As noted, Fitch's stable outlook is not uniform across all sectors and credits within the oil & gas industry. In general, upstream, oil focused companies should see improved cash flows and credit metrics during the year stemming from higher oil prices. Natural gas prices are expected to remain weak which could result in weaker credit profiles for companies focused on natural gas related drilling. However, the refining sector remains under the most pressure as a result of continued low utilization rates, weak margins and continued falling end-user demand.
While the drilling and services sector is expected to weaken modestly, contract backlogs and the run in oil prices are expected to continue supporting activity levels and credit profiles of these firms. Merger & acquisition (M&A) event risk continues to be a concern, although high oil prices and strong 2010-2011 futures prices for natural gas have mitigated activity to-date. Offshore drilling companies continue to look to the current downturn as an opportunity to expand fleets. Weak refining conditions have resulted in significantly reduced prices for refining assets leading to potential risks for bondholders across the sector. Fitch would note that event risk remains issuer-specific.
Summary of Sector Outlooks:
- North American Integrateds: Credit quality for the large, integrated oil companies is expected to remain robust as these firms benefit from oil-heavy upstream portfolios, sizable cash balances and still low net debt levels. Across all the sectors in the energy space, integrated oil has generally been the least impacted by volatile commodity prices, due to its high credit quality, significant headroom to absorb incremental leverage, and willingness to take a longer, 'through the cycle' view on reinvesting in the space. The decoupling of oil and natural gas pricing is expected to continue to benefit integrated firms in the near-term but also leave cash flows reliant on the continued strength of oil prices.
- European Integrateds: The creditworthiness of European integrated oil majors is supported by their ability to generate positive free cash flow (FCF) through the business cycle, strong oil markets, recovery expectations in 2010 and continued benefits from lower industry-wide operating costs. While credit profiles did weaken during 2009 resulting in all of the European Majors to return to the bond markets to meet capex and dividend outflows, Fitch expects improved industry conditions in 2010/2011 to support a return to their ability to internally fund capital expenditures.
- Russian Integrateds: The Russian oil industry continues to face significant challenges as the industry deals with a rapid slowdown in production growth. Higher oil prices are expected to reverse the trend in 2009 of capex cuts, although budgets have been slow to increase. Governmental policies continue to be accommodative; however, there is a risk in 2010 that economic growth could lead to scaled concessions for the industry in an effort to improve the country's federal budget deficit.
- Latin American Integrateds: The Latin American oil and gas sector is dominated by national oil companies (NOCs), many of which are highly linked to the sovereign ratings. As a result, the key risks for the stability of the ratings of Latin American oil and gas companies will be the impact of the global recession on the Latin American sovereigns as well at the price for crude oil and natural gas. Improved oil prices in 2010 should increase FCF generation and also decrease political intervention risk in the region. The sector continues to benefit from improved capital markets access both domestically and internationally and saw record issuances in 2009 resulting in strong liquidity for most companies.
- N.A. Independent E&P: Credit quality for North American independent exploration and production (E&P) companies is expected to stabilize at levels consistent with 2009 levels. While higher oil prices continue to support the industry, this group remains more heavily exposed to U.S. natural gas prices which are expected to remain weak in 2010. E&P firms should continue to benefit from lower costs and more flexible capital expenditure budgets resulting in neutral to modestly positive FCFs. Increased hedging should reduce cash flow volatility for many of the firms in the sector and proceeds from asset sales should allow for some de-leveraging during the year.
- Drilling and Service Companies: The drilling and service sectors outlook remains weak for 2010. Credit quality is supported by sizable contract revenue backlogs, reduced capital expenditures and lower costs stemming from restructuring efforts. Additionally, industry activity levels will benefit from strong oil prices and contango futures market prices. Asset quality will continue to be a key differentiator in 2010 and M&A risk for the offshore drilling sector remains high.
- Downstream: Refining continues to be the worst-performing subsector in energy, with an unfavorable supply/demand balance, low plant utilization, and rising competition from renewables all pressuring key credit protections. Currently, most refiners rated by Fitch have Negative Outlooks. Fitch anticipates that sector credit metrics may bottom out at levels worse than those seen during the last industry downturn (2002), and could remain depressed for an extended period, given high U.S. unemployment and the potential for a slow economic recovery. Event risk is also fairly high for the sector. Fitch notes that while refiners as a group have responded vigorously and early to the downturn by paring back operating costs, cutting shareholder distributions, eliminating non-critical capex, and shuttering some capacity there may be relatively little left to cut in the system at this point in the event of another leg down in industry demand.
