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Royal Dutch Shell: Here’s Why S&P Downgraded Credit Rating

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By Muhammad Ali Khawar on Feb 2, 2016 at 6:49 am EST

Standard & Poor’s (S&P) recently downgraded Royal Dutch Shell’s (ADR) (NYSE:RDS.A) credit rating from “AA-” to “A+,” as a result of the depressed crude environment. Since June 2014, crude oil prices have fallen more than 70%.

The downgrade came just weeks after the S&P lowered Brent crude expectations for the year. Initially, it expected the global crude oil benchmark to trade at around $55 per barrel. However, only last month the firm cut its price forecast to $40 per barrel, when the market conditions failed to recover.

S&P has also issued a negative outlook for other European giants, including Total, BP, Statoil, Repsol, and Eni. The firm may downgrade their ratings, if the crude environment worsens further.

In the past 18 months, the market imbalance has forced oil prices to fall from $110 per barrel in mid-2014, to below $40 per barrel now. In Asian markets today, Brent is trading at $33.63 per barrel, while the West Texas Intermediate (WTI) is trading at around $31 per barrel. S&P believes the crude oil market is likely to remain depressed, given a global supply glut due to weak demand from China and emerging economies.

On the one hand, the Organization of Petroleum Exporting Countries (OPEC) and non-OPEC members, including Russia, are struggling to grab a large share of the market and don’t want to lower production. US oil producers are cutting production, but only slowly. On the other hand, China, one of the world’s biggest energy consumers, is suffering from a slow growth rate, high inflation and unemployment rates, and low demand.

The credit rating firm believes that the market may not rebound anytime soon. As a result, the debt coverage metrics of many energy companies are expected to remain weak in the next two to three years.

Last year, oil and gas companies managed to cut capital and operating expenditure levels. However, the S&P believes that these levels failed to match the significant decline in crude over the past one and a half year. Thus, given the low crude environment, liabilities of the energy companies could continue to increase, and their liquidity position could continue to worsen.

Shell-BG Merger

This is the first time in 26 years that Shell’s long-term credit rating has been downgraded to the fifth-highest investment grade. However, as the new rating is not inclusive of its merger with BG Group Plc (ADR) (OTCMKTS:BRGYY), the New York-based rating firm has put the rating on further review.

Last week, the $77 billion merger received overwhelming support from shareholders of both the companies. The deal is expected to close on February 15.

This merger may increase Shell’s liabilities and worsen its liquidity ratio. The S&P, therefore, may review the debt structure of the combined energy company by the end of the second quarter to assess the impact of the merger on the Anglo-Dutch company.

Moody’s Review for Downgrade

In January, Moody’s placed credit rating of Shell — along with that of 72 other US and European energy companies — on review for future downgrade. The firm cited weakness in the industry and the crude environment as the reasons for the decision.

If Moody’s also downgrades Shell’s credit rating, investor confidence may get shaken badly. Already, the market is speculating whether Shell CEO Ben van Beurden took the right decision to merge with BG Group.

Following the S&P credit rating downgrade, Shell stock closed down 1.32% at $43.35 on Monday. The stock is further down 2.86% in pre-market hours today, as of 5:59 AM EST.

SOURCES

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