The credit outlook for the integrated oil and gas sector* has improved to stable from negative on better price assumptions and companies’ decisive action to shore up their balance sheets last year, says Scope Ratings.
“Credit risks remain, even if they are more medium-term than short-term, in the form of tougher environmental regulation and peaking oil demand,” says Marlen Shokhitbayev, analyst at Scope.
“President Joe Biden’s election has provided new impetus to global efforts to limit greenhouse-gas emissions which brings forward potential credit risks for the IOCs,” says Shokhitbayev.
The US has returned to the Paris Agreement on climate change. Biden’s administration is promising tougher environmental regulations which will impact the oil and gas sector. Regulations are tightening in Europe.
“IOCs will focus more on developing O&G reserves which are low cost and have low greenhouse-gas (GHG) intensity,” says Thomas Faeh, analyst at Scope. Many IOCs followed Repsol’s example in 2020 in announcing pledges to reduce net carbon emissions.
The prospect of tougher regulation and low oil prices – some in the industry, such as BP, say oil demand has already peaked – raise questions over asset quality. IOCs wrote down assets in H1 2020 by USD 170 billion as the COVID-19 crisis struck and oil prices plummeted.
More severe write-downs could be in the offing. According to Carbon Tracker, the world’s listed oil and gas majors need to cut combined production by 35% on average by 2040 to hold CO2 emissions within climate targets.
“Such a drastic shift would strand IOCs’ assets by forcing them to write much of them down or write them off entirely before their full economic lifespan,” says Faeh.
Near term, Scope expects a recovery in oil and gas prices, with Brent averaging around USD 50/barrel this year compared with USD 42/barrel in 2020, in addition to moderate increases in refining and petrochemical margins.
“Balance sheets will improve this year, though we do not expect a full recovery to pre-pandemic levels before 2022-23,” says Shokhitbayev. “IOCs are more resilient to lower oil and gas prices than before the pandemic due to deep cost cutting in 2020,” he says.
IOCs reduced operating costs while capital expenditure fell on average by around 20% compared with 2019. They suspended share buybacks and, in some cases, cut dividends. Organic free cash flow break-even after dividends has fallen to around $50/barrel or even lower.
The measures were important considering financial leverage – measured by Scope-adjusted debt/EBITDA multiples – rose to levels in 2020 not seen since 2016 for supermajors and exceeded them for large and medium-sized Europe-based IOCs.
“We expect the IOCs to maintain spending discipline this year even as the recovery takes shape,” says Shokhitbayev.
*Scope analysed the five supermajors – BP PLC, Chevron Corp, Exxon Mobil Corp, Royal Dutch Shell PLC, Total SA – and the large and medium-sized Europe-based integrated producers: Eni SpA, Equinor ASA, Galp Energia SGPS SA, MOL Hungarian Oil and Gas plc, OMV AG, and Repsol SA.