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Write-Downs, While Eye-Catching, Are Not The Largest Issue Facing Oil And Gas Supermajors

Write-downs and production cuts have been headline news for oil and gas supermajors since the pandemic hit the sector. These can look quite scary at first glance, and they can be significant. However, S&P Global Ratings believes they often aren't enough to trigger rating actions on their own, depending on what caused them. In fact, we view these most recent second-quarter write-downs as part of the bigger, structural issues supermajors face. These can be a short-term symptom of long-term issues—specifically lower prices.

This is not to dismiss supermajors' strengths. In fact, given the high ratings we have on these companies, even with modest deterioration, bond investors are likely to continue benefiting from the supermajors' solid balance sheets, substantial operating cash flows, and contribution to the global energy mix for many years. But even as these companies work to reinforce financial resilience through lower cash outflows and lower leverage, we are increasingly focused on the industry's evolution and visibility of its ongoing cash generation compared with that of other sectors.

Indeed, write-downs aside, the two biggest challenges facing the oil sector and supermajors are its volatility and cyclicality, which is not a new issue but one that the pandemic is testing to the maximum, and how to respond to the existential and structural questions posed by climate change and the energy transition. Issues such as reserve lives, strategy, and their links to environmental, social, and governance (ESG) factors are major parts of our analysis, because we recognize the long-term implications from these will be very significant in the sector.

Write-Downs And Ratings Often (Don't) Go Hand In Hand

From a credit rating perspective, write-downs of balance sheet asset values and equity aren't good news, but they don't necessarily have a direct impact on our corporate ratings (see box). One reason for this is that, in some cases, the revised asset value can be more consistent with our rating assumptions. When BP PLC announced an impairment of up to $17 billion post-tax, the reason was the reduction in the company's long-term oil price to $55 per barrel (/bbl). Because this price is now in line with our existing long-term assumptions, cash flows are lower compared with BP's previous forecasts (for accounting purposes), but implicitly better aligned with our base-case scenario.

Another reason is because the write-downs by themselves don't have a material impact on cash-flow-related financial metrics, especially given our sector-wide assumptions. Write-downs can result in a large income statement impact and even a reported loss. This means lower earnings and equity and increased earnings' volatility. Gearing, measured as debt to equity or debt to capital, is therefore higher than otherwise before the impairment. Royal Dutch Shell's impairment of $16.8 billion post-tax at second quarter 2020, which reduced average assets employed by 6%, accounted for 2.8 percentage points of the reported gearing increase to 32.7%. However, we focus on cash flow-to-debt metrics in our financial analysis, so there is no mechanical impact on the metrics. Of importance, cash previously invested in impaired assets is already factored into the company's net debt. Our cash flow forecasts are based on our price assumptions, which are consistent across companies. Hence, we did not take rating actions on BP, Royal Dutch Shell PLC, or Total S.E. (see table 1 for current ratings) following their write-down announcements. Chevron's impairments of $4.8 billion included a $2.6 billion write-off of its Venezuelan assets.

Table 1

Ratings On Supermajors As Of Aug. 3, 2020
Issuer credit rating Business risk Financial risk

Chevron Corp.

AA/Negative/A-1+ Excellent Modest

Exxon Mobil Corp.

AA/Negative/A-1+ Excellent Intermediate

Royal Dutch Shell PLC

AA-/Negative/A-1+ Excellent Intermediate

Total SE

A+/Negative/A-1 Excellent Intermediate


A-/Stable/A-2 Excellent Significant
Source: S&P Global Ratings. Please see ranking list publication or individual company analyses for modifiers and other analytical descriptors.

Nevertheless, the decision to impair and the timing are important. It is not just a bookkeeping exercise. For example, where companies report and communicate on target ranges for gearing, it guides our understanding of financial policies and choices. For example, BP was already above its target range at March 31, 2020. This is why it's important the company has continued to deliver on disposals, like the petrochemical sale to INEOS, and its recent issuance of nearly $12 billion in hybrid bonds (which increase cash and equity, without increasing debt equivalently). Large write-downs can imply capital was misallocated. This raises questions about earlier strategic decision making and investments, although the sector outlook has also shifted since some of these original investment decisions. In that sense, these write-downs can often illustrate bigger, structural issues for supermajors.

Performance Metrics--Operations And ESG Factors

Oil and gas production remains the key factor for the supermajors' cash generation

Combined oil and gas production reported by the five supermajors in 2019 was about 6,400 million barrels of oil equivalent (mmboe), 3% higher than in 2018 and about 13% more than 2015. This represented about 10% of global oil production and 11% of total gas production. Total S.E. increased production by more than 8% in 2019 (and by almost 30% compared with 2015, including the Abu Dhabi concession), the highest increase across the supermajors. On the flipside, ExxonMobil's production has declined since 2015 by about 4%, but the company remains the largest producer. We expect production to continue increasing overall after a COVID-19-related drop in 2020, although the profiles differ by company. On average, about 25% of production comes from equity affiliates (the rest is consolidated subsidiaries) that are usually in higher-risk countries. Among the supermajors, BP in particular relies on its stake in Russian Rosneft Oil Co. PJSC, which accounted for about 35% of the company's combined oil and gas production.

We generally consider liquids production more profitable than gas. However, gas is seen as a cleaner source of energy and potential bridge fuel for the energy transition. Across all supermajors, slightly above 55% of the production profile consisted of liquids on average. Chevron Corp. is still the most liquids-focused player, at about 60% of its production profile in 2019 (this is partially the reason for its higher per barrel cash flow). By contrast, in 2019, only about 50% of Royal Dutch Shell PLC's production was liquids. Shell is also the largest gas producer with 700 mmboe in 2019, while ExxonMobil remains the largest liquids producer with 870 mmboe in 2019 (see chart 1).

Chart 1


Amid increasing production, reserve life is falling

In 2019, combined reserves were about 76,000 mmboe, down by about 4% compared with 2018 and about 1% higher than in 2015. Under the U.S. Securities and Exchanges Commission's (SEC's) rules, net proved reserves incorporate only those that can be produced economically, as specified. Therefore, reserves change because of both additions and production, reserve revisions, and price changes. ExxonMobil Oil Corp. remains the largest supermajor by SEC reported reserves, with about 22,500 mmboe, and Shell is the smallest, with about 11,100. As with production, about 25% of reserves comes from equity affiliates, and BP stands out, given that the contribution of Rosneft to its reserves is about 50%.

Reserves have increased far slower compared to production. The reserve life index (RLI; the number of years reserves can last assuming constant production) has decreased for all supermajors in the past five years (see charts 2 and 3). This is mainly due to reduced capex and investment decisions in the past few years, as the industry responded to the oil price drop in 2014-2016--and also maintained returns to the shareholders as far as possible. As a result, most supermajors are approaching a 10-year RLI, which we view as a threshold for a strong proven (1P) reserve life. We see reserve life as one input for our analysis. For example, we also consider the value of reserves and the likelihood of proven and probable reserves being upgraded and developed. Shell has only about eight years of reported 1P reserves, assuming constant production, while Chevron and Total have 10 and 11, respectively. Thanks to its stake in Rosneft, BP's RLI looks more supportive, at about 14 years. However, the RLI of BP's consolidated entities is just above 10 years. ExxonMobil remains the leading supermajor by RLI, with a substantial 15 years. A weaker RLI on its own will likely not affect the ratings, but the comparative visibility we have for future production is a factor when we review our excellent business risk assessments.

Chart 2


Chart 3


Cost control remains a priority

In 2019, cash flow (before exploration and capex) per barrel of oil equivalent (boe), was largely unchanged year on year, at about $22 per boe on average (the Brent price was about $64/bbl). This is despite oil prices having fallen by about 10%. Supermajors managed to keep the focus on costs, reducing break-evens and enhancing efficiencies. Across the supermajors, the most cash-generative company per barrel of oil equivalent is Chevron, given its focus on more valuable liquids rather than gas. Overall, assuming an average Brent oil price of about $35/bbl in 2020 (about $30/bbl less than in 2019) and still-weak gas prices, the supermajors' implied upstream cash flow would be very low without cost-cutting, although taxes and currency effects could also be offsetting factors (see chart 4).

Chart 4


ESG Performance Improves Amid Continued Public Scrutiny

The decline in long-term oil and gas demand remains a risk for all oil and gas supermajors. This is a key part of the energy transition as policies and consumers look for more sustainable energy sources. In our view, the supermajors' gas assets provide optionality, even if gas is ultimately also a fossil fuel.

In their traditional upstream and downstream divisions, supermajors are also trying to limit harmful impacts on the environment. Oil and gas production activities can influence GHG emissions directly and indirectly. Directly, the production process itself can lead to the release of GHGs, especially methane. Indirectly, the combustion of oil, gas and derivatives by end users results in carbon dioxide (CO2) emissions. Oil and gas producers can influence the amount of GHG emitted during the production, but their control over how efficiently their products are used is limited. Nevertheless, long-dated "net zero" emissions targets are already changing companies' strategies, both directly and indirectly.

Overall, we see improvement over the past few years--average GHG emissions from operated facilities reduced to about 65 kilograms per boe in 2018 from about 80 kilograms per boe in 2014 (see chart 5). All supermajors reduced CO2 equivalent emissions, but Total recorded the most dramatic decline by about 30%. The company's absolute emissions went down despite production growth thanks to flaring reductions and improved energy efficiency.

Chart 5


In terms of social impact, all companies have initiatives that promote safety at workplace, improve diversity, and invest in local communities. Supermajors in particular demand very high standards of safety at their sites and have invested heavily in processes that ensure prevention and monitoring of potential threats. This resulted in low incident rates compared with the industry as a whole and the supermajors continue to show improvement. We estimate that average incident rate has gone down to about 0.8 per 1 million work hours in 2018 from about 1.1 per 1 million work hours in 2014 (see chart 6). Chevron and ExxonMobil show the lowest rates, which could be because of their operations in OECD countries, where safety standards are stricter than in non-OECD nations. However, methodologies used to calculate these and other data might differ by company, making comparisons difficult.

Chart 6


Credit Metrics Are Set To Improve

Our base-case forecasts show credit metrics deteriorating aggressively in 2020 as operating cash flow drops, before recovering significantly in 2021 (see chart 7). This profile largely mirrors the modulation of our oil price assumptions. We project that multi-year ratios will be consistent with rating thresholds for companies. The horizontal lines show our standard thresholds for different financial risk profiles. We typically assign a financial risk profile one category below the core ratios to recognize capital intensity and material shareholder distributions.

Chart 7


Taken together, the supermajors entered the COVID-19 crash with higher reported and adjusted debt than in 2013 or 2014, before the previous oil crash. At March 31, 2020, combined reported debt was close to the level of Dec. 31, 2016, after Brent crude averaged $44/bbl for the year and Shell closed the large BG Group acquisition (see chart 8). At a company level, the positioning of full-year 2019 ratios--and those of recent years--compared with rating thresholds partially explain the downgrade of ExxonMobil to 'AA', due to no remaining headroom; in contrast, the stable outlook on BP reflects that funds from operations to debt was above our 30% target. Headroom for Shell and Total was only moderate while Chevron had modestly more cushion.

Chart 8


The negative outlooks on the other supermajors reflect the risk that metrics do not recover sufficiently in 2021, after weak ratios in 2020, well below those we see as appropriate for the ratings. The underperformance versus our base-case assumptions could result from adverse variances in average or assumed oil prices, refining margins, disposals or insufficient mitigating or credit supportive actions.

Of note, for overall credit quality, the ratio thresholds for a given rating depend on the business risk. For example, for the same rating, if the business assessment is meaningfully weaker, the financial ratios would need to be stronger to compensate.

Evolving Industry Risk And Business Risk Profiles

For a rated company, our business risk profile can be seen as an assessment of the engine that generates the cash to service debt. In particular, our business risk assessment captures the quality or certainty of those cash flows. As some of these supermajors' engines start to be powered less by oil and gas and more by other sources, business models need not become more predictable (and disclosures might not be sufficient). Other market and investment uncertainties could replace the volatility of oil and gas. Even if a renewables division has more stable earnings, it need not be countercyclical. In addition, supermajors' historical energy preeminence based on oil and gas might moderate as the energy transition unfolds and oil substitutes for mobility and transport take market share. These changes are particularly relevant for ratings on the supermajors, for which we have some of strongest business risk profiles across corporates. We see two aspects to the pressure on the industry and individual business risk assessments. The first is rooted in past financial performance and the second in future impacts and strategic responses to the energy transition.

Profitability and volatility

The supermajors are managing through the second severe sector downturn in five years, and the third in 12. Whether or not prices and performance are becoming more volatile, the oil and gas sector's cyclicality and volatility are higher than those of other highly rated industries.

Chart 9


Chart 10


The average returns for the supermajors have been declining for a decade as measured by EBIT divided by capital (see charts 9 and 10). We do not ascribe this to the energy transition because oil demand has increased over that period. The absolute level has moved from a position where returns were above those of other companies we assess as having an excellent business risk profile, to below. This is partially a function of increased capital invested, particularly during the decade of significant cost inflation until 2014. Consequently, higher depreciation charges then affected earnings further. The current significant write-downs of assets will partially reverse this dynamic, due to modestly higher earnings and a lower capital base--implying a higher return on capital than without the impairments.

This lower profitability weakens the case that the cyclicality and capital intensity of the oil and gas sector can be tolerated because the returns are higher than other sectors. Ironically, reduced profits from oil and gas can make capital allocation to--historically lower yielding--renewables a less dilutive prospect for group earnings. Furthermore, one presumed characteristic of supermajors was that with strong balance sheets, they could afford to invest at lower cost through cyclical troughs, thereby garnering higher returns than weaker peers. On the contrary, more recently, given the lack of balance-sheet capacity, stickiness of dividends, and severity of recent downturns, capex cuts by the majors have been broadly in line with those of smaller peers at 20%-30%.

In 2020 and 2021, for the supermajors and other integrated companies in particular, we see the challenge of a period of low oil and gas prices as well as weak refining and petrochemical margins, as undermining the benefits of the integrated model, at least in this cycle. To a degree, diversification along the value chain has been a cushion for the operating cash flow of integrated companies through cycles (see table 2). Lower oil prices can correlate with higher downstream margins, especially if demand is sustained as in 2014-2016--but not in 2008 or 2020. These lower prices may only be partly offset by improved efficiency and lower costs and capex.

Table 2

Supermajors' Announced Measures To Preserve Cash
2020 operating expenditures cut 2020 capex cut Dividend/share repurchase 2020 oil and gas production vs. 2019
Exxon Mobil

$7.4 billion

$10 billion
Chevron $1 billion $6 billion

$3.25 billion of share repurchase stopped

Flat, excluding asset sales and contractual effects
Royal Dutch Shell $3 billion-$4 billion $5 billion

$9.25 billion of share repurchase stopped $10 billion of dividend cut

Total >$1 billion and >$1 billion energy savings $4 billion $1.45 billion of share repurchase stopped $1 billion potentially from scrip option on final 2019 dividend 5% reduction
BP $2.5 billion by end 2021 $4 billion Lower

Responses To The Energy Transition And Potential Implications For Business Risks

We believe cash flows from oil and gas companies may be even less certain in the coming decades than in the past 10 or 20 years. The likelihood is that the energy transition away from fossil fuels results in lower oil consumption and higher taxes on hydrocarbons, even if global energy demand continues to increase overall. The supermajors are recognizing and responding to this ultimately existential challenge in various ways. Although national oil companies are responsible for the largest share of global supply, the supermajors together produce about 10% of oil production--similar to Saudi Aramco alone, listed supermajors have a totemic significance for investors and activists alike.

Unsurprisingly, to date, the proportion of public communications about greener strategies or renewable initiatives by these companies has not been matched by the share of non-oil and gas investment planned, still less the proportion of capital invested or cash flow generated. The International Energy Agency noted that spending outside core activities has been up to 1% of total capital.

Overall, we expect oil and gas to remain the largest contributor to supermajors' cash generation for many years. Striving for improved efficiency, through digitization and other means, is therefore critical. These measures can include efforts to reduce scope 1 emissions from the production processes themselves. Some companies, including ExxonMobil, are developing carbon capture and storage technologies (CCS). These can remove a cause of global warming, the CO2, without rendering the fossil fuel unburnable. CCS at a gas-fired power station could likely also work for a coal-fired generator.

We believe it is appropriate for companies to test adjacent energy markets and business models at a manageable scale. These can include expanding power trading operations, deploying electric vehicle recharging facilities to maintain traffic at retail sites, direct investment in renewable power generation, and commercialization of hydrogen. We see the size of investments to date outside traditional oil and gas activities as affordable. Some of the largest to date have been Total's SunPower Corp. and Saft Groupe acquisitions. In some respects, BP's steps into solar two decades ago were just too early. This shows the difficulty of developing and delivering the right offering in the right place at the right time. From a credit perspective, some modest investments by a supermajor in an existing renewables or battery business could be preferable to a similar sum invested in riskier exploration. The specific details are critical, but a lower-risk and lower-reward profile from renewables might be strategically appropriate. Developing scalable businesses that are complementary or do not diminish the integrated group's credit strengths as a whole, however, is a considerable challenge. The difference in scale between many renewable projects or ventures and the existing businesses and supermajors' balance sheets is a partial protection against the risk of transformative acquisitions having a material impact on ratings.

Table 3


As the energy mix changes, newer business models across power generation and energy distribution, including transport, might or might not succeed, but it is difficult to conclude today that they will have equally robust business characteristics, on the scale of the majors' existing operations. Specifically, companies' plans are generally steering clear of regulated utility activities. These businesses can have strong credit profiles but are typically asset-intensive with low returns. Merchant activities entail greater market risks, compared with regulated power generation, although the majors have more experience managing commodity risks. It may be that the majors and supermajors, with their scale, have project management processes and access to low-cost capital, so are better placed than others to evolve into new energy companies, still meeting the world's changing energy demands. However, this is not clear either in terms of strategies or credit implications. In addition to the nature of the businesses themselves, ratings could also be affected by debt-financing used to improve equity returns (see table 3).

The differences in supermajors' strategic responses are already remarkable, and we anticipate strategies will continue to evolve in response to market conditions and lessons learned. In the coming years, there may be write-downs of renewable or non-oil and gas assets. But it will probably be some time before these assets are large enough to permit impairments of the order of magnitude that companies are reporting on their oil and gas assets.

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Simon Redmond, London (44) 20-7176-3683;
Secondary Contacts:Carin Dehne-Kiley, CFA, New York (1) 212-438-1092;
Paul B Harvey, New York (1) 212-438-7696;
Ivan Tiutiunnikov, London + 44 20 7176 3922;
Thomas A Watters, New York (1) 212-438-7818;

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