Smaller refining companies that have lower complexity and high debt leverage, such as Alon USA Energy [ALJ], United Refining, and Western Refining (WNR), will continue to struggle with weak margins because they lack the cost advantages of more complex refineries.
In addition, although lower crude oil prices have eased working capital needs, the decrease in the value of crude and refined products will limit the amount refiners can borrow and could limit availability for non-working capital needs. Nevertheless, the unexpected strength in asphalt could provide a cushion to low fuel margins over the summer months.
More downgrades are likely in North American oilfield services and contract drilling
Our 2009 outlook for the oilfield-service and contract-drilling sectors has become increasingly gloomy over the past six months. As a result, we are expecting more negative rating actions. In particular, North American-focused speculative-grade companies could see further credit deterioration -- particularly those with high leverage, tight liquidity, and/or limited headroom under their financial covenants.
Following our oilfield-service sector review in February, we took negative rating actions on 14 companies. Despite largely good fourth-quarter results for the majority of oilfield-service companies, we expect that first-quarter earnings will be where the rubber hits the road. Because a decline in oilfield-service companies' financial performance tends to lag weakening commodity prices, we expect that first-quarter results will illuminate the financial effects of weaker industry conditions over the previous six months.
We expect that the dramatic decline in commodity prices from 2008 highs [particularly for North American natural gas], sharp drops in rig counts, and reduced upstream capital spending levels will translate into weaker service demand and increased pricing pressure. In the U.S., rig counts have declined roughly 50% from their September 2008 peak levels and most independent E&P firms operating in the region have substantially slashed their 2009 capital spending budgets. According to the American Petroleum Institute [API], first-quarter drilling activity in the U.S. has declined to 2004 levels.
In general, we expect prospects for larger and more internationally diversified companies to be relatively better. Rig-count declines outside of North America have been less severe thus far -- down only 8% to 10% from 2008 peak levels. Nonetheless we expect all customer groups [independent, national, and integrated oil companies] to continue to push hard for further pricing reductions.
In a better position to weather the downturn in the short run are investment-grade offshore drillers -- particularly those with long-term contracts for their deepwater units, such as Diamond Offshore Drilling Inc. (DO), Pride International (PDE), Noble (NE), and Transocean (RIG) -- and oilfield equipment providers with substantial backlogs, such as Cameron International (CAM), FMC Technologies [FTI], and National Oilwell Varco (NOV). Still, we expect backlogs, new unit orders, and pricing for equipment providers to continue to erode over the next few quarters until industry conditions recover.
A service of YellowBrix, Inc.
