
FIG 1: Capital raised: value and volume Source: ThomsonOne, EY analysis
We may see capital restructuring in the highly leveraged pockets of the sector, as three planned interest rate hikes by the US Federal Reserve in 2018 could be set to increase the cost of capital globally. Moreover, tax reforms in the US that limit relief for interest payments could also negatively impact highly leveraged oil and gas companies. Equity markets, which have been relatively quiet over the past year, could likely be supported by the multi-billion-dollar initial public offerings of various national oil companies over the coming years.
The oil and gas market remains highly sensitive to the production cuts agreed by the Opec and non-Opec countries that began in early 2017, as well as growth in US shale production. While oil prices recently crossed the $70-a-barrel mark, they're still lower than the historic highs of over $100/b. Investors will likely be selective and prefer companies that have strong prospects for profitability and cash flow. Oil and gas companies will have to communicate a compelling investment story and clearly highlight their focus on capital discipline and shareholder returns to attract or retain investors. They also need to maintain greater financial optionality, seek alternative sources of finance and move away from heavy reliance on traditional capital, such as bank loans (which accounted for 59% of the total capital raised in 2017).
Two-thirds of oil
and gas executives
surveyed plan to
maintain or increase
The Americas dominate
The Americas region (with total proceeds worth $338bn) accounted for nearly two-thirds of capital raised globally in 2017. The US has experienced a robust debt market as rising oil prices helped expand credit limits for reserves-based lending, benefiting upstream independents who have relied heavily on external debt.
Oil and gas producers in the US have taken advantage of the low interest rates to secure long-dated debt to support increased shale drilling. But also to repay or refinance debts and finance imminent or long-term acquisitions. In addition to financing future acquisitions, Canadian companies raised sizeable capital to fund multi-billion-dollar oil sands deals, as the sector consolidates under Canadian ownership.
FIG 2: Capital raised by area Source: ThomsonOne, EY analysis
After three years of capital discipline, staff cuts, cost reduction and investment high-grading, oil and gas majors are now on a relatively stronger financial footing. With improved profitability, they're increasingly relying on free cash flow to finance their projects and pay dividends. Select oil majors have also bought back shares and announced cash dividends, signaling growing confidence in the sector. Capital raised by oil and gas majors has steadily declined since 2015 to $24bn in 2017, and was likely aimed at refinancing, and meeting working capital requirements and other general corporate objectives for downstream businesses.
NOCs tap debt markets
The oil price drop, combined with uncertain oil market dynamics, has led many large national oil companies—especially those in oil-reliant economies—to rethink their capital structure and seek external funding. Large NOCs with strong credit ratings, particularly in the Middle East and Latin America, continue to have access to external capital.
FIG 3: Oil majors’ financial position and capital raised (US$/b) Source: ThomsonOne, EY analysis
NOCs in the Middle East have increasingly relied on external debt to fund upstream activity, downstream expansion and business diversification since the oil price crash in 2014. Continued strong activity among regional NOCs pushed the total capital proceeds in the Africa, Middle East and Central Asia regions to $49bnn in 2017—the highest level in the past five years.
NOCs are now taking advantage of low interest rates to tap international debt markets—either directly or through their financing arms or overseas business units. And in addition to IPOs of downstream businesses, they're also using innovative or unconventional deals, such as asset-level bond issuances, to monetise their sizeable infrastructure base.
Jon Clark is EY EMEIA Oil & Gas Transactions Leader. The views reflected in this article are the views of the author and don't necessarily reflect the views of the global EY organisation or its member firms.