Small EMEA oil firms’ survival chances vary widely-Fitch Ratings

The ability of European, the Middle Eastern and African (EMEA) high-yield oil exploration and production companies to survive continued significant pressure in 2016 and 2017 varies significantly, Fitch Ratings says. Companies with higher volumes, stronger liquidity, lower production costs and better hedging will be the best placed to survive, the ratings agency Fitch has said.

In a report relased Monday, Fitch said “our preliminary assessment of 10 (mostly unrated) companies in the sector indicates Det norske, Tullow Oil and Premier Oil have the highest credit quality. These three also have the highest production volumes in the peer group. This highlights the importance of scale, which correlates with project diversity, experience in the sector, access to capital markets and the ability to capture economies of scale, all of which are important contributors to credit quality.

“Det norske also has the highest production potential – its merger with BP Norge to create Aker BP should help boost production over the coming years to more than three times Det norske’s 2015 output.

Fitch further said liquidity is another key factor, as demonstrated by the default of Afren last year. Smaller companies are more vulnerable to liquidity problems because of concentrated production, often higher leverage, negative free cash flows and limited capital markets access. The three companies in our peer study with the lowest credit quality – Seven Energy International (B-/Negative), Kuwait Energy (B-/Stable) and EnQuest – all also have below-average liquidity.

Production costs are an obvious differentiator, but become even more important when prices are low and some companies are struggling to cover their operating cash costs. The recent recovery may prove short-lived and we assume Brent prices to average USD35 a barrel in 2016, rising to USD45 in 2017 and USD55 in 2018.

In this low-price environment hedging can help preserve liquidity. The recent oil price increase has reopened the hedging window, so oil companies now have an option to strengthen their hedging position at a reasonable cost. We consider Tullow, Kosmos Energy (B/Rating Watch Negative), Ithaca Energy and EnQuest as better hedged than their peers for 2016.