LONDON (Alliance News) - Ratings agency Moody's unveiled the results of its review of the oil and gas industry on Friday, with BP PLC maintaining its long-term debt rating and securing a positive rating outlook, whilst peer Royal Dutch Shell PLC was downgraded and given a negative outlook.
Although Moody's believes the majority of major oil and gas companies are facing similar headwinds related to earnings from their main upstream oil and gas producing units and their ability to generate positive cashflow, the agency thinks BP is in a better position than its peers, which is reflected in its debt rating.
BP kept its A2 long-term debt rating and was assigned a positive rating outlook by the agency, with A2 being the rating it held before being placed under review in January as Moody's carried out its industry-wide inspection.
Meanwhile, Moody's downgraded Shell's credit rating to Aa2 from Aa1, and gave it a negative rating outlook.
"The confirmation and positive outlook recognize that BP's credit metrics and business profile compare favourably with its major oil peers, and that it faces the same negative free cashflow and upstream return challenges," said Tom Coleman, senior vice president of Moody's.
"Still, the July 2015 Macondo settlement reduced legal uncertainties and has helped define the scope of cashflow impacts, providing greater clarity and focus on BP's fundamental performance," he added.
The Macondo settlement refers to BP's Deepwater Horizon oil spill that occurred in the Gulf of Mexico back in 2010. Following years of deliberation over the oil spill which occurred after a gas leak triggered an explosion on the Deepwater Horizon rig on the Macondo exploration well, BP managed to strike a settlement earlier this year with the US federal government, five Gulf Coast states, and more than 400 local government entities.
Those settlements were to the tune of USD18.70 billion and addressed all the major federal, state and municipal claims and all of the penalties under the Clean Water Act, which pushed up the cumulative pre-tax charge associated with the accident to a staggering USD55.50 billion.
"Despite the size of the settlement, the scope and extended payout terms are positive developments, allowing BP to move forward with more certainty around the future cash flow burden," said Moody's.
However, the settlement does not signal the end to the saga for BP as some claims related to the spill remain unresolved.
Although shareholders in BP will be pleased with the ratings dished out by Moody's, the agency flagged that BP is still set to generate negative free cashflow in 2016 and 2017. Moody's added that BP's downstream unit, which generated record levels of earnings in 2015, will decline going forward even if refining margins and product demand hold up in 2016.
Before oil prices began to fall in the middle of 2014, major oil and gas companies generated the majority of their earnings from upstream operations covering production. However, those price falls led to a shift in 2015, when major firms saw upstream earnings plummet whilst downstream units covering refining and processing operations produced earnings increases.
BP's upstream unit saw its replacement cost profit in 2015 plummet to only USD1.19 billion from USD15.20 billion in 2014, whereas the downstream unit saw underlying profit rise to USD7.54 billion from USD4.44 billion the year before.
Similarly, Shell's underlying earnings from its upstream unit dropped by 89% to USD1.78 billion from USD16.50 billion whereas underlying earnings from the downstream unit rose 55% to USD9.74 billion from USD6.26 billion.
BP, like the wider industry, has taken action to realign the business to suit lower oil prices, but the industry is still battling and is likely to continue to struggle over the next few years.
"BP's financial metrics will remain relatively weak, with retained cash flow/net debt in the area of 25% in 2016, down from 43% in 2015, and showing only gradual improvement in 2017 and 2018 as cost reductions flow through," said Moody's. "At the same time, we view BP's credit metrics as broadly in line with its higher rated peer companies."
BP is hoping to cut its capital expenditure by around 16% in 2016 compared to 2015 levels, and the company is also lowering its operating costs, deferring projects, enhancing its spending efficiency and offloading assets to shore up its balance sheet and improve its profitability.
BP has managed to commit to its dividend despite the challenging environment, but Moody's believes the scrip option will help conserve cash flow and reduce the negative cash flow profile. The 2015 dividend cost BP a total of USD6.70 billion, which was equal to over one third of BP's total funds generated from its operations during the year.
BP offloaded USD10.00 billion worth of assets in 2014 to 2015 and is targeting between USD3.00 billion and USD5.00 billion of sales in 2016 to help it reduce its debt and strengthen its balance sheet. However, asset sales from 2017 onwards are likely to reflect a more normalised approach to managing its asset portfolio and funds can be used to support capital spending and dividends rather than debt reduction, according to Moody's.
"BP maintains strong liquidity, including USD26.4 billion of cash as of year-end 2015. Its net gearing in 2015 increased to 21.6%, well within its targeted range, or about 37% including Moody's adjustments. While negative cash flow and potential debt reduction are likely to reduce cash balances in the next two years, we expect the company to retain sizeable cash balances for flexibility," said the ratings agency.
Moody's said BP has been given a positive outlook as the company's credit metrics "compare well" with its higher rated peers and because the liabilities associated with the Deepwater Horizon oil spill are "diminishing".
BP could be upgraded if it unveils further clarity over the Deepwater Horizon oil spill settlement, continues to deliver on its strategic plan, achieves neutral cashflow in a lower oil price environment or manages to leverage its large cash position. However, it could also be downgraded if there are any setbacks to its strategic plan or reveals any "sizeable, unexpected" liabilities related to the oil spill back in 2010.
BP shares were trading down 0.1% to 350.65 pence on Monday.
At Shell, Moody's believes the company's upstream unit could generate losses in 2016, despite the fact production is likely to soar thanks to the acquisition of BG Group which was formally completed earlier this year.
"The downgrade of Shell's ratings is driven by Moody's expectations of negative free cash flow and weaker cash flow-based metrics at least through 2017," said Moody's.
"We expect financial metrics to remain relatively weak, with post-acquisition retained cash flow/net debt in the low 30% area in 2016 compared to 55% in 2015, and net debt/Ebitda of about 1.8 times in 2016, with only gradual improvement in 2017 and 2018 as oil and gas prices recover and cost reductions are realized," the agency added.
Reducing debt is a key priority for Shell, but as Moody's forecasts the company will generate negative free cashflow over the near term, it means its USD30.00 billion asset sale programme has to be delivered in order for that debt to fall.
Shell has said it will not reduce the price of its assets based on the lower prices of oil and gas, which is likely to lead to asset sales taking longer. Moody's believes Shell can deliver its asset sales targets, but said the sales programme will be "key to maintaining Shell's Aa2 rating and eventually stabilising its outlook".
Moody's said cutting operational costs and stripping out duplicated costs derived from the acquisition of BG Group also will be integral to improving the company's profitability, and it believes Shell could spend less than its USD33.00 billion capital expenditure budget outlined for 2016.
Like BP, Shell has committed to its dividend moving forward ,and Moody's believes the continuation of the scrip programme will help reduce cash outflows in a lower price environment.
"Shell's Aa2 rating continues to reflect its strong business profile, which positions it among the top integrated oil companies in the longer term, reflecting a broader and more diversified reserves and production base following the BG acquisition, an industry-leading position in liquefied natural gas and the integrated gas value chain, and one of the largest and most profitable downstream refining, marketing and trading operations among the integrated oil companies," said Moody's.
The negative outlook slapped on Shell reflects Moody's concerns over integrating BG Group's assets, delivering the asset sale programme on time and because of the near-term expectation for negative cashflow. Stronger cashflow, debt reduction and asset sales could lead to an upgrade whilst weaker cashflows, failure to reduce debt or failure to offload its assets on time may lead to another downgrade.
Shell 'A' shares were trading down 0.6% to 1,722.50 pence per share on Monday whilst 'B' shares were down 0.8% to 1,727.50 pence.
By Joshua Warner; joshuawarner@alliancenews.com; @JoshAlliance
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