What A Carbon-Constrained Future Could Mean For Oil Companies’ Creditworthiness
Carbon Tracker and Standard & Poors have been working together on the implications of carbon constraints for credit ratings of the oil and gas sector.
The effect of limiting emissions translates into a peak demand situation. This has knock on effects for fundamentals such as the price and volume of sales going forward:
- Adjusting the price and demand assumptions to reflect lower emissions levels results in risk of downgrades for pure oilsands operators.
- This scenario puts pressure on cashflows which may result in dividends being cut or projects being cancelled.
- But more fundamentally it questions the business model going forward of investing more capital in tarsands.
- The three oilsands operators analysed have issued US$13.6 billion of corporate bonds, with over 50% of these maturing post-2020. The companies may find a very different context to try and refinance any of the debt which matures in the next few years. The uncertainty around the bonds which mature out to 2042 is not reflected in the current short outlook of a 3-5 year credit rating outlook.
- This research shows that credit ratings need to start looking at alternative futures, as a carbon constrained world will not see past performance of this sector be repeated.
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Michael Wilkins, head of environmental finance at Standard & Poor’s, said ‘Financial models that only rely on past performance and creditworthiness are an insufficient guide for investors. By analysing the potential impact of future carbon constraints driven by global climate change policies, our study shows a deterioration in the financial risk profiles for smaller oil companies that could lead to negative outlooks and downgrades. However, the effect on the majors would be more muted‘.
James Leaton, Carbon Tracker’s research director, thinks ‘Bringing in emissions ceilings has clear implications for the future fundamentals of the sector – demand and price. The uncertainty around the future of carbon intensive fuels needs to be translated across credit analysis of business models going forward‘.
Simon Redmond, a director in S&P’s oil and gas team, said ‘Rating or outlook changes seem unlikely in the very near term, as the scenario is not materially different from the current price deck assumptions. However, as the price declines persist in our stress scenario of weaker oil demand, meaningful pressure could build on ratings. First the relatively focused, higher cost producers, and then also more diversified integrated players, as operating cash flows decline, weakening free cash flow and credit measures, and returns on investment become less certain and reserve replacement less robust‘.
Vicki Bakhshi, Associate Director of F&C Investments believes ‘This report clearly demonstrates the value of integrating environmental, social and governance (ESG) issues into credit analysis. At F&C we believe that factors such as climate change and environmental regulation can impact on the performance of the companies we invest in. S&P’s report is very welcome in helping us to identify where the risks lie within the global oil sector, and ensuring that they are integrated into our investment analysis‘.
For further information on how credit ratings work and relevant information visit here