European integrated oil and gas companies have largely adapted to lower oil prices and most of them should be able to broadly balance their sources and uses of cash in 2017-2018, Fitch Ratings says. This improved outlook is reflected in the rating actions we have taken in the past few months. Since the beginning of the year we have revised Outlooks on Total, OMV and Repsol to Stable from Negative; and BP’s rating has been affirmed with a Stable Outlook.
Eni and MOL are also on Stable Outlook. Royal Dutch Shell is the exception – its ‘AA-‘ rating has been affirmed but the Outlook remains Negative as the company’s debt remains high following the acquisition of BG. We expect Shell’s FFO-adjusted net leverage to decline from 2.8x at end-March 2017 to 1.8x by end-2019 on continued cost-cutting, disposals and gradually recovering oil prices. However, the Negative Outlook reflects the risk that weaker-than-forecast oil prices, high cash dividends or a resumption of share buybacks could limit deleveraging.
Our forecasts for other European integrated oil companies show that their leverages should be comfortably below the point at which we may consider negative rating action in 2018-2019. Most companies with higher upstream exposure had leverage above these levels in 2015-2016, but we rate through the cycle and put more emphasis on 2018-2019, when we expect the cycle to be well on its way to normalising. Integrated companies have managed to significantly reduce their opex and capex, benefiting from weaker currencies and cost deflation, but also through simplification and cost-cutting.
BP and Total, which have greater upstream exposure, also introduced scrip dividends, which allowed them to significantly reduce cash payouts. Disposals have been another important part of the response, particularly for Shell, which has committed to raise USD30 billion through assets sales. Of this, USD20 billion has already been realised or announced and a further USD5 billion is in advanced stages, with 1.5 years of the programme remaining.
All these measures have allowed integrated oil companies to significantly reduce negative free cash flows. We estimate that the cumulative negative free cash flow of seven Fitch-rated integrated players, after dividends and excluding working capital movements, fell to USD6 billion in 2016 from USD21 billion in 2015. Based on our oil price expectations, we estimate that the cumulative deficit will continue to shrink in 2017 and should turn positive in 2018.
This is supported by oil majors’ 1Q17 results, with Shell, Total and BP having generated positive post-dividend free cash flows (adjusted for working capital movements). Our base case is for prices of Brent crude to gradually improve from an average of USD52.5 a barrel in 2017 to USD60/bbl in 2019 and USD65/bbl in the longer term. An alternative stress-case assumes USD40/bbl in the long term. If a stress-case scenario comes to pass, ratings of some integrated companies may come under pressure, though rating action is still likely to depend more on the companies’ actions rather than the level of oil prices. We plan to publish more on these topics and other key issues for the EMEA oil and gas sector in a ‘What Investors Want to Know: EMEA Oil and Gas Companies’ report in the coming days.