The Federal Reserve’s decision to raise interest rates will increase borrowing costs and lead to greater credit risk for lower-rated companies, Moody’s Investors Service said in a report.
And amid bargain-basement commodity prices, U.S. oil and gas companies continue to make up a disproportionate share of the firm’s lower-rated issuers. As of Dec. 1, Moody’s said the oil and gas sector accounted for 61 issuers on its “B3 Negative and Lower Corporate Ratings List,” which is made up of “239 U.S. companies whose low ratings reflect a combination of weak business fundamentals and aggressive capital structures.” That’s more than 25% of all “B3” and lower issuers and almost double the 33 from the services sector, the next highest on the list.
In the year-ago period, oil and gas accounted for 8.6% of the “B3 negative” and lower list.
“Rising U.S. interest rates will have a neutral effect on most U.S. companies, which can afford the increase,” Moody’s said. “However, credit risk will increase for some weaker companies because refinance risk will rise for them as interest rates edge higher while debt markets become increasingly risk averse.”
On Wednesday, Federal Reserve Chair Janet Yellen announced an increase in federal interest rates to between 0.25% and 0.5%. This comes after a seven-year period of near-zero interest rates as the nation attempted to climb out of the Great Recession.
Yellen pointed to the move as a signal of confidence in the nation’s continued economic recovery. She cited a number of positive signs in the economy, including “solid gains” in business investment “outside of the drilling and mining sector, where lower oil prices have led to substantial cuts in investment outlays.”
Patrick Rau, NGI director of strategy and research, said that although the Federal Reserve increased the interest rate “by the least amount it can,” the effects could still be felt by financially constrained exploration and production (E&P) companies.
The rate is “still extremely low, and it shouldn’t be much of a problem for companies with strong balance sheets. But for those companies that are cash poor, and are struggling to meet everyday obligations, it will hurt. Most E&P credit revolvers are variable rate facilities, and although they are largely tied to LIBOR [London Interbank Offered Rate], LIBOR is usually closely related to the U.S. federal funds rate,” Rau said.
“Another negative impact is rate hikes tend to strengthen the U.S. dollar, and there tends to be an inverse relationship between the U.S. dollar and oil prices. So the U.S. rate hike may produce a triple whammy on U.S. operators: lower revenue, higher interest expense and a higher cost of capital. Throw in the fact that 2015 hedges are winding down, and that puts even more stress on cash-strapped operators.”
Throughout 2015, analysts have observed increased financial stress on oil and gas companies resulting from low commodity prices. Both Moody’s and Standard & Poor’s Ratings Service (S&P) have noted increases in the U.S. distress ratio and speculative-grade default rate, driven in large part by oil and gas (see Shale Daily, Nov. 30; Nov. 17).
And according to Moody’s, the oil and gas sector’s liquidity stress has markedly exceeded that of U.S. companies as a whole (see Shale Daily, Nov. 3; Sept. 4).
The fed’s decision to raise interest rates came just as Congress had reached an agreement on a 2,000-plus page omnibus spending bill that would lift the nation’s 40-year ban on crude oil exports (see Shale Daily, Dec. 16). But while regarded as good news for the industry, several analysts said lifting the ban is unlikely to bring much near-term uplift for domestic producers under the current energy glut.
Goldman Sachs said Thursday that the recent decision by the Organization of Petroleum Exporting Countries (OPEC) not to reduce output, combined with concerns over storage levels, could mean further declines in oil prices.
“Although prices are now below our three-month $38/bbl [West Texas Intermediate] forecast, we still see high risks that prices may decline further as storage continues to fill,” the firm said.
Meanwhile, the pricing outlook on the natural gas side remains generally bearish for the time being. BNP Paribas’ director of commodities strategy said this week that warm weather could lead to an “unmanageable level of inventories” that would increase physical congestion in 2016 (see Shale Daily, Dec. 16).
The Department of Energy’s weekly storage report Thursday also revealed a withdrawal that was below expectations (see Daily GPI, Dec. 17).