The rating outlook for North American energy remains negative, reflecting lingering challenges in the exploration and production (E&P) and oil field services/drillers subsectors, according to Fitch Ratings.
The E&P market remains split. In the investment-grade (IG) E&P space, a key theme was one of compression, with most rating actions limited to a combination of a single-notch downgrade and/or a Negative Outlook. Many IG names mitigated rating actions this year by strong self-help measures to preserve credit quality in the face of lower prices, including severe capex and dividend cuts, equity raises, asset sales and deleveraging. Multi-notch downgrades were generally associated with event risk or acquisitions.
At the same time, high-yield E&P defaults have skyrocketed and stood at approximately 30% for E&Ps as of October. Many supports for the lowest rated high-yield credits - hedges, monetizable assets, borrowing base availability - have fallen away. With stricter regulatory trends in energy lending, Fitch believes banks have made their decisions about which credits they are inclined to support, or not. Fitch believes high-yield E&P defaults are close to peaking at the current level.
The pace of cost improvements for US shale-based producers is a key story in the current downturn; efficiency gains and services cost deflation have pushed US shale costs down faster than in the rest of the world, setting the stage for rebounding activity in the US shale patch at lower price levels. A key question in 2017 is how many of these gains the sector can hold onto in a rising price environment. Fitch expects that while some giveback is inevitable, many producers will continue to benefit from the shift toward pad drilling, longer laterals, enhanced completions and other structural efficiencies. These should improve full-cycle economics and cash generation per barrel, all else being equal.
In contrast, we expect any pickup in activity and pricing power in the offshore segment to continue to lag, given the considerable oversupply in the rig market, limited moves to rationalize capacity, and the near-term reallocation of capex budgets to short-cycle shale and away from longer term projects, including those offshore.
The overall sector outlook for North American energy is stable, as a trend of gradually improving fundamentals led to a better pricing environment after lows seen in the first quarter. While oil inventories remain high and global demand is still subdued, a significant supply response in the US (1.0 million barrel per day decline versus the June 2015 peak) emerged. Two years of sharply lower global E&P capex should set the stage for further production declines and stabilization in pricing.
We expect additional ratings stabilization in 2017 as gradually rising oil prices improve metrics. Should a rising price scenario fail to materialize, further rating adjustments may be necessary absent additional corporate actions.