LONDON (Standard & Poor’s) Oct. 5, 2015-Standard & Poor’s Ratings Services said today that it has taken rating actions on 14 EMEA-based oil and gas exploration and production (E&P) companies after completing a review of the sector.
Most rating actions reflect weak debt coverage measures in 2015 and 2016 and sometimes material negative discretionary cash flow (DCF) after capital expenditures (capex) and dividends.
Our review of the sector followed the recent revision of our hydrocarbon priceassumptions (see “Standard & Poor’s Revises Its Crude Oil And Natural Gas Price Assumptions,” published Sept. 24, 2015, on RatingsDirect). This price revision reflects the meaningful declines in futures curve for Brent, the result of a currently over-supplied global market, as well as the ongoing reset of production and development costs at lower levels.
(Standard & Poor’s will hold a live interactive Webcast and Q&A to discuss the revision of S&P’s hydrocarbon price deck and recent rating actions on Tuesday, Oct. 6, 2015, at 11:00 a.m. Eastern Time. You can register for the complimentary event at the following URL:
As a direct consequence of these updated price assumptions, we have updated our forecasts on E&P companies. Actual and forecast financial results in 2015 are typically weak or very weak. Correspondingly, credit metrics are likely to be at or below our guidelines for ratings, and we see very substantial negative DCF for European oil and gas majors in particular. Also, our analyses explicitly factor in our projections for 2016 and 2017. The extent of the deviation from rating guidelines and the rate and likelihood of a recovery in credit measures are important distinguishing factors between companies.
Following the 2014 sustained fall in Brent and other crude oil benchmarks, the industry has been in a period of cost decline. The magnitude of the oil price drop–down 45% on average in 2015 against 2014 levels, under our assumptions–will not be matched by oil producers’ cost and capex adjustments in 2015 or 2016. In large part, this delay reflects the contractual nature of field development and offshore drilling and the time-lag to plan and implement efficiency schemes. Companies across the sector have already implemented large-scale measures to reduce cash outflows or protect credit quality.
In particular, we note the following internal and external factors or strategies: At this juncture, these factors have been critical in reducing the likelihood of downgrades. The balance between these factors and the longer-term consequences is also important to our analysis. We see the decision to cut investment to facilitate generous shareholder distributions as a negative from a credit perspective, because the reduction in investment will affect future cash-generating assets. We continue to use forward-looking cash flow-based debt coverage metrics, averaged over three or five years, which typically results in lower headroom compared with companies’ balance sheet-based debt leverage targets.
We lowered the rating on EnQuest PLC to ‘B’ from ‘B+’ and assigned a negative outlook. The downgrade reflects our revised estimates of debt to EBITDA stemming from our new oil price assumptions. We now anticipate Standard & Poor’s-adjusted debt (adjusted for asset-retirement obligations and other standard adjustments) to Standard & Poor’s-adjusted EBITDA to reach about 4x by year-end 2015 and remain near that level throughout 2016, despite hedging in place. We anticipate negative adjusted free operating cash flow (FOCF) in both 2015 and 2016, and under the current investment plans, we do not exclude that the company would have to seek additional liquidity to finance its capital investments beyond the next 12 months.
The negative outlook underlines the continued uncertainty around cash flow volatility and generation given the company’s dependence on production increases and limited flexibility to adjust its capex until Kraken comes on stream. If the company couldn’t reduce its operating costs per barrel or ramp up production in line with our base case–leading to weaker-than-forecast operating performance, such that debt to EBITDA would be above 5x without clear signals of a rapid debt reduction–we could consider a further downgrade. Any liquidity constraints or pressure on the covenant could also prompt a downgrade.
Tullow Oil: Corporate Credit Rating Lowered To ‘B+’ From ‘BB-‘, Outlook
Negative We lowered the rating on Tullow Oil to ‘B+’ from ‘BB-‘ and assigned a negative outlook. The downgrade reflects our expectation that, under our revised Price assumptions, Tullow’s credit metrics will weaken further in 2016 and will no
longer be commensurate with the rating. Although the company has meaningful hedges in place, we think it would be difficult for the company to achieve an average funds from operations (FFO)-to-debt ratio of 20%, which we see as a minimum for our ‘BB-‘ rating.
The negative outlook accounts for our view of the potential downside risk for Tullow. We believe that if prices should further deteriorate, FFO to debt could drop to below 12% in 2016 from about 15% in 2015, which would lead us to lower the rating further. It also reflects the risk of delays to the TEN Project in Ghana, which could set back deleveraging efforts and squeeze liquidity. That said, our ‘B+’ rating takes into account Tullow’s currently”adequate” liquidity, as the company has secured the required financing and renegotiated its covenants in the first half of 2015