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Here’s Why Royal Dutch Shell plc Was Downgraded By S&P

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According to S&P, the softness in crude oil prices and significant capital expenditures, despite recent spending cuts, have weakened Shell’s financial risk profile, which is reflected in the ratings downgrade.

By: MICHEAL KAUFMAN: Jul 22, 2015 

Standard & Poor’s (S&P) has downgraded the credit rating of European oil major Royal Dutch Shell plc (ADR) (NYSE:RDS.A) by one notch, according to a note released Tuesday. The credit rating agency has lowered the long-term corporate credit rating for Shell from AA to AA-, while affirming a short-term rating of A-1+.

“We removed the long- and short-term ratings from CreditWatch, where we placed them with negative implications on April 9, 2015,” S&P said in the note. According to S&P, the softness in crude oil prices and significant capital expenditures, despite recent spending cuts, have weakened Shell’s financial risk profile, which is reflected in the ratings downgrade.

The current credit rating does not account for the planned acquisition of UK natural gas company BG Group plc (ADR) (OTCMKTS:BRGYY), as the transaction has not been completed yet. Completion of the deal is subject to regulatory approval from international authorities, including China’s Ministry of Commerce. Moreover, it requires shareholders’ approval as well.

The outlook has been maintained at Negative, reflecting potential for further downward revisions to the rating. If the acquisition of BG Group is finalized and weighs on the company’s credit metrics, Shell may face another one-notch downgrade, according to analysts at S&P. This is mainly because the acquisition is partly funded by net debt, which leaves leeway for adverse effects on the company’s credit metrics.

The transaction is expected to complete during early 2016, followed by a rating affirmation or downgrade by S&P. The rating agency’s assessment will depend on the conditions in the energy sector at the time of the deal’s conclusion, S&P’s own outlook on crude oil and natural gas prices, and other actions that Shell may take in the meantime to improve its credit situation.

S&P now expects lower funds from operations (FFO) to debt ratio during 2015 to 2017, with the ratio not meeting the 60% threshold to qualify for an AA rating until at least 2017. Expectations of a low ratio can be attributed to weak oil prices. S&P is assuming Brent crude oil to hover around $55 per barrel for the remainder of 2015, average $65 per barrel in 2016 and $75 per barrel thereafter.

S&P assess the company’s financial risk profile as “intermediate,” while it previously viewed it as “modest.” It reflects expectations of core FFO to debt ratio to stay around 45%.

On a more positive note, however, S&P continues to view Shell’s business risk profile as “excellent,” reflecting its status as one of the largest integrated oil and natural gas companies in the world. S&P has cites Shell’s “massive, globally diversified exploration, production, and liquefied natural gas (LNG) operations, as well as significant global downstream operations.”

Shell’s measures to address the challenges faced by the integrated oil and gas sector, signified by a slump in crude oil price, are viewed positively by S&P. The measures include reintroduction of scrip dividends to lower cash dividends, and the suspension of share buyback program for the time being. Instead, the company is focusing on asset disposals and capital expenditure reduction, to improve its financial outlook.

Following the downgrade, Shell stock is trading lower today. Its American depository receipt (ADR), which trade on the New York Stock Exchange, are currently trading 1.58% lower at $56.13 as of 8:44 AM EDT.

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