Fitch Ratings have released a special report in where they warns against another speculation driven spike in the price of crude oil. According to Fitch, there is a risk that the price of crude oil might be pushed up to around 150 dollar a barrel, at a time when companies still struggle with recovering from the recession.
“As a result, under this scenario, Fitch anticipates that the potential for negative ratings actions could be higher than previously experienced.”
“Despite this evidence of lack of tightness in oil markets, the possibility of further increases in crude oil pricing based on dollar weakness remains an ongoing risk for corporate issuers, given widespread investor concerns about the unprecedented expansion of the U.S. money supply in the wake of the global recession and looming structural deficits,” the Fitch analysts writes.
“While such a spike does not represent Fitch’s base case expectation, Fitch believes there is significant analytic value in thinking through possible impacts that such a scenario could have on credit quality across a range of corporate sectors and credits outside of exploration and production in the current still-fragile economic environment,” they continue.
Fitch’s outlook for the oil and gas sector in 2010 calls for $70 base case oil prices in 2010, but the rating agency points out that non-fundamental factors are a significant driver of crude prices in the current environment.
Low-Hanging Fruit Have Already Been Plucked
“An important credit consideration for most sectors across the space is the degree to which companies have already performed aggressive adjustments to maintain margins and financial flexibility in response to the last crude oil run-up and subsequent recession.”
These actions include workforce reductions, general and administrative cuts, facility closures,reductions in discretionary capital expenditures, lower dividends, and changes to healthcare and pension benefit programs, among others.”
“As a result, the ability to offset a future spike in energy input costs through further restructurings in other parts
of the business is limited at this point in the cycle, as the low-hanging fruit have already been plucked.”
Unsustainably high oil prices, by definition, tend to sow the seeds of their own destruction as consumers respond to high end-user prices by cutting back on demand.
“Note that while this report focuses solely on oil, a scenario of dollar weakness would also affect other dollar-priced commodities which could exacerbate the pressures mentioned in this piece,” Fitch adds.
As seen in the chart below, dollar depreciation accounted for a significant portion of $150 per Barrel Crude Oil:
“The scenario of a U.S. dollar depreciation based on a run-up in oil prices would likely create a tailored version of this event, as the spike in pricing and accompanying demand response would be expected to be largely concentrated in the U.S and dollarpegged currencies. However, even with the rapid growth of oil demand in emerging markets, the U.S. remains a large enough oil consumer (approximately 22% of 2009 global demand) that a significant U.S. demand response would be expected to be sufficient to eventually push global pricing back down. Similar to the aftermath of the 2008 run-up and collapse in crude pricing.”
“Fitch anticipates that a crude oil spike could create a period of wrenching adjustment for a number of corporate issuers, including airlines, trucking, chemicals, and consumer products industries. From a credit perspective, however, a key difference between a future crude oil spike and the most recent run-up lies in the reduced ability of many corporate issuers to offset the impact of higher energy costs through adjustments and restructurings in other parts of their business, given the aggressive actions most have already taken to preserve margins and maintain credit quality.”
As a result, under this scenario, Fitch anticipates that the potential for negative ratings actions could be higher than previously experienced, the analysts conclude.
These industries will be hit hardest:
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