The global oil and natural gas industry's plight isn't expected to improve in the new year as the strain of low commodity prices is expected to continue dragging down budgets and limiting financial flexibility in 2016, according to a report released Monday by Moody's Investors Services.
The stagnant cash flows and deteriorating liquidity that began to take a grip last year are expected to persist, Moody's said. Oil prices collapsed by nearly two-thirds from mid-2014 to late 2015, while natural gas prices were already low. The report is the latest dark appraisal for the industry to show that commodity prices won't rebound in any meaningful way until at least 2018 (see Shale Daily, Dec. 31, 2015; Dec. 30, 2015).
"Excess supply will continue to drag on commodity prices in 2016 in the global oil markets and the U.S. natural gas market," said Moody's Managing Director Steven Wood. "Furthermore, the potential lifting of sanctions against Iran could bring even more supply to the market in 2016, offsetting any expected declines in U.S. production."
With oil producers across the globe refusing to turn down the spigot in a battle for market share, the ratings agency said it doesn't believe production will fall before the second half of 2016 at the earliest, "when the effects of recent investment cuts lead to less new production to offset existing declines."
Moody's said capital spending across the exploration and production segment would drop by at least 20-25% this year, "leaving the oilfield services and drilling industry the most stressed sector in 2016." Most E&P companies have not announced their 2016 capital budgets, the report said, but the industry remains pessimistic about prices for oil, natural gas and natural gas liquids. The projected decline in 2016 spending would follow last year's roughly 50% decline from 2014 levels.
The continued slide in commodity prices has further eroded cash flows, "worsening the inherently limited financial flexibility of speculative-grade oil and gas companies, which have relatively weak credit profiles," Moody's said in the report. Likewise, liquidity has dried-up for already leveraged E&Ps, and some of the significant reductions to borrowing bases that were expected in 2015 could come this year.
"E&P companies with unhedged production volumes leave themselves entirely exposed to low commodity prices and risk significant borrowing base reductions," the report said. "Rather than take over the E&P assets themselves, banks generally give E&P companies some time to improve their liquidity, but will take action if necessary. At this point, we have not seen many reductions of borrowing bases but we anticipate borrowing-base reductions will reduce liquidity further in 2016."
The agency also said that while it expects an increase in mergers and acquisitions across the industry this year, such activity is expected to remain "fairly subdued" with the timing of a commodities rebound uncertain. A rise in distressed exchanges and defaults in the oil and gas industry is also anticipated this year as oil and gas prices are expected to remain low. Both integrated and national oil and gas companies are also expected to see their cash flows stressed.
Even master limited partnerships (MLP), which have had a long record of growth in distributable cash flow, are expected to feel more of a squeeze in 2016. The sector's growth started to flatten last year with the weak oil and gas prices that reduced demand for new transportation and gathering infrastructure (see Shale Daily, Oct. 21, 2015). Increasing interest rates could not only raise the cost of debt financing, but they could also increase the cost of equity capital and threaten the MLP growth model this year, Moody’s said.