European major oil and gas companies’ 1H16 results indicate they are likely to generate large negative free cash flows (FCFs) for the full year as average oil prices remain lower than in 2015, Fitch Ratings says. This will push up leverage in the near term but we expect cash deficits to fall in 2017 as oil prices start to gradually recover and the majors progress with their cost-cutting initiatives.
Four Fitch-rated European oil majors (Shell, Total, BP and Eni) announced results last week, with all of them reporting lower operating earnings due to weaker oil prices. On average, the majors’ 1H16 per-barrel EBITDAX decreased by 36% year-on-year as the average Brent price fell from USD58/bbl in 1H15 to USD41/bbl in 1H16 and as refining margins moderated. Capex also fell but the decrease was not enough to offset lower cash inflows.
This resulted in average 1H16 pre-dividend and post-dividend FCFs of minus USD5/bbl and minus USD11/bbl, respectively (before working capital movements). These figures suggest that oil majors will find it difficult to balance their cash inflows and outflows until oil recovers to above USD50/bbl, which we expect to happen in 2017-2018. According to our forecasts the majors should significantly improve their cash flow generation in 2017, with the average pre-dividend FCF turning positive and average post-dividend FCF improving to around minus USD5/bbl. This progress should be driven by a combination of slightly higher oil prices, further cost cutting and falling capex.
Large negative FCFs in 2016 means leverage will increase and is likely to be outside the range we normally consider appropriate for current ratings. Eni is the only exception – we expect its leverage to edge down in 2016 and to remain within our guidance, helped by the sale of its Saipem stake.
However, we rate ‘through the cycle’ and concentrate on the projected 2018 figures, when we expect the cycle to be well on its way to normalising. Shell’s (AA-/Negative) and Total’s (AA-/Negative) Outlooks signal that they will have very limited leverage headroom in 2018, while BP (A/Stable) and Eni (A-/Stable) can absorb a more significant leverage increase at their current rating levels.
Disposals remain an important part of the majors’ efforts to balance their cash flows. We expect disposals to cover around one-third of their post-dividend FCF deficit in 2016. Our assumptions on disposals are more conservative than the companies’ guidance as low oil prices and high supply of assets for sale have resulted in a buyers’ market. This means some disposal programmes may not be realised in full.