Royal Dutch Shell Ratings on CreditWatch negative
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PRESS RELEASE: LONDON: Standard & Poor’s Ratings Services today placed its ‘AA’ long-term and ‘A-1+’ short-term corporate credit ratings on international oil and gas major Royal Dutch Shell PLC (Shell) on CreditWatch with negative implications.

We also placed on CreditWatch with negative implications the ratings on various other Shell entities–Solen Versicherungen AG, Shell Oil Co., Shell Petroleum N.V, and Shell Petroleum Co. Ltd.

At the same time, we placed our ‘A-‘ long-term rating on exploration and  production (E&P) and liquefied natural gas (LNG) company BG Energy Holdings Ltd. (BG), the subsidiary of BG Group PLC, on CreditWatch developing rather than CreditWatch negative. We placed BG on CreditWatch on Dec. 22, 2014.

Finally, we have placed our ‘A-2′ short-term corporate rating on BG on CreditWatch positive, indicating that we would raise the short-term rating if we raised the long-term rating on BG.

The CreditWatch placement on Shell reflects our view that overall credit quality could deteriorate materially if the proposed acquisition completes in the announced form. We consider that the acquisition could further strengthen Shell’s position in the global liquefied natural gas (LNG) business, where it is already a leader, and could also increase production by 20% and reserves by 25%, especially in Brazil. Nonetheless, we see the short-term increase in financial risk as more material for the ratings.

We revised our view of the CreditWatch implications for BG to reflect the possibility that we could raise the ‘A-‘ long-term rating on BG by one or more notches if the transaction closes. If the parties do not agree the acquisition or it does not complete for other reasons, we could revise the CreditWatch placement to negative or lower or affirm our ratings on BG (see “Summary: BG Energy Holdings Ltd.,” published on Jan. 9, 2015). We have placed our ‘A-2′

short-term corporate rating on BG on CreditWatch positive, indicating that we would raise the short-term rating if we raised the long-term rating on BG. If we lower the long-term rating on BG, as discussed above, the short-term rating would remain ‘A-2′.

We already forecast relatively weak credit measures for the rating on Shell in 2015 and 2016 as a result of our oil price assumptions and negative cash generation after capital investment and dividends. We assume Brent crude oil of $55 per barrel (/bbl) in 2015, $65/bbl in 2016, and $75/bbl thereafter. We estimate that Shell’s credit measures after the acquisition would come under

pressure from two sources: the cash payment of about $20 billion and the fact that BG is more leveraged than Shell. We anticipate that the combined funds from operations (FFO) to debt would fall to close to 45%–we see an average of 60% or more as being consistent with a ‘AA’ rating on Shell.

If we revised our assessment of Shell’s financial profile to intermediate from modest as a result of lower forecast credit measures, it could cause us to lower the rating to ‘AA-‘ or even ‘A+’. If we lowered the long-term rating to ‘A+’, we would likely lower the short-term rating to ‘A-1′ from ‘A-1+’. Pro forma the transaction, we estimate that adjusted debt for the enlarged Shell group would have been about $120 billion on Dec. 31, 2014 (including the $20 billion cash purchase component). We understand that Shell would not immediately repay BG’s financial debt of $17.5 billion following completion, but let it mature over time.

Offsetting some of these pressures on financial risk, Shell is targeting a higher level of disposals than previously, at $30 billion over three years from 2016, which could lower the increase in debt over time. It also proposes to use equity to fund most of the acquisition consideration. That said, the group’s intention to stop the scrip dividend (and therefore pay dividends in cash) and to invest over $25 billion in buying back shares from 2017 to 2020 (subject to unquantified debt reduction and Brent oil prices recovering to about $90/bbl) would limit the benefit of the disposals.

Shell reported cash of $22 billion on Dec. 31, 2014, and has put in place a bridging bank facility to ensure the funding of this acquisition. We understand that the acquisition is subject to regulatory and shareholder approvals.

We will review the implications of the acquisition on our assessment of Shell’s business and financial risk. We will also discuss with management the steps that will and could be taken to protect credit quality, as well as the timing of such steps and the impact on Shell’s free cash flow profile and credit metrics in the coming years.

Unless oil prices recover meaningfully in 2015, to well above our assumptions, we consider a downgrade of Shell by one notch to ‘AA-‘ to be a clear possibility. We cannot yet exclude the possibility of a two-notch downgrade to ‘A+’, with a short-term rating of ‘A-1′, if we forecast credit metrics such as FFO to debt remaining at or below 45% for several years after the transaction

closes.

The long-term rating on BG has been placed on CreditWatch developing to indicate that we could raise the rating by one or more notches if the acquisition by Shell proceeds as announced. We do not expect to raise the ratings until the transaction closes. However, if the acquisition is not approved, we would likely resolve the CreditWatch by affirming or lowering the

ratings on BG.

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