Sunday, July 25, 2010

Trying to Decipher Oil Majors’ Debt Ratings

Last month, BP’s image and shares were not the only things taking a plastering. Its bonds, due for repayment in 2013 were nearly downgraded to junk status trading at a price of less than 90 cents in the dollar. Given BP’s asset base, even if the ultimate cost of the Gulf of Mexico clean-up and legal costs amount to US$50 billion, there is not a cat in hell’s chance of the company defaulting on its debt obligation unless the oil price plummets dramatically. So quite frankly, the development was a load of rubbish which piled up owing to media pressure.

Now, it gets even more interesting. Following, BP’s asset sales to the tune of US$7 billion, Moody's cautiously placed the asset purchaser Apache Corporation’s ratings, including its A3 senior unsecured ratings, under review for downgrade on July 21st. However, Its P-2 commercial paper rating is not under review.

The ratings agency observes that while substantial existing cash and equity will fund the BP transaction, the: “leverage is amplified by the fairly low proportion of production and producing reserves relative to the price paid for the BP assets (by Apache), the corresponding substantial proportion of undrilled yet-to-be-funded proven undeveloped reserves and probable and possible acreage, the pending $3.9 billion acquisition of Mariner Energy and the June closing of its $1.050 billion acquisition of Devon Energy properties.”

Overall nearly US$5 billion of Apache’s rated debt is affected. Moody’s says that if Apache were to be downgraded, it would be no more than one notch. The principal methodology used in rating was the Independent Exploration and Production (E&P) Industry rating methodology published in December 2009.

I have reason to question the knee-jerk reaction of the markets to BP’s debt and but can find no reason to question Moody’s downgrade – except that caution has prevailed following the financial tsunami of 2008. Furthermore, a “who’s to say what might happen” sentiment is doing the rounds in the city of London. We’ve said time and again – from Enron to Lehman – that they were too big to fail. BP won’t fail, but the sentiment does not help and permeates across the oil and gas sector, with agencies being stricter than ever. Ratings agency, at the present moment in time are damned if they do and damned if they don’t. They’d rather “do” then “don’t” seems to be the consensus.

In a speech at the British Bankers Association (BBA) International conference that I attended on July 13th, Deven Sharma, President of Standard & Poor's, said that the industry realised the issue of transparency and accountability. He added that sound, consistent oversight of ratings firms will help build confidence in ratings, which has clearly been affected by the crisis.

However, Sharma also noted that, "Most of our ratings during the last three years have performed broadly in line with previous periods of economic stress - including our ratings of corporates and sovereigns globally and our ratings of European structured securities. However, the performance of our ratings on US mortgage-related securities clearly has been disappointing, which we very much regret."

Sharma said serious steps are being taken to address the scenario through major changes to ratings process and analytics. "S&P's aim is to make our ratings more forward looking, more stable and more comparable across asset classes," he added. We hope so too Sir!

© Gaurav Sharma 2010. Photo courtesy © Cairn Energy Plc

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