Tuesday 16 January 2018

Big Oil on a borrowing binge as rates fall

The old adage says that when there's blood on the floor, you buy. So what do oil companies do when their price point is plummeting? They borrow, writes Rakteem Katakey

Oil rigs in the Golf of Mexico. The price of oil has gone through the floor in the past three years
Oil rigs in the Golf of Mexico. The price of oil has gone through the floor in the past three years

Rakteem Katakey

The world's biggest oil companies are borrowing record amounts of money to cope with a slump in crude prices. Luckily, there's rarely been a better time to go on a debt binge.

Exxon Mobil, Royal Dutch Shell, Chevron, Total, BP and Eni have together sold the equivalent of $37bn of bonds this year, about double the amount issued in the period before oil prices plunged, according to data compiled by Bloomberg. While this is stretching their balance sheets and even resulting in credit-rating downgrades, the lowest debt costs in a year are softening the blow.

"They're making hay while the sun shines," benefiting from improved investor sentiment as oil prices have recovered, said Alex Griffiths, a London-based managing director at Fitch Ratings. "Treasurers are making use of good market conditions to maintain liquidity buffers."

Even though oil has increased from the lows of January as a global surplus diminished, prices are still less than half their level two years ago. The world's biggest companies have sought to keep investors happy through the downturn by maintaining dividend payouts and investing for the future at the same time. With profit and revenue sharply down, the only way to do that is borrow more money.

Debt markets are opening up for companies worldwide as central banks in the US and Europe keep benchmark borrowing rates low. Investors currently demand a return of 3.09pc to hold dollar-denominated debt of companies with an investment-grade rating, the lowest level in a year, according to data from Bank of America Merrill Lynch. For euro securities, they seek 1.01pc, close to the record low of 0.93pc in March 2015, the data shows.

Oil companies have further benefited from the recovery in prices. Brent Crude, the global benchmark, has increased 70pc since January, aided by supply disruptions from Canada to Nigeria and falling production in the US. This has seen the 20-company Stoxx Europe 600 Oil & Gas Index rebound 3.8pc in 2016 following two years of declines.

At the same time, the premiums for credit default swaps for the biggest US and European oil companies, which investors use to protect against defaults, have dropped from the highest level in at least five years.

Shell sold $1.5bn of five-year bonds this month, which were priced to yield 1.99pc, data compiled by Bloomberg show. A $2bn five-year debt sold by the company about a year ago yielded 2.13pc on the first day of trading, the data shows.

BP sold $1.25bn of 10-year notes last month with a 3.12pc coupon, versus 3.51pc for a similar issue in March 2015. Both bonds were sold at face value. Chevron issued $1.35bn of five-year notes this month with a yield that was 32 basis points, or 0.32 of a percentage point, lower than a sale in November.

Shell's net borrowing has increased to about $70bn and its gearing (the ratio of net debt to total capital) has risen to above 26pc from 14pc at the end of last year. In addition to the plunge in oil prices, the $54bn acquisition of BG Group added to Shell's debt, prompting Fitch to cut the company's credit rating in February. BP's gearing was 23.6pc at the end of the last quarter compared with 21.6pc in December. "The majors still have strong balance sheets to raise debt at competitive rates so they can manage their capital agenda, for example, to maintain dividends and strategic capital investments," said Jon Clark, leader for oil and gas transaction-advisory services in Europe, the Middle East and Africa at Ernst & Young. "It's also a good opportunity to refinance more expensive debt."

Oil's slide has forced companies to cut billions of dollars of spending, delay or cancel projects and renegotiate contracts - yet they continue to make dividends their top priority. 

Shell hasn't cut its payments to investors since at least the Second World War. Exxon even increased its payout a day after losing its coveted AAA credit rating last month. 

Shell, BP, Eni, Total, Exxon and Chevron will together pay out about $14bn for the first quarter, according to data compiled by Bloomberg. Some of those companies may pay a portion of these dividends in shares rather than cash.

Jim Chanos, founder of Kynikos Associates, said on Thursday that he is shorting Shell and Chevron's shares because they have negative free cash flow and are relying on borrowed money to pay dividends.

"What that means is the CEOs have convinced the boards that they should borrow to pay their dividend," Chanos said in an interview with Bloomberg. "How long that will be sustainable, we don't know."

Last February, BP chief executive Bob Dudley said he was happy to let the company's debt rise this year to maintain dividends.

Debt and gearing is "something that I might lose sleep about, but not just yet," Shell's CFO Simon Henry said earlier this month.

"You've recently seen an easing of bond market risk aversion and a higher oil price," Fitch's Griffiths said. "That makes it a good time for Big Oil to tap the market."

© Bloomberg

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