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Negative Interest Rates: Normal, Abnormal - or The New Normal?

Stocks Rocked the House Post Midterm Elections

Oil refining executives wary of RFS program despite falling compliance costs

Oilfield service majors to limp into 2019 as North America land market struggles

Strong shale output drives major US oil producers' earnings to multiyear highs

Negative Interest Rates: Normal, Abnormal - or The New Normal?

Are negative interest rates taking developed economies into an upside-down world, or are they simply the latest manifestation of the new normal? S&P Global brought together econ"Negative Interest Rates" on Aug. 17, 2016.

"What's fascinating is that we used to have this concept of a zero bound," said S&P Global Ratings chief economist Paul Sheard, as well as other fundamental economic ideas such as the time value of money—the basic notion that lending money over time comes at increasing cost to the borrower. At some point, these sacrosanct concepts bit the dust. Negative interest rates (NIR) weren't on the radar of the U.S. Federal Reserve even during the financial crisis. "At some point, the penny dropped," and central bankers began to see negative interest rates as more of the same, instead of something completely different. And rightly so, because it's their job to size the aggregate amount of money in the banking system. Indeed, NIR are working, in that they're pushing down the whole yield curve. And while it's a tax on the banking system, the time value of money and the zero bound are still holding, at least on the liability side of banks' balance sheets—that is for deposits. "Central bankers can only do two things, tighten and loosen, and negative interest rates are an additional tool to ease," Mr. Sheard said.

Three Distinct Types Of Negative Interest Rates

The term "negative interest rates" comprises three phenomena:

  • Negative interest rates that central banks are applying on commercial banks' overnight deposits at central banks;
  • Negative interest rates in the bond markets; and
  • Companies issuing debt with negative coupons.

That said, the three are related. For example, central banks' negative interest rate policies are pushing down interest rates in some government bond markets to below zero, which has resulted in the issuance of some debt at negative interest rates.

That said, there are variations on central banks' negative interest rate policies (NIRP), which make them that much more difficult to understand. The European Central Bank (ECB) cut its deposit rate to below zero, Sweden its repo rate, and Denmark its main policy rate, for instance. The Bank of Japan introduced a negative anchor rate on banks' marginal excess reserves in late January after more than 15 years of ultra-low interest rates and quantitative easing. "I'm not a fan of negative interest rate policies," said Mr. Sheard, "mainly because they are counterintuitive and confusing to the public." They go against a central bank's job is to manage inflation expectations by communicating a clear and transparent policy. "But if you create a scheme that is so complicated that the likes of us around this table struggle to get our heads around it, you've lost that transparency," he said. Don't such contorted instruments indicate that an economy ought to consider something more straightforward, like fiscal policy?

What's more, the various NIRPs are aimed at different end-games. In Sweden, Switzerland, and Denmark, it's all about defending the currency. In the EU, the ECB has a number of stated and unstated goals that it aims to address through a panoply of programs—such as quantitative easing and TLTROs, an NIR-like program that essentially gives cash to banks for a more aggressive loan balance sheet--all while keeping an eye on the direction of Fed policy, said Jean-Michel Six, chief economist for Europe, the Middle East, and Africa at S&P Global Ratings. The ECB's stated goal is to lift inflation to near 2%, but it would also like to reduce financial fragmentation in the eurozone, foster bank lending, and weaken the euro's foreign exchange rate with the U.S dollar.

One of the most immediate effects of all NIRPs was a drop in benchmark 10-year government bond yields to less than zero. The value of the assets affected is enormous, said Jason Giordano, director of fixed-income product management at S&P Dow Jones Indices. Globally at the start of 2016, a total of $3.6 trillion of assets were negative yielding, which skyrocketed to $8 trillion after the Bank of Japan carried out its rate cut in January, and peaked at $13.5 trillion on July 5 and is currently $11.2 trillion, comprising mostly Danish, Swedish, Swiss, and Japanese bonds. In terms of GDP, negative-yielding sovereign debt represents 17% of global GDP. By mid-July, the entire Japanese yield curve was negative, Switzerland's was negative out to 20 years, and Sweden's out to 15 years. In sum, 25 countries all had some part of their yield structure below zero.

The Yield Curve As A Sign Of Inflation Expectations

In the era of negative interest rates, Mr. Giordano asked, can the market still depend on yield curves to predict inflation in a country? Or have they been manipulated beyond usefulness? Mr. Sheard responded that the distortion the market perceives may actually represent the transmission of monetary policy by central bankers, who aim to flatten the yield curve.

In monitoring global credit conditions, S&P Global Ratings is seeing that NIRP is starting to lower unemployment rates, said chief economist Robert Palombi, who heads the company's credit condition committees, and in that way are incrementally contributing to recovery. The committee's concern is that since negative interest rates are a tax on savings, it could create an incentive to investors to pull their money out of the financial system and put it into bank vaults. However, Mr. Palombi believes that's not happening yet, because there is actually a cost to storing money, which the IMF calculates to be about 1%-2%. Plus, we're not seeing indications that negative interest rates are producing stress in the economy.

So far, signs of a boost to the economy from Japan's NIRP have been difficult to discern, said Ryoji Yoshizawa, director, financial institutions, at S&P Global Ratings, noting that the country has operated under very low interest rates for more than 15 years. Indeed, after negative interest rates were adopted, Japanese share prices dropped in value. Meanwhile, the low and now negative rates are creating uncertainty and having unintended consequences, with the household and corporate sectors carrying significant surplus savings. Mr. Yoshizawa projects that core operating profits at major Japanese banks are likely to fall 8% because of direct and indirect NIRP effects, and 15% for the country's regional banks. Meanwhile, bank lending is not showing any substantial increase.

Warping The Yield Curve

While they aren't a cure-all, NIR do generally seem to be a good way to weaken exchange rates, said David Blitzer, Ph.D., managing director, index management, at S&P Dow Jones Indices and chairman of the Index Committee. Beyond that, however, they introduce a distortion into financial markets, for example, in warping the yield curve as a risk indicator. "We're seeing much more interest in speculative-grade bonds and junk bonds, anything with high risk compared to the whole spectrum." Central banks are encouraging banks to take on risks that they normally wouldn't want to take on.

While central banks are pushing banks to lend more, regulation is delivering a different message: don't take risk, noted Mr. Six. This comes at a time when some banking systems, for example, Italy's, are still saddled with high levels of nonperforming loans. It also explains why actual trends in bank lending remain fairly weak.

Risk is on the rise in the reallocation of capital for nonfinancial corporates as well, as a result of low rates, said Diane Vazza, managing director of fixed-income research at S&P Global Ratings, on the back of "soaring issuance across all asset classes that's defying all expectations." For example, 10-year credit spreads on U.S. investment-grade corporates (versus those on the 10-year U.S. Treasury bond) are off their 2009 peak of 336 basis points to 190 basis points currently, while speculative-grade spreads are down to 558 basis points from levels eight years ago of 1,029 basis points. Corporates have also been able to extend their debt maturity profiles; for example Europe has seen the most growth in 10-year and greater maturities. In Asia-Pacific, 40% of companies are issuing 10-year bonds, double the share of just a few years ago. What's worrying from a credit perspective is the rise in the 'B' rated issuer. "We saw that movie before, prior to the last recession," Ms. Vazza said.

Central banks seem to be ignoring consequences of such risk-taking, which were at the heart of the last financial crisis, said Franklin Allen, Professor of Finance and Economics and Executive Director at the Brevan Howard Centre for Financial Analysis at Imperial College London. Rising prices for assets like housing will inevitably burst, bringing the banking sector down, with spillover onto the real economy. And bringing the banking sector back to health takes a long time. "Today, we've never seen such low interest rates, and we've never seen such high asset prices," Mr. Franklin said. Japan is an example of the negative long-term effects of ultra-low interest rates: it went from having a vibrant financial sector to one that is moribund, with not much lending to the real economy and a corporate sector that has lost its status as one of the most competitive in the world. The answer doesn't lie in a fiscal surge either that builds bridges to nowhere, but perhaps in a regular long-term program of infrastructure investment.

Banks Are On The Defensive

It might be too early to say whether NIRP is hurting European and U.K. banks. In crunching the data, Firdaus Ibrahim, senior equity analyst at S&P Global Markets Intelligence, was surprised to find that their net interest margin (NIM) actually rose 1 basis point from 2012 to 2014, and 4 basis points in 2015. Excluding U.K. banks, NIM fell in the two years to 2014 but still rose in 2015. He supposes banks are repricing deposits and loans to cope with the margin pressure of lower interest rates.

"The lesson from the data is that it takes time for asset and liability repricing to feed through to bank reported financials," said Richard Barnes, senior director in the banking team at S&P Global Ratings, "and banks have put into place balance sheet hedges to protect their margins." The effect of NIR is already showing up in the lower market capitalizations for European banks, whose shareholders doubt they can make decent returns. Although banks cannot pass on negative rates to their retail customers, and are under considerable political pressure to lower borrowing costs, they are passing on negative rates to corporate and institutional clients, and are charging higher fees across the board. One silver lining is that credit losses are running low because with NIRP, borrowers have more financial capacity to pay back their loans.

What will happen if NIRPs persist in the next one to two years? Cristiano Zazarra, head of global risk services relationship management at S&P Global Market Intelligence, said he sees further fee compression, and investors moving into higher-yielding but risker speculative-grade and emerging-market debt, and shifting to passively managed funds with typically lower fees. Hedge funds are likely to rethink their expensive fee structures, Mr. Zazarra said.

Negative interest rates are also throwing a wrench into the valuation of market risk, which banks use to assess capital requirements. That's because just a few years ago, the most common valuation models were calibrated with the assumption that interest rates would be zero or positive. This has implications for stress test scenarios and hedging interest rates, said Hans Crockett, product manager and developer at S&P Global Market Intelligence. "Some systems simply refused negative interest rates as inputs," he said. Systems can be adjusted to a point, though mathematically log normal volatility assumptions just don't compute at negative values. Plus, a lot of valuation models use as an input some kind of mean reversion assumption, that is, things go back to normal over a certain period of time. Under negative interest rates, what is back to normal? What is the period of time?

Money Market Funds: The Canaries In The Coal Mine

The first financial sector to feel the effects of negative interest rates were money market funds, which invest in very short-term and short-term investments. "Money market funds are the canaries in the coal mine," said Andrew Paranthoiene, director at S&P Global Ratings. To pass on negative rates to investors, the industry adopted the idea of share cancellation to maintain their price at 1 (euro or other currency) per share for stable net asset value funds. While the industry has seen outflows and consolidation, investors—among them multinationals—see value in these funds as diversified pools of highly liquid and high-credit-quality instruments. They're seeking safety and liquidity first, and then yield.

Negative interest rates are the main threat to European insurers today, especially for the life business, said Lotfi Elbarhdadi, analytical lead in the insurance practice at S&P Global Ratings. That's because interest rate assumptions are the backbone of pricing. Yet, companies are adapting by modifying product features, for example, eliminating or reducing guarantees on new business. "They're becoming more of a fee-based rather than a spread-based business," and becoming more like asset managers than insurers. Mr. Elbarhdadi doesn't see insurers taking on significantly more risk, because of regulatory constraints, but he does see them extending asset maturities on their investments in the search for yield. One positive outcome of negative interest rates is that conditions for issuing debt are favorable, and insurance companies are releveraging.

A World Unprepared For Low Rates

In structured finance, partly because they are without legal precedent, NIR have created a potential for dispute risk over negatively calculated coupons, some of which do exist among the issuance we rate, said Darrell Wheeler, managing director, structured finance research, at S&P Global Ratings. Most of that paper was originally issued between 2005 and 2008 when nobody anticipated negative interest rates. In the past 18 months, however, we're not seeing issuance of floating-rate notes without floors. What's more, most of our criteria is sized to high interest rate stresses. "I think the world is well prepared for a high rate environment. I'm not sure it's well-prepared for the stresses of a low rate environment."

The conundrum for commodities is that the fall in prices was one reason behind NIRP, and that it may actually increase deflationary pressures in the sector in the medium term, according to Yulia Woodruff, director of client strategy and energy solutions at Platts. NIRP is lowering the costs of carry and encouraging the buildup of inventories, and reducing the costs of production by cannibalizing investments in higher-cost projects. "Most commodity markets are supply-long, and investments aren't likely to increase until the markets rebalance and the price outlook is positive," Ms. Woodruff said.

In what was otherwise a cloudy assessment of negative interest rates, Niels Lynggard Hansen, director and head of economics at Denmark National Bank, spoke about the country's successful use of the policy. He explained that Denmark's use of NIR is to solely defend the currency—a different rational than in other countries—and is in the context of a fixed exchange-rate policy that's been in place for more than 30 years. Although housing prices have increased, and strongly in Copenhagen, higher disposable income and changing demographics explain much of the rise. Pretax profit at the country's seven-largest banks was strong in 2015, though admittedly net interest income has decreased and banks are increasing fees to compensate. Should the ECB have introduced a tiered scheme of negative interest rates, like Denmark's, thus better shielding the banking system?

Will It All End In Tears?

Negative interest rates might not be as abnormal as they sound, if the natural rate of interest has fallen, in which case the zero bound is likely to be broken. However, when the next downturn hits, how will policy respond? If S&P Global Ratings' forecasts prove to be correct, that won't happen. In theory, the Fed would be the first one out of the gate with higher interest rates, and other central banks would follow step by step, exiting from their negative interest rate policies, said Mr. Sheard. If that takes too long, a downturn would leave central banks with a tough policy challenge. It's difficult to imagine that the answer will be to lean on the central banks to do more. Monetary policy is stretched, and close to the limits of what it can do. Will it all end in tears?

Besides being difficult to understand, NIRPs are creating an excuse for central bankers to avoid talking about how fiscal policy can help. Central banks might be able to put the discussion back on the table by reintroducing the idea of perpetual bonds, which pay interest but don't pay back principal. It comes back to the question: how do we get out of the slow-growth quagmire? Are central banks relying too much on the notion that negative interest rates can stimulate the economy? As one panelist put it, "We've got to get back to the world where the financial services industry focuses on identifying good investments so economies can grow."

Stocks Rocked the House Post Midterm Elections

After the S&P 500 logged its 9th worst Oct. on record, losing 6.9%, it has bounced back 2.6% month-to-date through Nov. 9, 2018. Though the monthly returns for the eight Novembers following the historically bad Octobers were only positive twice – in 1978 (President Jimmy Carter midterm year) and 1933 – the fact there was a midterm election this year may help the chance of a solid rally if history repeats itself. Historically, the S&P 500 has been positive in most periods after the midterm elections.

In the months of Nov. and Dec. during historical midterm election years, the S&P 500 gained 14 of 22 times in Nov. and in 15 of 22 times in Dec. with a combined 2-month gain in 17 of the 22 midterm election year-ends. In percentage terms, the S&P 500 gained in 64% of midterm election Nov. months and 68% of the following month that when combined into a 2-month return resulted in gains 77% of the time. Also, the magnitude of the average gains in the 2-month period was 6.1%, more than the magnitude of the average loss of 4.1%.

Oil refining executives wary of RFS program despite falling compliance costs

While the price of biofuel blending credits has fallen toward insignificance, the uncertainty surrounding the direction of U.S. biofuel policy has some U.S. refining executives looking to limit their company's exposure to an opaque market that they see as primarily driven by politics.

The Renewable Fuels Standard, or RFS, program, administered by the U.S. Environmental Protection Agency, requires U.S. refiners to blend an increasing volume of biofuels such as ethanol into the transportation fuels they produce each year, escalating to 36 billion gallons by 2022.

The EPA sets annual renewable volume obligations each year based on overall volume requirements and projections of domestic gasoline and diesel production.

Those companies that cannot meet the blending requirements must purchase credits, known as renewable identification numbers, or RINs, to meet their blending obligations.

After a Philadelphia refiner blamed the regulations for its bankruptcy, actions taken by the Trump administration have led the RINs market to plummet 84% year-to-date through Oct. 10, according to S&P Global Platts.

In April, a federal judge approved a settlement between the EPA and PES Holdings LLC that allowed the bankrupt refiner to shed a substantial portion of its RFS compliance obligations.

The EPA's granting of "hardship" compliance waivers to small refiners has benefited the broader refining industry.

Despite the reduced compliance burden, some refining executives are still wary of the policy.

CVR Refining LP President, CEO and Director David Lamp said during an Oct. 25 earnings call that the company had started blending B5, a blend of petroleum-based diesel containing 5% biodiesel, across all of its racks to increase internally produced RINs by 5% of its renewable volume obligation and that the company also has "several deals in the works" to reduce its RINs exposure.

"I would tell you that if I had a crystal ball, I could predict what RIN prices are going to be," Lamp said. "Frankly, I don't trust them. I don't trust the politics. I don't trust the law itself. ... And if they don't issue waivers like they did last year, I would say the price is going to go straight up, maybe not immediately, but … over time as the RIN bank goes away. I think it's kind of foolish to stick your head in the sand and say this issue is gone just because the RINs are cheap right now."

Lamp's comments come as the ethanol industry is in the midst of challenging the Trump administration's RFS waivers in federal court.

Some refiners continue to lobby for RFS policy changes, but during earnings calls they did not outline investments to mitigate the policy's effects.

"We're not fully where we think the market needs to go and where the administration needs to go as far as fixing the RFS problem, but we're continuing to work on it diligently," Marathon Petroleum Corp. Chairman and CEO Gary Heminger said during a Nov. 1 earnings call.

During the third quarter of 2017, Marathon said biofuel blending reduced the indicative gross margin of its refining business by $743 million, but a year later, executives declined to outline a specific benefit from lower RIN costs.

"We are not believers that RIN costs drive differential profitability within the refining system. We have a ... view that as RIN prices rise, it gets reflected in the crack, and on a net basis, the system is no better or worse off than where things are at. So I'm not sure we'd highlight an incremental benefit to the lower RINs costs," Marathon Senior Vice President and CFO Timothy Griffith said. "It certainly introduces a lot less noise into the market relative to what the real economic cracks are, but we would not identify any natural economic benefit in total to the system related to the lower prices."

Whichever direction biofuel policy takes, other refiners are investing in renewable fuels because they see them as a long-term part of the global fuel mix.

"If you step back and look at ethanol, it's going to be in the gasoline pool for a long time, and it's a core part of our strategy," Valero Energy Corp. Vice President of Alternative Fuels Martin Parrish said during an Oct. 25 earnings call. "We see corn ethanol as the most competitive source of octane in the world."

On Oct. 11, Green Plains Inc. announced it would sell three of its ethanol plants to Valero.

Parrish expects that growing U.S. ethanol exports and slowing domestic production growth will lead to improved margins for Valero's renewable fuels business, which the company recently decided to expand.

Valero executives pushed back on the notion that their decision to invest in renewable fuel production was related to the Trump administration's proposal to allow year-round sales of E15 — gasoline blends containing 15% ethanol — which the oil industry has vowed to fight in court.

"[It's] going to take a couple of years for that to work its way through the courts before you get a final answer [on its legality]," Valero's senior vice president of public policy and investor relations, Jason Fraser, said Oct. 25. "Put yourself into the shoes of one of those retailers who's got to spend money to be able to offer E15. You're going to spend money with the risk of having stranded capital because in a couple of years, the court may void [the rule]."

Oilfield service majors to limp into 2019 as North America land market struggles

Diversification helped oilfield service majors navigate through a difficult third quarter in North America land markets, but analysts see more downside risk for the sector in the last quarter and persistent challenges into 2019.

Bottlenecks in the Permian basin limited exploration and production in the prolific basin, impacting third-quarter earnings across the oilfield services sector.

Customer activity weakened during the third quarter as takeaway constraints in the Permian limited production growth, Schlumberger Ltd. CEO Paal Kibsgaard said during the company's Oct. 19 earnings call.

Halliburton Co. CEO Jeffrey Miller said Oct. 22 that the North America land market presented challenges in the third quarter amid a combination of off-take capacity constraints and customer budget exhaustion that led to less demand for its completion services.

Analysts said that the diversification of services offered by the two leading oilfield services companies sheltered them from larger negative impacts to quarterly earnings.

Schlumberger and Halliburton's international businesses performed well in the third quarter but could face challenges early in 2019.

Kibsgaard said Schlumberger's revenue from its international business, excluding Cameron, was up 4% sequentially to $4.6 billion in the third quarter. The strength of international markets, where the company expects "flattish" revenues in the fourth quarter, should outweigh any further challenges in the North America land market, the CEO said.

Halliburton saw international revenue in the third quarter climb 5% sequentially to $2.4 billion, and Miller said he is excited about the international markets in 2019. "It's a bit of a mixed bag in the sense that there are going to be markets like Asia-Pacific and Europe, Africa, Eurasia, that, in my view, may recover more so, pretty strongly on a percentage basis, just given where they started," Miller said. "But there's other parts of the market, all in Middle East, that have been fairly resilient throughout the downturn."

On its third-quarter call, Halliburton guided fourth-quarter earnings per share to a range of 37 cents to 40 cents, "well below consensus of 48 cents," analysts with B. Riley FBR said in an Oct 24 note. The company based its outlook on the collective impact of bottlenecks and budget exhaustion not only in the Permian, but also the Marcellus/Utica and DJ Basin. Schlumberger's Kibsgaard said its North America land revenue and earnings per share will be down in the fourth quarter, and the level of the decline will be a function of how severe the shutdowns are going to be in November and December.

The reasons for the headwinds in North America around takeaway issues and budget constraints were well understood by the market, but the pace of declines implied by the guidance from the two industry leaders likely caught some by surprise, said West Carlyle, an analyst with Evercore ISI. "The fact that the industry will see extended breaks with some starting before Thanksgiving mean that customer activity levels will decline for the last six weeks of the year and makes visibility challenging with pricing and utilization falling in the spot market," he said in an Oct. 22 note.

Halliburton expects these challenges to ease through 2019. In addition to a Permian re-acceleration, Halliburton expects to see bullish budgets for the Eagle Ford, Bakken, Marcellus/Utica and DJ Basin. FBR agrees with Hallburton management's view "of the transient nature of and resolution timing of the challenges," analyst Thomas Curran said Oct. 24.

FBR revised Halliburton EBITDA and earnings per share outlooks for 2018 and 2019 from $4.4 billion, or $1.98, and $5.3 billion, or $2.65, respectively, to $4.3 billion, or $1.86, and $4.8 billion, or $2.27, and set their 2020 outlook at $5.9 billion, or $3.32. Evercore analysts lowered Halliburton 2019 earnings per share estimate to $2.00, while CitiGroup analyst Andrew Scott said the bank lowered first-quarter 2019 earnings per share estimate for Halliburton to 39 cents and fiscal year 2019 to $2.04. A double-digit decline in fracking activity drove the bank to "take a hatchet" to its fourth-quarter earnings per share outlook to 37 cents to 40 cents, while the international business should be up modestly, Scott said.

Schlumberger said the company's international businesses would see 10% top-line growth in 2019 with national oil companies leading the charge on spending and the fastest growth rates for Latin America, sub-Saharan Africa and Asia. It also expects a continued climb in deepwater drilling activity, following an expected 8% rise this year, as well as help from pricing improvements.

FBR lowered its 2018 and 2019 EBITDA and EPS outlooks for Schlumberger from $7.53 billion, or $1.73, and $9.3 billion, or $2.55, to $7.22 billion, or $1.72, and $9.30 billion, or $2.45, on the net costs and disruptive impact of the company's broad, rapid rig mobilization internationally. For 2020 EBITDA is forecast at $10.60 billion, or $3.32 per share.

Curran said Schlumberger's third-quarter earnings call and annual sell-side roundtable reinforced the firm's thesis that outside of North America, the company is pivoting from a focus on investing and mobilizing to executing and harvesting. This "rest of the world," or non-North America land market, makes up 70% of Schlumberger's revenue. FBR expect Schlumberger to generate "a robust 2018-20 [free cash flow] trajectory and to return meaningful portions of it to shareholders."

Baker Hughes a GE company made strides developing its international presence to compete with the larger names in the international markets and said in its Oct. 30 earnings call that its smaller exposure to North America land fracking helped shield its earnings in the third quarter.

Jefferies analysts said Oct. 9 that Baker Hughes has plausibly gained a little share in oilfield services with non-North American market revenues flat in the first half compared to the second half of 2017, when compared with Halliburton and Schlumberger. "We don't doubt that [Baker Hughes] is pricing aggressively as it explicitly targets market share, although it feels far more consistent with peers' behavior through cycles than not," Jefferies said.

Jefferies lowered its 2019 earnings per share outlook for Baker Hughes to $1.45 from $1.65, and trimmed its 2020 estimate to $2.15 from $2.65. "That said, we model just under $4 per share in 2022 with the assumed later cycle contribution and assuming about 40% incrementals," the analyst said. Guggenheim Securities analysts said they expect all four of Baker's segments to contribute to growth in 2019 that should drive 11% and 29% growth in revenue and EBITDA, respectively.

For National Oilwell Varco Inc., its rig systems business suffered third-quarter losses as customers limited spending to only the most essential items in the third quarter, as a shrinking commodity price and subsequent activity decline led customers to limit capital spending.

Analysts with Tudor, Pickering Holt & Co. said Nov. 7 that during National Oilwell Varco's analyst day on Nov. 6 the company offered "some quantitative color" on its 2019 and three-year outlook. Amid "lots of assumptions," fiscal-year 2019 EBITDA was bracketed in $1.0 billion to $1.3 billion range, while Tudor Pickering Holt & Co. said its range was already around the midpoint, "which could be more like $1.8 billion to $2.5 billion a few years down road."

Barclays analyst David Anderson maintained National Oilwell Varco with an Equal-Weight and lowered the price target from $44 to $40. Raymond James analyst Praveen Narra maintained the company with an Outperform and lowered the price target from $55 to $45, and CitiGroup analyst Scott Gruber maintained National Oilwell Varco with a Neutral and lowered the price target from $48 to $40.

While the market remains challenging right now, the underlying trends still look positive for 2019, the Evercore analysts said. "Customer budgets will reset in 2019 with a backdrop of stronger commodity prices especially compared to where they entered 2018. The DUC count continues to rise which provides a backlog for demand when it gets worked down. Lastly takeaway capacity will expand and customer urgency will come back. Also the international recovery continues to emerge," the analysts said.

Strong shale output drives major US oil producers' earnings to multiyear highs

Following misses in the second quarter, many U.S. oil majors such as Exxon Mobil Corp. and Chevron Corp. saw third-quarter earnings soar to their highest levels in four years as oil prices remained strong and production, much of it from shale, increased.

After sinking in the second quarter to a multiyear low, Exxon's total output rebounded in the third quarter to 3.8 million barrels per day, up 4% on the quarter but still 2% below the same period in 2017. Third-quarter liquids output climbed 6% as growth in North America more than offset higher downtime.

Exxon's third-quarter shale oil output from the Permian Basin was up 57% on the year due to the ramp-up to the current 38 rigs in the Midland and Delaware basins. Exxon's third-quarter Permian production was up 170,000 barrels of oil equivalent per day, or 11%, on the quarter.

During the third quarter, Exxon's cash flow from operations and asset sales was $12.6 billion. Third-quarter cash flow from operating activities of $11.1 billion was the highest since the third quarter of 2014, the company said.

Separately, Chevron's shale production during the third quarter was 338,000 barrels per day in the third quarter. "Shale and tight production increased 155,000 barrels per day, primarily due to growth in the Midland and Delaware basins in the Permian where production grew by 80% from a year ago," Chevron CFO Patricia Yarrington said during a Nov. 2 earnings call.

Calif.-based Chevron continues to bet on rising returns from its Permian investments, with production levels trending about one year ahead of the guidance provided in March when executives announced plans to expand the overall upstream fleet and improve cash flow

"Chevron's rising production volumes and greater proportional exposure to oil and oil-linked LNG pricing really shined through in its third quarter results," Moody's Senior Vice President Pete Speer said. "The company generated nearly $4 billion of free cash flow in the quarter, as its more upstream weighted business mix combined with its oil price exposure really differentiated Chevron's financial performance from its major integrated peers."

Chevron reported third-quarter earnings of $4.05 billion, or $2.11 per share, beating the S&P Global Market Intelligence consensus estimate of $2.06 per share.

Chevron's quarterly cash flow from operations was $9.6 billion, the highest it has been in nearly five years.

Ongoing healthy cash flow could allow Chevron to expand its $3 billion-per-year share buyback program, the company said. During the third quarter, Chevron spent $750 million on share repurchases. The company had not repurchased shares in several years, since around the time global crude prices began to crumble. Buying back existing stock generally makes the remaining shares more valuable.

Texas-based oil and gas producer ConocoPhillips reported adjusted net income for the third quarter of $1.6 billion, or $1.36 per share, far exceeding S&P Global Market Intelligence consensus estimate of $1.19 per share.

While a key driver was a settlement with Petróleos de Venezuela SA to fully recover an arbitration award of approximately $2 billion, ConocoPhillips also reported strong output during the third quarter that worked to lift its earnings.

In the third quarter, the company's output, excluding Libya, was 1.22 million barrels of oil equivalent per day, up 22,000 boe/d from the same period a year ago but below the S&P Global Market Intelligence consensus estimate for daily production of 1.24 MMboe/d.

In the Lower 48, production from the company's high-margin "big three" unconventional plays grew to 310,000 boe/d, a 48% increase year over year. Production from the big three unconventionals, which include the Eagle Ford Shale, the Delaware play and the Bakken Shale, is expected to grow more than 35% for the full year.

Fourth-quarter production is expected to be between 1.275 MMboe/d and 1.315 MMboe/d, reflecting the completion of seasonal turnarounds, growth from several conventional project startups and ongoing development in unconventional production, the company said.