For years, oil and gas companies have struggled to win over investors, largely because of the energy sector’s notoriously volatile history, marked by boom-and-bust cycles and sometimes frightening levels of debt . You might think that the pandemic and the resulting turmoil in energy markets would only make things worse, but the chaos actually forced E&Ps to get their finances in better order and, in many cases, to acquire other companies or be acquired themselves . Financial discipline and consolidation brought another benefit: significantly improved credit ratings, which have the side effect of making companies even more attractive. In today’s RBN blog, we discuss the forces behind and the significance of the improvement in credit ratings that resulted from this massive wave of consolidation.
Let’s break it down. Businesses need money to grow, right? And where do they get it? Capital markets are a primary source of funding, which is primarily used to fuel capital project activity. And this is where credit ratings come into play: the better a company’s credit rating, the more likely they are to attract capital investment into their business and the cheaper it will be to borrow money. In other words, it’s a win-win situation. Companies can continue to grow and investors can get higher returns. But if a company can’t compete in the capital markets, its future plans are toast. Oh, and let’s not forget the change in investor sentiment. Investors these days want consistent returns. The oil and gas industry has always been a wild ride, which has caused some investors to move away from it and put their money into more stable industries. But guess what? The industry is changing its outlook, recently focusing on regular dividends, share buybacks and other financial programs to attract investors. And you know what helps with that? Yes, you got it: higher credit ratings.
Let’s start with the basics. Credit ratings are kind of like report cards for business finances, except they’re also forward-looking. They help you assess how likely a company is to pay its debt in full and on time. There are three main credit rating agencies: Standard & Poor’s (S&P), Fitch Ratings and Moody’s Investors Service. S&P is the biggest, so we’ll focus on them. Just like in school, these agencies give companies a letter grade. The credit rating, or rating, reflects the agency’s view of how likely a company is to meet its financial obligations. The best grade is AAA, but unfortunately, there is no oil and gas company that makes the AAA league anymore. (ExxonMobil used to be there.) Industry giants like Shell and ExxonMobil are AA-rated, meaning they have only a small chance of default (less than 0.01%, to be exact). The worst credit rating is D, which means the company has already gone under. (The ratings may also have plus or minus signs, indicating a slight improvement or slight decrease in the stand-alone letters.) Although all credit rating agencies provide similar terminology to describe creditworthiness, they sometimes have slight differences in the way they convey grades. It can be a little confusing, but look at Figure 1 for all the details. For example, a BBB+ rating from S&P is comparable to a Baa1 rating from Moody’s.
