Private Client Group

February 24th, 2016

Energy Companies Downgraded: Should You Be Worried?

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The Standard & Poor’s and Moody’s ratings agencies recently downgraded energy giants like Chevron, EOG Resources, Royal Dutch Shell and Hass. Top-tier companies, once thought fairly insulated from oil’s downturn due to their sheer size, are now seen as under serious stress. Is this energy issue going to keep getting worse?

Indeed, more than 120 of the world’s largest energy companies were downgraded following Moody’s revision of its oil price estimate to $33 per barrel from $43. Lower oil for long periods of time mean weakened cash flows and increased financing costs as companies find it more difficult to fund capital projects at current oil prices.

With U.S. production exceeding oil demand by more than 2 million barrels per day (bpd), and with Iran producing an additional 500,000 bpd in 2016 (with the removal of western sanctions on Iran), rating agencies are convinced it could be years before oil prices recover in earnest. Ratings agencies claim that lower oil coupled with weak industry fundamentals presents substantial risk to corporate health looking forward, hence the downgrade.

But what does a ‘downgrade’ really tell us? In reality, it’s nothing more than ratings agencies telling us something we’ve already known for some time – yes, the Energy sector is under some duress, and risks are rising. But, to downgrade a company one letter (A to B) or one notch of a letter (AAA to AA) doesn’t provide palpable investment insight. It tells us to be on alert, which we’ve already been for months and months. In other words, it’s fair to say that ratings agencies give us a reflection of the market, but are by no means leading indicators.

Case in point: Standard & Poor’s made headlines in when it downgraded America’s AAA credit rating. But, this rating revision became public only after the U.S. Treasury had publicly claimed that it had its deficit projection wrong to the So, it is clearly evident that the agency is not telling the investor community anything new.

There are also examples of ratings agencies outright failing to perform their function. Perhaps the most notable in history came regarding the 2001 Enron scandal, where the rating agencies didn’t downgrade the company until a few days prior to its bankruptcy! There’s also the fact that Standard & Poor’s agreed to pay a $1.5 billion penalty for failing to assess the exorbitant risks present in the subprime mortgage CDO market. There were even instances where AAA ratings were assigned to large volumes of “toxic” mortgage-backed securities and collateralised debt obligations before the financial crisis. A huge miss.

Yet, in spite of this track record, rating agencies have emerged pretty much unscathed – even in a world where many investor decisions to hold a particular type of debt depends on their ratings. Every time a downgrade occurs, it seems to make big news. We’re not sure why.

Bottom Line for Investors

Investors shouldn’t get too caught up in downgrades of the minor sort, especially when it’s related to an industry or company that’s already widely known to be feeling some pressures. Ratings agencies are notorious for being late to the game.

Disclosure

Past performance is no guarantee of future results. Inherent in any investment is the potential for loss.

Zacks Investment Management, Inc. is a wholly-owned subsidiary of Zacks Investment Research. Zacks Investment Management is an independent Registered Investment Advisory firm and acts an investment manager for individuals and institutions. Zacks Investment Research is a provider of earnings data and other financial data to institutions and to individuals.

This material is being provided for informational purposes only and nothing herein constitutes investment, legal, accounting or tax advice, or a recommendation to buy, sell or hold a security. Do not act or rely upon the information and advice given in this publication without seeking the services of competent and professional legal, tax, or accounting counsel. The information contained herein has been obtained from sources believed to be reliable but we do not guarantee accuracy or completeness. Publication and distribution of this article is not intended to create, and the information contained herein does not constitute, an attorney-client relationship. No recommendation or advice is being given as to whether any investment or strategy is suitable for a particular investor. It should not be assumed that any investments in securities, companies, sectors or markets identified and described were or will be profitable. All information is current as of the date of herein and is subject to change without notice. Any views or opinions expressed may not reflect those of the firm as a whole.
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