After more than a year since we last hosted our annual Rating Agency Energy Panel Discussions in Calgary, Mizuho’s team was thrilled to be back with a hybrid in-person and virtual event on March 17th. This was the fourth installment of our incredibly popular series that brings together energy analysts from Moody’s, S&P, Fitch and DBRS’s upstream and midstream teams to discuss the state of energy markets and the outlook for credit quality across the industry. With markets experiencing disruptions on a scale not seen in decades as a result of Russia’s invasion of Ukraine, we had plenty to talk about over the course of our two-hour session, hosted by Michael Gorelick, Mizuho’s Head of Ratings Advisory for the Americas.
Our last session in October 2020 took place in the shadow of a still out-of-control pandemic, dramatic declines in global energy demand, historically weak crude oil and natural gas prices, and severe credit stress across the industry. In contrast, this year’s meeting occurred with the backdrop of Russia’s aggression in Ukraine resulting in surging energy prices and companies flush with excess cash flow. As a result, rather than concentrating on fallen angels and weak corporate liquidity, this year’s focus was on rising stars, prospects for production growth and the adequacy of infrastructure investments to keep up with shifting energy flows. The following are some of the key takeaways from our discussions:
- Commodity Price Surge Expected to Result in Further Improvements in Credit Quality and Higher Shareholder Distributions for Upstream Companies: Elevated commodity prices as a result of potential Russian supply disruptions have resulted in the agencies increasing their near-term oil and gas price assumptions, while their long-term/ mid-cycle assumptions have generally remained unchanged. As companies benefit from higher near-term prices, capital allocation decisions are likely to be the primary drivers of future rating actions. Companies still in the process of repairing their balance sheets may be able to accelerate upgrades with faster debt reduction than previously expected. At the same time, companies that had already restored debt to target levels should not expect pressure on ratings as they seek to return excess cash to shareholders.
- Upstream Capital Discipline Expected to Hold, Limiting Midstream Growth Opportunities: Despite elevated commodity prices, agencies expect the “contract” made between upstream energy companies and their shareholders in recent years to hold such that issuers will continue to prioritize shareholder returns over growth. Supporting this expectation, the agencies noted very limited excess oil and gas takeaway capacity from key producing basins across North America, together with the difficulty in permitting new pipelines, as further reinforcing producer discipline. The midstream panelists echoed this sentiment, noting that with asset lives of 40-50 years, midstream energy companies are unlikely to make large capital expenditures to develop pipelines and related infrastructure absent long-term contracts substantiating underlying demand and anchoring project cash flows. As a result, growth opportunities across midstream are much more limited now versus just a few years ago when upstream companies were focused on increasing production.
- Outlook for New LNG Development is More Favorable, But Supply Response Will Take Time: The war in Ukraine has highlighted the risks of excessive EU reliance on imports of Russian natural gas, increased prices and forced European countries to evaluate alternative sources of supply. As a result, the fundamentals are now in place for further development of LNG export facilities in North America, Qatar and elsewhere to serve this demand. Nevertheless, new liquefaction capacity will need to be supported by long-term contracts in order to reach FID, at which point additional supporting investments can also begin to advance, including pipelines and import facilities to receive the LNG cargoes. While the outlook is favorable for projects to move forward, the required commercial agreements and infrastructure will take several years to develop.
- Improvements in Midstream Credit Quality Have Largely Played Out: The midstream sector has evolved considerably in recent years as MLPs and other distribution-oriented entities have simplified their organizational structures, reduced payouts and repaid debt in response to evolving industry dynamics and a limited set of growth opportunities. As a result, many of the larger, investment grade issuers that had been downgraded have now stabilized their credit profiles. There is additional scope for deleveraging among some of the speculative grade midstream issuers, and in a limited number of instances, upgrades may follow.
- Environmental, Social and Governance Risks Attracting Greater Focus: Over the last 1-2 years, rating agencies have begun to publish ESG impact assessments, which break out the degree to which these considerations factor into ratings evaluations. ESG credit impacts are limited for now, however, the agencies are paying attention for signs that these pressures may be growing, as they are expected to do over the intermediate-to-long term. At the same time, energy companies are increasingly publishing targets for reducing their carbon emissions footprints, including plans to consider carbon capture and sequestration. While European companies have taken the lead on investments related to the energy transition, some of the large North American producers may also increase investments in renewables and alternative energy technologies such as green hydrogen.
Conclusion and acknowledgements:
A sincere thank you goes out from Mizuho to all of the panelists, including:
Michelle Dathorne, S&P Global Ratings
Paresh Chari, Moody’s Investors Service
Mark Sadeghian, Fitch Ratings
Ravikanth Rai, DBRS Morningstar
Mike Grande, S&P Global Ratings
Paresh Chari, Moody’s Investors Service
Tom Browsword, Fitch Ratings
Ram Vadali, DBRS Morningstar
Environmental, Social and Governance Discussion:
Michael Ferguson, S&P Global Ratings