The energy sector has long been a lucrative sector for all stakeholders. Oil and gas exploration and refining operations have always offered attractive returns and have been one of the favorite industries for investors.
Things have changed drastically in the last two years. The US shale boom revolutionized the world with advance hydraulic fracturing techniques that allowed companies to dig deeper and extract more oil. While the move came in order to satisfy the rising US demand, little did these companies know that it would continue to haunt them.
As production from US increased, the Organization of Petroleum Exporting Countries (OPEC) led by Saudi Arabia was threatened that they would lose market share. Hence the cartel failed to intervene and correct the market in a move to protect its market share. Following OPEC’s decision of maintaining output and the growing US shale industry, the world saw a crude oil supply glut and the commodities crashed significantly.Even after two years, the massive supply glut continues to weigh in on the prices. During Asian trading hours on Friday, as of 2:31 (EDT), the US benchmark for crude oil, West Texas Intermediate (WTI) was down 1.12% at $41.46, while on the other hand its counterpart, the global benchmark for crude oil during the same time was down 1.15% at $43.78 per barrel.
Impact On Big Oil
Initially when the supply glut came into effect, the US oil and gas industry never had anticipated the prices to fall to the levels that they are today. However as prices begin to drop below expectations; the downturn in the industry began. Companies with smaller market capitalizations began to feel the brunt of the oil prices. In the past two years, over 85 companies have filed for bankruptcy.
The repercussions of the low crude oil prices are now creeping into the balance sheets of major oil companies such as Exxon Mobil Corporation (NYSE:XOM), Royal Dutch Shell plc. (ADR) (NYSE:RDS.A), BP plc. (ADR) (NYSE:BP), and Chevron Corporation (NYSE:CVX).
Normally when an industry is in a boom phase and a company takes on leverage or debt, then it turns out to be beneficial for the companies. On the other hand, when an industry is hit by a recession, additional leverage isn’t a good thing as it shrinks their profitability or return on equity (ROE).
The big majors in these two years have taken a lot of debt. According to the data compiled by Bloomberg, the debt loads of these companies have managed to double by 100% to $138 billion.
Another problem for big oil companies is their consistency in paying dividends. Dividends are one of the key metrics that can be used to maintain confidence among investors in a downturn. However this is an additional burden on the company and negatively impacts them. Dividend payouts along with capital expenditures lead to significant cash outlays and leave no choice to these companies but to take on additional debt.
In the last two years, Chevron has seen its debt-to-equity ratio double from 15.22% to 30.40%. Meanwhile in the same period, the return on equity for the company of 13.53% has translated into a loss on equity of 0.49%. Exxon’s debt-to-equity in the same period surged from 11.57% to 25.14%. Return on equity however plunged significantly from 19.67% to 6.14%. BP European integrated oil and gas company also reported a loss on equity of 5.30% declining from a return on equity of 8.77% from the last period. BP’s debt-to-equity rose by 19 percentage points to 59.22%.
As reported by Bloomberg, Virendra Chauhan from Energy Aspects Ltd. indicated that the debt levels for the oil and gas space are rising at a rate of 11.5%, doubling from 5.1% which was in the period between 2009 to 2014.
Business Finance News believes that if the crude environment does not improve in the future, the companies might see a further increase in debt and decrease in profitability. The current fundamentals of the crude market show that a supply glut is still there and would take some time to clear out from the market.
I am David, economist, originally from Britain, and studied in Germany and Canada. I am now living in the United States. I have a house in Ontario, but I actually never go. I wrote some books about sovereign debt, and mortgage loans. I am currently retired and dedicate most of my time to fishing. There were many topics in personal finances that have currently changed and other that I have never published before. So now in Business Finance, I found the opportunity to do so. Please let me know in the comments section which are your thoughts. Thank you and have a happy reading.