Is Oil Company Credit Risk Really Back to Normal?
The popular wisdom is that oil and gas company financial distress is behind us, and the industry has returned to normal. But is that assessment accurate, or overly optimistic?
Now that the price of oil has rallied, many believe that prices will average $55 a barrel or higher for 2017. As a result, oil producers are ramping up capital spending, since many more E&P operations are profitable at this level, according to the Wall Street Journal. (Source: U.S. Oil Producers Ramp Up Spending: Companies Are Optimistic That Higher Crude Prices Are Here To Stay)
Certainly, many distressed producers have emerged from the last crisis with a more resilient financial structure. But our data still shows lingering credit risk, so let's take a closer look.
1. Negative Rating Bias; Bankruptcy Risk Still High
For 2017, S & P Global Ratings still forecasts a negative rating bias for the industry.
And, while the FRISK® Stress Index -- an aggregate measure of industry bankruptcy risk -- has come way down in the past year, it’s still more than twice the norm, as shown below.
2. Oil Price Forecast Uncertainty
There are dissenting views about the price forecast. While many are convinced that prices will average at $55 or higher a barrel during 2017, others, such as ING and JP Morgan, forecast a price of $45. The wild card is OPEC’s ability to keep cash-strapped member countries from producing, while U.S. oil and natural gas projects are ramping back up.
3. Macro Factors: A Strong Dollar, Interest Rates
Rising interest rates, in addition to causing more debt defaults, helps to contribute to a strong dollar – which in turn exerts negative pressure on oil prices. These macro impacts don’t always happen predictably, but it’s one more reason that oil prices could stay low.
Not Out of the Woods, Yet
Even if we get the higher oil prices that the industry needs to recover, challenges remain.
- Financial distress still has to work its way through the system. Higher prices will still come too late to reverse the damage of the past price slump for some companies, such as the three energy companies that filed for bankruptcy last month.
- Supply and demand is volatile and hard to predict. If OPEC produces more, domestic suppliers drill more, or some other combination of global economic factors cause a supply glut, prices could hit the low end of the forecast.
- Prices can go up like a rocket, and come down like a feather ... or a stone. Despite increased drilling activity, some of these new projects could still end up operating at a loss. If the price slips, companies that used debt financing (expecting a higher price) could get hit hard all over again.
Your Credit Risk Strategy For Any Oil Price Environment
When it comes to public company credit risk, what’s the best way to manage your energy customers with confidence?
- Double-check your independent credit assessments with an accurate predictive financial risk score. For instance, the crowd-sourced FRISK® score is a great way to support your decisions. It predicts 96% of public company bankruptcies, within 12 months.
- Take advantage of alerts to learn of problems early. Use automated credit monitoring to detect growing financial distress.
- Maximize the value of your own trade files to help you pinpoint risk, by participating in a free Trade Contributor Program.
While it’s true that the bankruptcy rate will fall as oil prices stabilize, credit challenges in the oil patch aren’t over yet. Drill, baby, drill … with caution.
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CreditRiskMonitor is a financial news and analysis service designed to help professionals stay ahead of public company risk quickly, accurately and cost-effectively. More than 35% of the Fortune 1000, plus thousands more worldwide, rely on our commercial credit reporting and predictive risk analytics for assessing the financial stability of over 58,000 global public companies.
At the core of CreditRiskMonitor’s service is its 96% accurate FRISK® score, which is formulated to predict public company bankruptcy risk. One of four key components calculated in the FRISK® score is crowdsourced subscriber activity. This unique system tracks subscribers' patterns of research activity, capturing and aggregating the real-time concerns of what are essentially the key gatekeepers of corporate credit. Other features of CreditRiskMonitor’s service include timely news alerts, the Altman Z” score, agency ratings, financial ratios and trends. CreditRiskMonitor’s network of trade contributors provides more than $135 billion in trade data on their counterparties every month, giving them visibility into their biggest dollar risks.