The Tables Have Turned on Big Energy Players

Oil companies, energy-exporting nations, and sovereign wealth funds will lose power as they try to maintain liquidity and financial flexibility

By Robert McNatt

Less than a year ago, the price of oil was close to $150 per barrel and many oil and natural gas producers were riding high with strong ratings and record profits. At the same time, nations whose economies were tightly tied to energy prices saw increasingly favorable trade balances. Those inflows also fueled the growth of powerful sovereign wealth funds that became major global investors. The oilfield services companies also profited from the boom, as demand for rigs and drilling services stayed strong.

But by mid-March of 2009, oil had been knocked down to roughly one-third its 2008 peak price, with similar steep declines for natural gas. Making matters worse for oil and gas producers, the world has also now settled in for what looks to be a wide, unexpectedly deep, and possible lengthy recession.

For energy producers, the tables have clearly turned. Oil-importing nations, some energy-intensive industries, and individual consumers can expect relief while oil prices remain low, but Standard & Poor's Ratings Services believes this global economic slump will be a time of stress for oil and gas producers—especially speculative-grade exploration and production companies—and to some degree, for sovereign wealth funds. Many speculative-grade U.S. oilfield services and drilling companies are facing a severe downturn in earnings and cash flow, and in February we revised the outlook on 11 of these companies to negative and lowered the ratings on three. Moreover, we believe this downturn may cause us to revise ratings on some sovereigns themselves—although even for countries that depend most on oil, energy prices are just one factor that influences sovereign ratings.

The long-term outlook for energy is undeniably strong. The mega-economies of India and China will again start pushing forward and driving up demand. The industrialized nations will once more begin to grow, and the global economy will eventually rebound. But until that day arrives, many oil producers can expect they won't be calling the shots the way they did a year ago, as they seek to maintain liquidity and financial flexibility in an era of low prices and less certain access to credit. In our opinion, that will make 2009 a crucial year for them.

Europe May Fare Worse Than the U.S.

This year and 2010 will be difficult for major producers. We believe the ratings of the big, integrated, Western European producers—BP (BP), Royal Dutch Shell (RDSA), Total SA (TOT), and Eni SpA (ENI)—could come under pressure as a result of continuing large dividend payouts and high levels of capital expenditures. In an era of low oil prices, such spending might limit their financial flexibility to a degree we don't expect to see at their U.S. counterparts—ExxonMobil (XOM), Chevron (CVX), and ConocoPhillips (COP)—which are less generous in dividend payouts. Taken together, we expect the four European majors to pay out nearly 40% of their funds from operations in dividends this year.