The turbulence in the financial markets has led to consumers of capital across privately owned, publicly listed and institutional sectors facing a series of challenges relating to their capital financing requirements.
With a combination of regulators increasing capital ratio requirements and banks lacking sufficient ability to raise new equity, the banks themselves are being obliged to shrink their asset base and reduce lending. Corporates are therefore facing increasing uncertainty over available bank debt funding, leading to an increasing focus on alternative funding options as they look to raise capital for new investment, refinance existing facilities and, in some cases, restructure their capital base following distressed situations.
Securing capital has always been a priority on the corporate agenda, but the fundamental changes seen in the market and business landscape since the onset of the recession have transformed the corporate relationship with, and attitude to, capital.
For the oil&gas industry, which is reliant on large capital expenditure to fund exploration, development and production, funding remains a major challenge and is having a significant impact on the sector. With the credit markets through the worst of the crisis, capital providers are assessing their risk appetite for lending on a basis acceptable to both themselves and their investors.
Due to the inherent long-term nature of the oil&gas industry, the lead time and capital requirements for exploration through to production and into the marketplace is significant. However, the longevity of the economic return from such reserves is equally important.
The majority of debt underpinning the oil&gas sector is most efficiently sourced from the capital markets, with long-term debt and operational business models reaching out to try to find one another to see where the return balance is which suits both lender and borrower.
The banking market will always be important for every corporate borrower, but is often better suited to funding certain project risks and providing shorter-term liquidity.
However, banks remain severely capital constrained and continue to deliver their balance sheets while readying themselves for additional credit losses in the consumer landscape through their exposures to unsecured personal borrowings (credit cards, motor loans and similar).
A number of analysts believe Eurozone banks appear to be less well capitalised than British or American banking institutions, with financial bodies, including the International Monetary Fund and Standard & Poors, continuing to question and observe the capital raising which certain banks will need to work through. All of this sets the scene for further capital constraints in capital availability from the banking market for the sec tor.
For the first time in history, investment grade bond issuance has outpaced bank lending. This is perhaps more of a reflection on the poorly performing bank markets than over-performance in the capital markets.
Given how well the bond markets are functioning, oil&gas majors should take some comfort as, quite often, their large-scale funding requirements are sourced from that market. Perhaps the smaller support-services businesses remain relatively more exposed to the banking market dislocation, which very much continues.
For the oil&gas sector, a number of themes are emerging from the credit crisis. Firstly, for the majors and large oilfield services companies in particular, maintaining a very robust and good-quality investment grade credit rating is of primary importance.
Corporates undergoing credit rating stress may be well advised to cure the stress through equity raising or deleveraging debt rather than suffering a public debt rating credit downgrade and then being punished by credit markets through constrained market access to capital and further raised credit margins and fees. Weaker credits should proactively engage in managing their credit relationships – this has always been important, but now more than ever so.
Funding diversification is also important, and the smaller players in the oil&gas sector should begin to look at the ever-growing private placement market in the UK, where debt is typically sourced to sit alongside the banking group.
The cost of credit (the risk margin) has also shifted higher, a reflection of credit losses experienced over the past two years, and there is little to suggest that such credit margins are likely to once again tighten.
Ernst & Young has recently completed a survey of 490 senior executives from large companies in 32 countries across a broad range of industrial sectors. The report highlights that capital is one of the most pressing issues in the boardroom.
The study provides a view of how key executive decision-makers are positioning their businesses and managing capital to maximise their competitive advantage in this environment. And the report shows that the vast majority of companies questioned (94%) accept that it won’t be “business as usual” when we eventually emerge from the recession.
In this shifting economic landscape, two further points become key. Firstly, companies in the oil&gas sector – in fact, all sectors – must focus on maximising the resilience of their core business. Secondly, they must maintain the flexibility in their business in order to respond to the changing conditions and the opportunities those changing conditions present.
Ernst & Young’s report notes that many companies feel compelled to “batten down the hatches” and hoard cash. However, being proactive rather than reactive and avoiding this inertia is key to seizing the opportunities that the economic landscape presents.
So when it comes to capital, a notable characteristic is the sheer scale and quantum the oil&gas sector requires; but obtaining it on an efficient basis is a challenge.
What is very clear is that all consumers of capital must embrace the market change if they are to continue to maintain access to the capital so important for business operation. This extends both to refinancing existing capital and sourcing new capital.
The largest consumers of capital are really going to need to work at this – perhaps capital itself has become as scarce and precious as oil&gas?
Dougald Middleton is a partner in Ernst & Young’s capital and debt advisory group
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