The harder they come, the harder they fall…
All - Oct 24 2018
One of the main drivers of innovation in the Beyond Ratings methodology of sovereign risk assessment is the weight given to energy determinants. In this respect, we adopt a multidisciplinary and holistic approach to risk that has led us to deal with the shale revolution in the United States through its different dimensions, financial, macroeconomic and geopolitical.
For more than three years, we have been considering that the recurrent and massive nature of the negative cash flows of the entire sector is an anomaly whose repercussions are extremely profound, as evidenced by the analysis developed in a series of Insights “Shedding light on the current state of the oil market and geopolitics: a tribute to Calouste Gulbenkian”, published on December 10, 2015 ; « Mitigating the impact of energy on the economic cycle: shale oil & gas not the game-changer », published on February 9, 2017 ; “From economy to geopolitics: the far-reaching implications of quantitative easing monetary policies”, published on January 18, 2018 ; « Intense news flow over energy resources in international relations calls for upgrade of risk methodologies”, published on February 22, 2018 ; “Interest rates normalization and the US tax reform are changing oil perspectives”, published on March 8, 2018.
The analysis of Beyond Ratings is not only already largely confirmed by the facts, but it seems that it is now also by the evolution of the position of institutional actors. The International Energy Agency quietly, in the middle of the summer, took note of the financial situation of the shale sector in the United States . « Since its inception, the industry has been characterized by negative free cash flow as expectations of rising production and cost improvements led to continuous overspending in the sector.”. It is true that it certainly became embarrassing for the IEA to ignore the feeling of distrust now voiced by investors. This position is a major development because, on the one hand, of the fact that the IEA has so far magnified the "shale revolution" without any critical analysis and in defiance of the fundamentals of the oil and gas industry, and on the other hand the IEA occupies a position of leading prescriber, by its analysis and scenarios, on a large part of the industrial and financial sectors in the world. The IEA thus recognizes the orders of magnitude of the industry's huge cumulative losses of 200 billion USD over the last five years, which are fully consistent with the 300 billion USD figure put forward by Beyond Ratings over the 2008-2017 period. The IEA, however, maintained an optimistic outlook as recently as July 26, 2018, expecting to see positive cash flows for the first time in 2018, in the wake of the rise of the price of oil. “Over the last few months, the industry as a whole has seen a notable improvement in financial conditions, though the picture varies markedly by company, and the overall health of the industry remains fragile. Several companies expect positive free cash flow based on an assumed oil price well below the levels seen so far in 2018 […]. On this basis, we estimate that the shale sector as a whole is on track to achieve, for the first time in its history, positive free cash flow in 2018. This result is all the more impressive given the context of rising investment.” Alas, a recent study confirms that this is still not the case. The analysis of a selection of 33 oil and gas companies active in the exploitation of parent rock hydrocarbons in the United States, among those that can be assumed to be the most efficient, shows that their combined cash flows were negative as high as 4 billion USD in the first half of 2018 and, as an aggravating factor, « these companies also depleted 5 billion USD in cash reserves to keep capital projects on track while sustaining distributions to investors ».
We are justified in taking up and reinforcing the arguments we have developed in recent years. The equilibrium of the world energy complex is much more precarious than the complacent presentation that has been made for almost 10 years by the majority of analysts. The rise in the price of oil in 2018 is explained by the normalization of the short-term equilibrium measured by stocks but we formulate the hypothesis that this trend includes a factor of anticipation that the real marginal cost is significantly higher than 100 USD, reflecting both industrial and geological fundamentals but not the distortion of financing flows resulting from unconventional monetary policies. This assumption is the seed of a broad reassessment to come of sovereign risk by markets, affecting both exporting and energy-importing countries.
1 - Investment Analysis: The journey of US light tight oil production towards a financially sustainable business. International Energy Agency.
Olivier Rech, Head of Energy and Climate Research - Sources : IEEFA, IEA, Beyond Ratings