Why Big Oil Companies Are Courting Good Credit

Ever since U.S. oil production began its resurgence several years ago, oil and gas giants have continually increased their capital expenditures, each year spending billions of dollars more than the last. ExxonMobil (NYSE: XOM  ) , for instance, spent $36.76 billion in 2011, $39.80 billion in 2012, and $42.50 billion in 2013. The same upward trend holds for Chevron (NYSE: CVX  ) , which spent $29.06 billion, $34.23 billion, and $41.90 billion in capital expenditure in 2011, 2012, and 2013 respectively.

Why have oil bigwigs increased their spending so much?

The cost of finding and producing unconventional oil and gas is much higher than the cost of finding old conventional resources. This is because applying technologies such as fracturing and horizontal drilling is costly relative to traditional methods. Similarly, integrated oil players, such as ExxonMobil, and midstream players, such as Enterprise Products Partners  (NYSE: EPD  ) , need relatively higher amounts of capital each year to meet the high demand for transport and storage infrastructure in the oil sector.

As is, the mismatch between the oil being produced domestically and the infrastructure needed to support these increasing volumes is as wide as the gap between the rich and the poor. Despite efforts by midstream players and integrated oil companies to fill this gap, a capital investment of more than $200 billion is needed by 2035, according to a recent study by Deloitte.

Debt: a viable financing option
To furnish the ever-increasing capital expenditures, big oil companies are turning to external sources of capital -- debt and equity. However, the latter is losing its luster.

Because of low natural gas and oil prices, big oil companies are suffering thinning margins. The price of the product is simply not high enough to accommodate the ever increasing cost of production. In the fourth quarter of 2013, for instance, ExxonMobil saw its upstream volumes reduced by 1.8%, reflecting the reduced incentive to produce a product that doesn't bring in sustainable profit. Chevron, on the other hand, saw its full year 2013 earnings come in at $21.4 billion, down from $26.2 billion a year earlier.

This slow growth in earnings as well as production has kept away some equity investors, placing a drag on upward share price movement, and in effect limiting big oil companies' ability to raise sufficient capital through equity. Similarly, thinner margins limit the capital that can be returned to shareholders through dividends and share buybacks.

ExxonMobil presents a good case in point. It has scaled back on its signature share repurchase program, which over the past decade has reduced shares outstanding by more than 30.5%. ExxonMobil cut back the value of repurchases from around $5 billion in Q1 2013 to $4 billion in Q2 2013, and just $3 billion in Q3 and Q4. This is despite the earlier figure of around $5 billion having remained unchanged for the preceding ten quarters.

The outlook for equity will remain low -- at least until oil prices increase. While the consensus is that oil prices will increase in the long term, it is highly unlikely for that to happen this year. It is an election year, and the folks over at Capitol Hill won't risk their careers by accommodating an energy policy that is out of touch with the average American. In consideration of this, big oil companies are no longer as confident in equity as source of capital. In response, they have made plans, all along knowing this day would come.

Most big oil companies have put internal controls in place to ensure impressive credit ratings. ExxonMobil has a rating of AAA from all major rating agencies (Moody's, Standard & Poor's, and Fitch), the highest designation, and better than most governments in the developed world. Chevron, on the other hand, has a rating of AA from S&P and Aa1 from Moody's, both of which are impressive.

Enterprise Products Partners had a rating of BBB+ as of October 2013. Although lower than Chevron and ExxonMobil, it is the highest in the master limited partner (MLP) space. 

These three players' debt-to-equity ratios also provide some insight.

Company

Debt-to-Equity Ratio (quarterly) as at December 31 2013

ExxonMobil

0.1253

Chevron

0.1277

Enterprise Products Partners

-50.19

Source: Ycharts

The debt-to-equity ratios are reflective of the trends in the sector. ExxonMobil and Chevron both have low ratios, showing that they are not as highly leveraged and that they can take on far much more debt in the future. To sweeten the pot, they both have impressive credit ratings essential to taking on this needed debt.

Enterprise Products Partners, being in the midstream sector, needs more capital to meet the gaping infrastructure gap. Its high debt levels, signaled by the negative debt-to-equity ratio, reflect the amount of debt it has taken so far to meet high infrastructure demand -- negative debt-to-equity ratios are typical of MLPs. However, it has the best credit rating in the MLP sector and will be able to take on even more debt going forward.

Takeaway
Now would be a good time to look at debt instruments being offered by oil bigwigs. The yields are likely to be attractive because of their desperate need for capital as well as the Fed's bond buying taper, which has placed an upward pressure on interest rates, prompting seekers of credit to increase their interest rates to make their debt securities more attractive in order to tap into the limited pool of external capital. 

How you can profit from rising energy spending
Imagine a company that rents a very specific and valuable piece of machinery for $41,000... per hour (that's almost as much as the average American makes in a year!). And Warren Buffett is so confident in this company's can't-live-without-it business model, he just loaded up on 8.8 million shares. An exclusive, brand-new Motley Fool report reveals the company we're calling OPEC's Worst Nightmare. Just click HERE to uncover the name of this industry-leading stock... and join Buffett in his quest for a veritable LANDSLIDE of profits!

 


Read/Post Comments (0) | Recommend This Article (1)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2836486, ~/Articles/ArticleHandler.aspx, 11/23/2014 4:35:56 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement