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Moody's Sees Risks From Slower Than Expected Oil Price Recovery -- Or Lower Prices

Moody's Investors Service Thursday placed the ratings of 69 U.S. exploration and production (E&P) and oilfield services companies on review for downgrade because oil prices have deteriorated substantially in the past few weeks "and have reached nominal price lows not seen in more than a decade."

Credit analysts adjusted their view downward for the likely range of prices.

"We see a substantial risk that prices may recover much more slowly over the medium term than many companies expect, as well as a risk that prices might fall further. Even under a scenario with a modest recovery from current prices, producing companies and the drillers and service companies that support them will experience rising financial stress with much lower cash flows."

The review for downgrade "considers that much weaker industry fundamentals have potential to warrant rating changes for all companies covered" in the action. The review focuses on companies rated in the range from "A1" to "B3," but Moody's also is reevaluating higher and lower rated companies in the context of industry conditions..." As part of its ongoing assessment of energy markets, Moody's sharply reduced its oil price assumptions but natural gas and liquids assumptions are unchanged.

"Natural gas production in the U.S. continues to increase, while costs decline and producers generate cash returns at ever-lower prices, although in many cases these appear insufficient to service their debt," analysts said.

Oil is a different story.

"Iran is poised to add more than 500,000 b/d to global supply while OPEC and many non-OPEC oil producers continue to produce without restraint as they battle for market share," analysts said. "The addition of Iranian oil to the market this year will offset or exceed expected declines in U.S. production of about 500,000 b/d.

"Increased production vastly exceeds growth in oil consumption, given modest growth in consumption from major consumers such as China, India and the U.S." Production, analysts said, "now exceeds demand by about 2 million b/d, adding to already high global oil stocks." Most companies are unable to internally fund sustaining levels of capital spending at current market prices, according to Moody's.

"Current industry conditions also reduce the value of assets offered for sale and have made accessing capital markets more expensive for some companies and unavailable for others. While integrated oil and gas companies benefit from the profitability of their downstream operations, the upstream operations represent a much larger part of the capital employed and cash flow for most of these companies."

Projected capital expenditure reductions by E&Ps and integrated oil companies "will severely challenge the drilling and oilfield services (OFS) sector beyond what it had already experienced in 2015."

Even if commodity prices were to recover, "OFS companies are unlikely to gain any pricing power because of the continued excess capacity across most OFS subsectors. As a result, Moody's expects credit quality to deteriorate for all OFS players in 2016."

"Multi-notch" downgrades are likely among issuers whose activities are centered in North America, "where natural gas prices have declined dramatically along with oil prices."

Most of the credit reviews are expected to be completed by the end of March.

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