Oil andgas producers are running out of options to cut their funding gaps and may be increasinglyforced into asset sales and defaults, according to a report by Standard & Poor'sRatings Services.
Majorcapital spending cuts in 2016 have not been enough to offset the damage done bylingering low commodity prices, the report said. Those low prices are expected toresult in lower revenues and "limit the fiscal techniques and tools the sectoruses in healthier economic times to fund cash flow shortfalls."
The lowprices coupled with the likelihood that banks and other lenders will on their willingness toextend credit to producers could be dire for companies that are already on lesssolid footing.
"Thoseconditions will likely cause many E&P companies, particularly those in the speculative-gradecategory, to consider divesting assets or, in select cases, tapping the equity marketfor critical cash to fund capital budgets that have already been slashed to thebone," S&P Ratings said. "Companies that can't find buyers for noncoreassets, or are forced to sell their most productive properties, face an increasingrisk of damaging their overall creditworthiness, or worse, bankruptcy."
S&PRatings said much of the blame for the situation belongs to the producers themselves,as their budgets for 2015 indicated that many companies expected the downturn tobe short.
"Despiteoverall cuts in capital spending of about 35% from 2014 to 2015, U.S. E&P companiesmaintained aggressive budgets. For the E&P companies we rate, the average freeoperating cash flow deficit (operating cash flow after capital spending) was about$522 million in 2015," the firm said. "Taking into account capital spendingand shareholder distributions, the average discretionary cash flow deficit was about$869 million the same year. These FOCF and DCF deficits represent a 94% and 26%increase over 2014 results, respectively, and demonstrates how the industry wasslow to react amid the commodity price collapse."
S&PRatings said it expects producers to cut their capital budgets by an average of40% from 2015 to 2016 and slash their dividends, which could help some of the better-positionedcompanies stabilize. Other companies, however, may need help funding their deficits,which could mean disaster for those with weaker credit ratings.
"Unliketheir investment-grade counterparts, capital markets will be an unlikely sourceof funds for speculative-grade companies in 2016 because investors remain leeryof the ability of highly leveraged companies to survive the latest industry downturn,"the firm said. "At the same time, lenders looking to decrease their risk exposureto the industry have limited these companies' ability to borrow under reserve-basedrevolving credit facilities."
S&PRatings said producers could issue equity to bridge the funding gap but again notedthat companies with lesser credit ratings are unlikely to find a receptive audience.The firm said some companies may turn to assetsales, but such an avenue may not be profitable.
"There'sbeen only a handful of asset sales to date in 2016 because market activity has crawledto a halt, putting many lower rated companies in danger of not being able to fundspending deficits in the latter half of 2016 unless hydrocarbon prices show a markedimprovement and cash flow deficits continue shrinking," the firm said. "Companieshoping to sell assets face a buyer's market this year, with a growing number ofproperties potentially flooding the market as better-positioned companies standready to pick up distressed assets for pennies on the dollar."
Thatleaves an unpleasant option for lesser-rated companies: default.
"Weexpect the risk of distressed exchanges and traditional defaults for lower-ratedcompanies, especially those that have exhibited weak liquidity or large cash flowdeficits, to increase significantly," S&P Ratings said.
S&P Ratings and S&P GlobalMarket Intelligence are owned by S&P Global Inc.