What Do Lower Oil Prices Mean For Credit Ratings?

However, although Kremlin spokesman Dmitry Peskov said Russia is ready to talk 'especially in such dramatic times', Alexander Dynkin, president of the Institute of World Economy and International Relations in Moscow said "Putin is known for not submitting to pressure", adding that Putin is ready to "protect national interests and to keep his political image as a strongman".

 

This disagreement has had a significant impact on financial markets with US high yield paper particularly affected. Despite lower oil prices, there is a long-term strategy in the response from Saudi Arabia and Russia.

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Artificially supported prices in recent years have helped US shale producers, and longer-term both Saudi Arabia and Russia will benefit as many of those US producers will have to cease operations.

Thus, US President Donald Trump's announcement of a possible intervention 'at the appropriate time', which has boosted oil prices. Crude prices were also supported by reports of the US' plans to increase its emergency stockpiles, thus reducing the flood of supply in the market.

One by-product of lower oil prices is it translates to lower energy costs for consumers, which is greatly needed at the current time.

Lower oil prices do not tend to affect credit rating as much as one might assume. Provided the nation has sufficient reserves and production costs are lower than the new oil price, then the country will still benefit from producing oil although income will fall if volumes remain constant.

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In the case of Russia and Saudi Arabia, both countries are expanding production and so to some extent the additional volume will offset the lower prices, although there is still an overall reduction in revenue.

The wealth of a nation builds up over many years and it is the starting wealth of a country that is most important. Seven-star rated countries such as Qatar, Saudi Arabia and the UAE all have net foreign assets in excess of 100% of GDP and are well positioned to withstand the negative impact of lower oil prices.

As a three-star rated country, Mexico has less wealth to fall back on, but Mexico hedges the downside to its oil price exports through a hedging program each year. The government stated in January that oil price exports for 2020 have been hedged at $49pb which is the same price as in the budget.

Russia has also, from time to time, weakened its currency as oil is sold in dollar terms, there overcoming what could be severe losses.

To illustrate the impact of oil prices on credit ratings, between 2010 and 2013 the oil price averaged $100 and the UAE was rated by Moody's at Aa2. By 2016, the oil price had fallen again to $48 and although Moody's undertook a rating review at that time, the UAE's rating remained unchanged at Aa2.

A key consideration will be whether the oil producing nations cut back their expenditure to reflect their new income levels. So, while a credit rating review may occur again, it does not automatically follow that a lower credit rating will be forthcoming.

Currently, market pricing builds in an assumption of 3-5 notch downgrades for Qatar, 6-8 notches for Mexico, 4-5 notch downgrades for Abu Dhabi, and 3-6 notch downgrades for Saudi Arabia, so market pricing has built in a considerable amount of bad news already.

Andy Seaman is CIO of fixed income specialist at Stratton Street Capital