S&P: US oilfield services sector outlook looks bleak as E&P companies tighten spending

US exploration and production (E&P) companies are tightening their capital spending belts, and the US oilfield services and equipment sector is getting pinched. In the past year, oil prices dropped to a six-year low (though West Texas Intermediate has rallied a bit to just below $60 per barrel) and natural gas prices have also been hit, leading oil producers to pull back on drilling activity in the Lower 48, according to a report published June 8 by Standard & Poor's Ratings Services.
The report, "Negative Outlooks Prevail For U.S. Oilfield Services Companies Amid The Commodity Price Slump," says that oil and gas E&P companies are delaying and halting some drilling projects, decreasing the number of opportunities for oilfield services companies. As a result, business rivals are cutting prices on existing and new contracts to maintain or improve market share, among other competitive tactics. The end result is that many oilfield services companies will display weaker financial performances and credit quality in 2015, despite layoffs and other cost-cutting measures.
"The bigger, more geographically diverse service providers with multiple business lines and stronger balance sheets will likely outperform smaller, more focused competitors," said Christine Besset, Standard & Poor's credit analyst. "And we believe that market conditions for the US oilfield services industry will remain weak overall for the rest of the year and won't likely recover before the first half of 2016. As such, we are maintaining an overall negative outlook on the sector."
As market conditions deteriorated quickly over the past couple of quarters, Standard & Poor's has lowered more ratings than raised ratings. The downgrade-to-upgrade ratio was 11 to three between June 30, 2014, and May 5, 2015. The negative rating actions have largely reflected Standard & Poor's lower EBITDA and cash flow generation expectations, leading to higher estimates of debt leverage for the next three years. Most negative rating actions were on speculative-grade companies, according to the report.  
Given the bleak industry outlook, Standard & Poor's believes that it is likely that downgrades will continue to exceed upgrades over the next year. As of May 1, Standard & Poor's maintained negative outlooks or negative CreditWatch placements on about 25% of the issuers the company rates in the sector. In terms of ratings distribution, Standard & Poor's rates approximately 80% of issuers "BB" or below, reflecting the limited size and scale of most companies in this fragmented industry. Large companies such as Schlumberger and the-soon-to-be-merged Halliburton/Baker Hughes entity have significant product diversity, exposure to international markets, and economies of scale that should help buffer the downturn in the North American market in 2015.
Smaller companies remain the most vulnerable to downgrades because they will struggle to maintain market share and margins vis-à-vis the larger competitors this year. Standard & Poor's also believes increased merger and acquisition activity is possible because companies might be forced to reorganize in response to a shrinking market. Standard & Poor's expects shareholder-oriented activity and capital spending to moderate this year, with companies preserving cash to weather the downturn.

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