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

Mainly About Fund Managers & BP

Do some mutual fund managers know something about BP that we don’t or rather the wider market does not?

The answer is a flat ‘no’. Following the Gulf of Mexico oil spill which began on April 20th, BP’s market value has declined 40%. All what these guys did was not react to the headlines. That is simply because they saw an opportunity based on the conjecture that BP is too big to file for a US Chapter 11 bankruptcy (even if it wanted to).

One contact of mine in the industry says, “When others panic we don’t. On the contrary we see value in a cheap stock because let’s face it - BP is not going to go bankrupt despite all the garbage in the popular press. Four weeks ago its stock was as cheap as it can get.”

There is a thought process behind all this. To begin with, the crude oil price has averaged US$78 a barrel for the first six months of the year and many in the market believe it will end the year above the US$80 mark. Furthermore, the oil giant’s financials indicate that it has been raking in over US$30 billion in operating income each year in recent financial years.

Additionally, BP is methodically making asset sales. It is in negotiations with US developer Apache Corp. with regard to a massive asset sale to the tune of US$12 billion according to UK media reports. Some reports are also naming Standard Chartered as the bank responsible for setting up the oil giant’s crisis fund of US$5.25 billion launched in May.

In a related development, Magellan Midstream Partners announced that it has agreed to acquire certain petroleum storage and pipelines for US$339 million, including about US$50 million in inventory from BP Pipelines (North America) Inc. Moody’s notes that the move will not impact Magellan’s Baa2 senior unsecured debt ratings and stable rating outlook at this time. Its rating has stayed at Baa2 since March 5, 2009.

Meanwhile BBC news has just reported that BP has temporarily stopped oil from leaking into the Gulf, pending further tests. A spokesman confirmed that further work is being carried out. Elsewhere political pressure continues to mount on the oil giant as US media reports suggests it could potentially be hit with a 7-year drilling ban.

Away from the oil spill, uncertainty off the Falkland Islands continues as shares in Falkland Oil & Gas fell sharply after the company said it would give up on one of its oil wells – Toroa – off the coast of the South Falklands.

Despite its optimism in May when it started drilling, the company now says there are no hydrocarbons there and it will plug the well. However, it said that it still hoped there was oil in the area. In June, Rockhopper Exploration said it was looking to raise US$75 million after striking above-expectation reserves of oil in the region. A number of the small scale UK oil & gas upstarts are searching for oil in the Falklands, despite strong opposition from Argentina.

Argentina and UK went to war over the Falkland Islands in 1982 after the former invaded. UK forces wrested back control of the islands, held by it since 1833, after a week long war that killed 649 Argentine and 255 British service personnel. The Islands have always be a bone of contention between the two countries. The prospect of oil in the region has renewed diplomatic spats with the Argentines complaining to the UN and launching fresh claims of sovereignty.

© Gaurav Sharma 2010. Logo courtesy © BP Plc