Following a full portfolio review, DBRS Limited (DBRS Morningstar) has placed all its North American oil and gas (O&G) issuers and oil field service (OFS) issuers Under Review with Negative Implications. The portfolio review was undertaken in response to the recent extreme price declines and heightened volatility in crude oil and petroleum product markets largely caused by the rapid global spread of the Coronavirus Disease (COVID-19) and the concurrent crude oil price war between OPEC (led by Saudi Arabia) and Russia. Because of the very high level of volatility and uncertain length of time for which weak crude oil and petroleum product markets will persist, the following DBRS Morningstar-publicly-rated North American issuers (11in this press release) have been put Under Review with Negative Implications:
-- Chevron Corporation*
-- Imperial Oil Limited**
-- Suncor Energy Inc.**
-- Husky Energy Inc**
-- Canadian Natural Resources Limited**
-- Cenovus Energy Inc.**
-- Ovintiv Inc.**
-- CES Energy Solutions Corp.**
-- Crew Energy Inc.**
-- Source Energy Services Canada LP and Source Energy Services Canada Holdings Ltd.**
The Under Review with Negative Implications status accounts for DBRS Morningstar’s view that because of (1) the extreme decline in the price of crude oil and petroleum product prices; (2) the significant rise in market volatility; and (3) the considerable uncertainty regarding the demand outlook for crude oil and petroleum products, DBRS Morningstar expects issuers’ credit profiles to experience considerable downward pressure over the weeks and months to come although the full extent of the recent shock to crude oil and petroleum product markets has yet to be established. The Under Review with Negative Implications status generally reflects DBRS Morningstar’s belief that downgrades for at least a significant part of the portfolio is likely. However, as situations and potential rating implications may vary, the final rating determination may change from the initial assessment. The Under Review with Negative Implications status is generally resolved with a rating action within three months. However, if heightened market uncertainty and volatility persists, DBRS Morningstar may extend the Under Review status for a longer period of time. Also, DBRS Morningstar notes that its commercial paper (CP) ratings are mapped from the long-term rating scale and Imperial Oil Limited is the only issuer in the portfolio with significant flexibility in its CP rating such that its rating would continue to map to R-1 (middle) if there was only a one- notch downgrade to its Issuer Rating.
CRUDE OIL AND PETROLEUM PRODUCT DEMAND AND PRICES UNDER SIGNIFICANT PRESSURE
The swift spread of the coronavirus across the globe and the simultaneous breakdown of the alliance between OPEC and a group of non-OPEC producers (OPEC plus) has created a large oversupply of crude oil and petroleum products. This oversupply is leading to a substantial buildup in inventories and has caused both crude oil and refined product prices to collapse. The magnitude and speed of the decline has been unprecedented with the benchmark West Texas Intermediate (WTI) crude oil price plunging to nearly USD 20/per barrel (bbl) recently and the price of Western Canada Select (WCS) sinking below the USD 10/bbl level.
As countries around the world take drastic actions to mitigate the spread of the coronavirus, global economic activity is rapidly contracting and, in parallel, so is the demand for crude oil and petroleum products. In particular, the demand for petroleum-based fuels, such as jet fuel and gasoline, has drastically fallen as travel and transportation activity has been curtailed. The extent and duration of economic damage caused by the coronavirus is very uncertain. Nevertheless, the short-term impact on consumption will be severe with some forecasts indicating as much as a 10% drop in global crude oil demand over the span of a quarter.
OPEC PLUS ALLIANCE BREAKUP ADDS ADDITIONAL PRESSURE ON CRUDE OIL PRICES
Exacerbating the impact of deteriorating oil demand is the breakdown of the OPEC plus alliance. Until March 6, 2020, the alliance was providing stability and some support to crude oil markets via measured production cuts. The global spread of the coronavirus and the negative impact on crude oil demand produced significant friction within the alliance (specifically between Russia and Saudi Arabia) related to the implementation of additional production curtailments. The bitter disagreement has resulted in OPEC plus coming apart. As the market disintegrated, Saudi Arabia—the largest producer in the OPEC cartel—announced plans to ramp-up its production volumes by over 2.5 million barrels per day (b/d) in April and to offer sizable discounts on its crude oil streams. The move by Saudi Arabia to protect market share has started an all-out price war, adding fuel to an already raging fire.
REFINING MARGINS UNDER PRESSURE—NOT PROVIDING SAME BUFFER AS IN PREVIOUS DOWNTURNS
Crude oil is the feedstock for refiners. Historically, for integrated companies, an oil price decline caused upstream profitability to shrink, but resilient profitability from refining (downstream) operations provided a partial offset or buffer to total integrated company margins. However, in the current situation, demand destruction for petroleum-derived products has been so sudden and severe that the squeeze on refining margins and falling demand is forcing operators to cut refining runs. Simply stated, the diversified model has not provided the same margin protection that integrated companies have historically enjoyed. Despite this, DBRS Morningstar expects that when economic activity rebounds and demand for lower-priced gasoline, jet fuel, and other refined products bounces back, downstream profitability will recover before the upstream business.
SO FAR, NATURAL GAS PRICES FARING BETTER RELATIVE TO CRUDE OIL AND REFINED PRODUCT MARGINS
Canadian and U.S. natural gas pricing has been more resilient than pricing for crude oil and refined product margins. In Western Canada, the price of natural gas has been relatively steady with the spot price in Alberta around $2/thousand cubic feet (mcf). Western Canadian pricing reflects an improvement in the supply/demand fundamentals largely because of declining production in the Western Canadian Sedimentary Basin over the last couple of years, as weak economic returns discouraged natural gas investments coupled with the challenge for producers securing market access.
In the U.S., mild winter temperatures—this was the sixth warmest U.S. winter in recorded history—led to less heating demand for natural gas, resulting in U.S. storage increasing to 15% above the five-year average currently, versus parity at year-end 2018. With ample U.S. natural gas inventory heading in to April, in order to temper inventory build and to support gas pricing, it would require (1) a colder-than-typical spring followed by strong air-conditioning demand this summer and (2) resilient industrial demand (for power generation and as feedstock for chemical, fertilizer, and hydrogen manufacturing) in the face of the coronavirus-caused economic decline. Given this challenging backdrop, DBRS Morningstar believes that the U.S. market price for natural gas will remain subdued for the foreseeable future, at or below USD 2/mcf.
OIL AND GAS ISSUERS RESPONDING TO NEAR-TERM FINANCIAL CHALLENGES
Commensurate with the collapse in demand and price of crude oil and refined products, O&G issuers rated by DBRS Morningstar are experiencing intense, near-term financial challenges. Issuers have quickly responded by sharply cutting operating costs and scaling back capital spending (capex) programs to levels that are in line with or below the level needed to sustain a base level of operations. However, at current WTI and WCS benchmark oil prices and incorporating actual and proposed 2020 capex cuts, the majority of DBRS Morningstar-rated issuers are not free cash flow positive (i.e., operating cash flow after subtracting capex and dividends). A WTI-basis oil price in excess of USD 30/bbl provides a small subset of low-cost, North American producers to achieve free cash flow breakeven. However, for most other producers, a much higher oil price is required. Additionally, all issuers have been scaling back production growth forecasts.
With continued, near-term pressure on the crude oil price and heightened volatility, DBRS Morningstar expects issuers to further reduce capex programs, cut operating and overhead costs, scale back or eliminate dividends, and lower production volumes. Ample sources of liquidity, commodity hedges that provide some short-term cash flow support, and the flexibility to utilize levers to shore up the balance sheet are critical for issuers to manage through current, very difficult market conditions. Nonetheless, DBRS Morningstar notes that many issuers do not have the same degree of flexibility they had during the 2014–16 oil price collapse. During this period, issuers implemented harsh cost-cutting measures, disposed of non-core assets, and reduced capex programs. In the process, many companies became much more efficient. Currently, reduced capex programs being implemented or proposed by issuers that DBRS Morningstar has reviewed appear to be below what is needed to sustain their base level of operations. Lastly, the current ability to sell assets and tap equity or debt markets to raise cash is considerably more challenging relative to the 2014–16 market environment.
DBRS MORNINGSTAR ANTICIPATES AN EVENTUAL RECOVERY IN OIL PRICES
DBRS Morningstar believes that the current, very depressed price of crude oil for producers is unsustainable over the long term. Current pricing does not provide an adequate economic return for much of existing production and certainly not for new developments. Inevitably, the lack of investment will cause global oil production volumes to decline. In particular, DBRS Morningstar expects U.S. shale oil volumes to materially drop due to the steep decline rates typically associated with this kind of production. Furthermore, the depressed oil price may eventually inflict enough financial pain on Saudi Arabia, other OPEC members, and Russia to compel them to cooperate. A renewed OPEC plus production cut agreement would help to stabilize the market and accelerate price recovery.
DBRS Morningstar believes the WTI oil price will eventually recover to a midcycle range of USD 50/bbl to USD 60/bbl. As the coronavirus runs its course and the global economy begins to rebound, lower-priced petroleum products will encourage consumption, boosting demand. However, at the current time, it is very difficult to forecast the extent and duration of the impact of the coronavirus on the economy and, therefore, the timing for oil price recovery. For the near term, DBRS Morningstar believes the price of crude oil will remain under intense pressure and volatility will remain extremely high. The current depressed price environment is expected to force O&G and OFS issuers to draw on sources of available liquidity, further eroding their credit profiles.
DBRS Morningstar reviewed several previous price crashes to quantify peak-to-trough pricing, followed by price rebound. Of these, the most relevant two are probably the Asian/Russian financial crisis (1996–98) and the 2008–09 financial collapse, both global economic shocks. In these instances, significant price recovery was achieved in 10 to 12 months after bottom. However, DBRS Morningstar cautions that given the vagaries of the current, coronavirus-induced economic slowdown, history may not provide a good guide.
CONCLUSION—HIGH PRICE UNCERTAINTY AND VOLATILITY MAKE ASSESSING CREDIT QUALITY DIFFICULT
Due to the drastic declines recently experienced by oil prices and the especially poor, near-term visibility regarding crude oil and petroleum product markets, DBRS Morningstar is placing all ratings for its North American rated O&G and OFS issuers Under Review with Negative Implications. DBRS Morningstar generally resolves the Under Review status within three months, assuming that greater clarity and stability returns to energy markets. With greater confidence about the direction of energy pricing and updated input from issuers regarding their immediate actions and longer-term plans, DBRS Morningstar will be in a better position to assess each issuer’s credit metrics. However, as denoted by the Under Review with Negative Implications designation, DBRS Morningstar notes that issuer credit profiles have weakened considerably and expects a number of negative rating actions.
All figures are in Canadian dollars unless otherwise noted.
The principal methodologies are Rating Companies in the Oil and Gas and Oilfield Services Industries (August 2019), DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 2019), DBRS Morningstar Criteria: Commercial Paper Liquidity Support for Nonbank Issuers (March 2020), DBRS Morningstar Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (November 2019), DBRS Criteria: Recovery Ratings for Non-Investment Grade Corporate Issuers (August 2019), and DBRS Morningstar Criteria: Guarantees and Other Forms of Support (January 2020), which can be found on dbrsmorningstar.com under Methodologies & Criteria.
For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.
The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link under Related Documents or by contacting us at email@example.com.
*This rating was not initiated at the request of the rated entity.
*This is an unsolicited credit rating.
*The rated entity or its related entities did not participate in the rating process for this rating action. DBRS Morningstar did not have access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
**The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
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