Global capital expenditures pared in 2009 among oil producers
Gianna Bern
Brookshire Advisory and Research
The adverse impact of the global recession has taken its toll on capital expenditure spending among energy industry participants. It is the industry's reaction to the worst global recession since World War II and one of the deepest slumps in crude prices. Brookshire's review of over 1,900 industry companies in Asia, Europe, North America, and South America reveals that they, irrespective of geography or size, have indeed pared back investment spending. Brookshire's sample includes large, mid, small, and micro cap energy sector producers and participants on almost every continent.
Supermajors, independents, midstream and pipeline companies, the oilfield service sector, and refiners have all curtailed capital spending in 2009 to a mere 4.7% increase compared to 2008 spending levels. The impact of a retrenchment in investment spending today implies that once economic growth returns to some semblance of normalcy, there could be new supply-related pricing pressures looming in coming years. Brookshire anticipates upwards pressure on crude oil prices returning over the medium term.
Investment rationalization not retrenchment
Since the 1970's, the oil and gas industry has endured many geopolitical crises and much economic distress both regional and global in nature. What remains constant is the industry's ability to persevere and continue to invest in projects with long-term benefits to supply energy to the world's growing population.
While 2009's minimal capital expenditure growth illustrates the industry's reaction to a severe drop in crude oil demand, the energy industry is continuing to strategically invest in projects that offer long-term economic and competitive benefits. Brookshire expects 2010 will be no different. In light of the downturn in crude prices, the global oil supply chain has had to re-evaluate marginal projects and reassess long term strategic plans. That is to be expected. The data depicts an environment where marginal, higher-risk projects are getting shelved.
With natural gas prices recently at some of their weakest levels, many producers are putting projects on the sidelines until an improved economic picture emerges. Similarly, many Canadian oil sand producers have had to wait until crude prices stabilize at $70 per barrel.
Cash flow challenges
The most significant factor behind a global decrease in capital spending is cash flow. Once the downturn in crude prices began in July 2008, after WTI reached a record high of $147.11 per barrel on the NYMEX, growth in cash flow from operations began to decrease. In 2008, growth in cash flow from operations was 14.2% compared to the prior year growth rate of 16.8%. By 2009, throughout the energy sector, there was a collective decrease of 1.9% in cash flow from operations compared to prior year. Undoubtedly, the decrease in crude demand coupled with weak crude and natural gas prices has had an adverse impact on the industry. Overall, virtually all producers are adjusting cost structures where possible and eliminating unnecessary expenditures.
Additional pressures are evident in the industry's return on equity which has similarly decreased by 15.4% and 9.1% in 2008 and 2009, respectively. As the industry endured near 50% decreases in revenues in the second quarter 2009 versus prior year, earnings have in many cases similarly eroded almost 50%. While supermajors have weathered the storm reasonably well, their earnings have been battered. Unsurprisingly some smaller producers have not fared as well. Financial flexibility and a strong balance sheet will continue to be strategic advantages in this environment.
Leverage creep gains a foothold
In addition to earnings pressures, the industry has begun to exhibit increases in leverage as defined by total debt to EBITDA. Over the last several years, leverage has slowly begun to increase. Again, the industry sample that Brookshire reviewed includes supermajors, independents, refiners, and pipelines and oilfield service sector companies. The data reveals industry-wide aggregate leverage ratios increasing to 1.6x in 2009 from 1.3x in 2008. Irrespective of geography or company size, the energy industry is reacting to the downturn in crude prices by tapping credit lines and turning to credit markets.
It is clear that the preponderance of industry participants have chosen to fill budgetary gaps and cash flow needs by tapping credit markets. Most producers have utilized credit markets with favorable results. Supermajors have not incurred obstacles in the international credit markets.
Similarly, most independents and mid cap producers have found market-friendly investors. The results also are clear, balance sheets are taking some hits in the current environment. Brookshire anticipates that there could be additional quarters ahead with cash flow and EBITDA pressures resulting in leverage ratios increasing further. As the industry carries out re-calibrated capital expenditure plans, the capital markets appear to be the funding source of choice among investment-grade producers.
Increases in crude oil prices loom
The most significant impact on today's investment retrenchment lies ahead. As the industry reacts to the extraordinary events of the past year and the global slump in crude demand, investment has indeed been rationalized. Economies such as China, India, and the Middle East should continue to emerge from the global recession and be at the forefront of growth and development. Crude oil demand in OECD geographies such as North America and Europe will remain lackluster. Brookshire anticipates that the ramifications of today's investment rationalization will begin to be felt by 2011 and 2012.
Crude oil prices have nearly doubled since December 2008 to a $65 to $70 holding pattern. Brookshire anticipates that growth in crude oil prices will continue in the coming years as the global recession abates and economic growth begins to return to OECD countries.
Conclusion
The oil and gas industry indeed has universally been affected by and reacted to the downturn in crude pricing. In addition to cutting non-critical expenditures, capital investments have taken a toll. The data reveals that across virtually all geographies, capital expenditure spending has increased a paltry 4.7% in 2009 compared to the prior year. Fiscal year 2009 will continue to exhibit marked decreases in earnings, revenues, and cash flows. While the industry continues to cut costs and react to what is the new normal, capital investment spending is a casualty of the crude oil slump as cash flow pressures prevail.
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