Better Together - Energy Industry Finds Strength, Better Credit Ratings in Post-Pandemic Consolidation

For years, oil and gas companies struggled to win over investors, largely because of the energy sector’s notoriously volatile history — marked by boom-and-bust cycles and sometimes scary levels of indebtedness. You might think the pandemic and the subsequent upheaval in energy markets would only make matters worse, but the chaos actually forced energy companies to get their finances in better order and, in many cases, to either acquire other companies or be acquired themselves. Financial discipline and consolidation provided another benefit: sharply improved credit ratings, which have the knock-on effect of making companies even more attractive. In today’s RBN blog, we discuss the forces behind, and the importance of, the improved credit ratings that resulted from this massive wave of consolidation.

Let’s break it down. Companies need money to grow, right? And where do they get it? Capital markets are a main source of funding, which is largely used to feed capital project activity. And here’s where credit ratings come into play: The better a company’s credit rating is, the greater chance they have of enticing capital investment in their business and the cheaper it is for them to borrow money. In other words, it’s a win-win situation. Companies can keep growing and investors can earn larger returns. But if a company cannot compete in the capital markets, its future plans are toast. Oh, and let’s not forget about the shift in investor sentiment. These days, investors want consistent returns. The oil and gas industry has always been a wild ride, causing some investors to shy away from it and put their money in more stable industries. But guess what? The industry is changing its tune, recently turning its focus to regular dividends, stock buybacks, and other financial programs to lure back investors. And you know what helps with that? Yep, you’ve got it — higher credit ratings.

Let’s start with the basics. Credit ratings are sort of like report cards for companies’ financials, except they’re forward-looking too. They help you assess how likely a company is to pay back its debt in full and on time. There are three major credit rating agencies — Standard & Poor’s (S&P), Fitch Ratings, and Moody’s Investors Service. S&P is the largest, so we’ll focus on them. Just like in school, these agencies give companies a letter grade. The credit rating, or grade, reflects the agency’s view of how likely a company is to meet its financial obligations. The best grade is AAA, but sadly, no oil and gas companies make the AAA league anymore. (ExxonMobil used to be there.) Industry giants like Shell and ExxonMobil are rated AA, which means they are seen to have only a tiny chance of defaulting (less than 0.01%, to be exact). The worst credit rating is D, which means the company has already gone belly up. (Ratings can have plus or minus signs, too, indicating a slight improvement or slight decline to the standalone letters.) While all credit rating agencies provide similar terminology to describe creditworthiness, they sometimes have slight differences in how they convey the ratings. It can get a bit confusing, but check out Figure 1 for all the details. For example, a BBB+ rating from S&P is comparable to a Baa1 rating from Moody’s.