During the last energy boom, American drillers plowed into mountains of readily available debt as they capitalized on investors and financiers willing to bet on the premise that fracturing operations could be much cheaper and more efficient than conventional drills. Predictably, the bubble finally burst, leaving plenty of deer in the headlights after going into debt to the tune of over $200 billion. Unsurprisingly, hundreds were forced to file for Chapter 11 before the global energy crisis finally comes to their rescue.
Unlike previous oil and gas booms, the U.S. oil sector this time exercised better capital discipline, paying down debt and returning excess cash to shareholders through dividends and share buybacks. In fact, they’ve gotten quite adept at getting out of debtor’s prison: a significant number of energy producers are on track to meet or exceed debt reduction targets within a year and half.
According to estimates by analysts interviewed by Market knowledge earlier in the year, the net indebtedness of companies in the S&P Oil and Gas Exploration and Production Index will have been cut by $100 billion — or almost half — between 2020 and the end of 2022.
A costly debt
There is yet another reason that debt levels in the US oil sector are plummeting: higher interest rates.
Rising interest rates have raised the cost of borrowing quite dramatically and forced companies to reduce their issuance of new bonds. In fact, it has become a global trend and affects many sectors: global corporate debt has fallen for the first time in eight years, the United States corporate net debt down to $8.15 trillion over the past year, from a high of $10.5 trillion.
Two years ago, at the height of the Covid-19 pandemic, businesses took advantage of low interest rates to borrow enough money to survive the pandemic. But with the prospect of higher interest rates, companies used their cash flow to pay down debt rather than shoulder the higher interest charges. In addition, many of these loans will take years to mature.
For instance, just $1.5 trillion in corporate debt in developed economies will mature over the next two years. Meanwhile, oil and gas drillers have mostly kept spending flat for the past two years as commodity prices rose, leaving them with extra cash to pay down debt and reward shareholders with higher dividends. . This kind of discipline has succeeded in convincing investors that oil and gas companies have become greedy stewards of capital despite their history of spending heavily on production growth when times were good.
Related: What to expect for Q3 Energy earnings
That’s a good thing because analysts are now predicting shareholder returns could jump in the energy sector as companies that were previously preoccupied with paying down debt start pouring more money into dividends and share buybacks.
According to a recent report from credit rating giant DBRS Morningstar, oil and gas companies are well positioned to navigate the current inflationary environment, a potential economic slowdown and rising interest rates.
“The main reason is the fact that they have deleveraged so much over the past two years that balance sheets are better today than they have been at any time in the past decade.said Ravikanth Rai, vice president and analyst at DBRS Morningstar.
Demand for energy stocks will ‘significantly increase’
According to Truist analyst Neal Dingmann, investors seem ready to start buying energy stocks again as profits start to roll in, and also because the sector remains cheap. Dingmann says he believes “demand for energy stocks is about to increase dramaticallyas earnings reports come in.
While the analyst expects around a third of the companies he covers to report Q3 free cash flow below Q2 levels, he notes that FCF returns will still be among the highest of all groups, which will make the sector even more attractive.
The energy sector has delivered bumper profits in the current year, with major oil companies setting records left, right and center. ExxonMobil (NYSE: XOM), Chevron (NYSE: CVX) and Shell (NYSE:SHEL) together generated $46 billion in second-quarter earnings, with all three setting new quarterly earnings records.
The energy sector is expected to post the strongest earnings growth of all 11 sectors in the US market at 119.4%. Higher year-over-year oil prices contribute to the year-over-year revenue improvement for this sector, as the average price of oil in Q3 2022 ($91.43) was higher 30% to the average price of oil in Q3 2021 ($70.52). ).
At the sub-industry level, the sector’s five sub-industries are expected to post a year-over-year revenue increase of more than 20%. The energy sector is also poised to be the leading contributor to S&P500 profit growth for the third consecutive quarter. If this sector were excluded, the index would show a 4.9% revenue decline rather than a 1.6% revenue growth.
By Alex Kimani for Oilprice.com
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