OVERVIEW – The U.S. oil industry has still to gear up for looming turmoil despite an all-time high productionIn December 2015, the West Texas Intermediate (WTI) oil price registered USD36.78 per barrel in the U.S. on a monthly average. On a yearly average, it amounted to USD48.76 per barrel in 2015 compared with USD101.57 per barrel in June 2014. We expect the WTI oil price will be lower in 2016 than in 2015, at USD37 per barrel on a yearly average. This stems from U.S. crude oil production leveling off at an all-time high of 9 million barrels a day and also because of very high levels of U.S. oil inventories.

The shale revolution has significantly boosted U.S. oil production since 2012. As shown in chart below, the 9.3 million barrels per day oil production on a yearly average at the end of 2015 in the U.S. was almost double the level in 2010. This situation keeps fueling an already very high level of U.S. crude oil stocks, with almost 500 million of barrels as of January 2016.

U.S. Crude Oil Production

Meanwhile, for two years the U.S. has been the leading producer of petroleum products in the world. It appears to be far ahead of Saudi Arabia and Russia, although those producers kept their crude oil taps open wide through that period. This unfortunately compounds the global oil glut.

Euler Hermes | February 2016

Industry Outlook: OilMarc Livinec

Sector Advisor for Energy, Chemicals and Pharmaceuticals

marc.livinec@eulerhermes.com

Sources: EIA, Euler Hermes

Key Points

1 The West Texas Intermediate (WTI) oil price has more than halved on a yearly average since Q2 2014. This has caused independent U.S. oil producers’ operating margins to plummet into negative territory in 2015 (to USD -10bn). The current global oil glut does not help put an end to this gloomy trend.

2 U.S. oil production went up +25% on a yearly average between 2013 and the beginning of 2016. However this growth has been funded at the cost of soaring indebtedness of U.S. oil companies operating new oil rigs. Since last year, banks’ restrictive measures in granting further loans to already highly indebted U.S. oil players have forced the latter to focus on the most productive rigs at the expense of others, some of which are being closed down.

3 U.S. oil companies, especially smaller ones, still have to cancel part of their Exploration & Production (E&P) investments (-13% in 2016 after -28% last year) against a background of a price war with Saudi Arabia and Russia. and acquisitions to acquire new capabilities and better pricing power. After peaking in 2014-15, deal valuation should total USD 94bn in 2016.

4 As the WTI oil price is unlikely to recover significantly in the short term (USD37/bbl. in 2016), dropping revenues and plummeting margins of independent U.S. oil producers increase the insolvency risk to certain tiers of providers and core companies of the energy sector.

Total Oil Supply* By Country

CURRENT ENVIRONMENT – A high level of indebtedness for many U.S. oil players Since 2011 and throughout the oil price upturn until the summer of 2014, U.S. oil companies borrowed heavily to increase production and add to their reserves. High debt levels taken on by U.S. oil producers are now hitting companies hard.

Total Debt to Total Equity (in %) for Independent Oil Players in North America

Lenders increasingly want U.S. oil companies’ loan conditions to be reassessed based on their real asset value in relation to the incurred debt and the current oil price. Leverage ratios have skyrocketed since last year. This results in potential trouble for U.S. oil companies with negative free cash flow because they may fall into the trap of incurring more debt to meet repayments on existing borrowings.

Based on second-quarter results from 45 U.S. oil companies, data from the Energy Information Administration (EIA) show the soaring share of companies’ operating cash flow used to service debt.

Euler Hermes North America Headquarters 800 Red Brook Boulevard Owings Mills, MD 21117 Phone: +1 877-883-3224 Fax: 410-753-0952 eulerhermes.usa@eulerhermes.com www.eulerhermes.us

* Total oil supply includes crude oil but also GPLs and other petroleum liquids

Source: EIA

Sources: Bloomberg, Euler Hermes

U.S. Onshore Oil Producers’ Debt Service as a Share of Cash Flow

OUTLOOK – Struggling U.S. oil companies in a time of low oil priceDue partly to a lack of enough (free) cash flow, U.S. companies last year started closing down their least productive oil rigs. The number of active oil rigs halved between 2014 and 2015 from 1500 to less than 750 on a yearly average. On a monthly average, it appears that the number of oil rigs closing has slowed a little since last summer. However, putting them back into operation will be expensive. The problem is that fracked wells have a short lifespan. They usually dry up within a year or two, which means that U.S. (shale) oil companies need to constantly drill new wells in order to maintain output.

However, a decline in active rigs has not been accompanied by an equivalent drop in production. This is because oil companies have kept their best wells running to pay off their debts. But this situation cannot continue much longer because U.S. oil companies will have to invest further in drilling new wells. The combination of running some of the least productive oil wells and the fall in the number of active oil rigs in the U.S. has led to American oil producers’ operating income nosing down significantly.

U.S. oil companies’ operating margins are expected to show a loss in FY 2015 because worldwide oil prices have been below the U.S. breakeven (shale oil) price.

Operating Margin of Independent U.S. Oil Players – Yearly Figures

Euler Hermes North America Headquarters 800 Red Brook Boulevard Owings Mills, MD 21117 Phone: +1 877-883-3224 Fax: 410-753-0952 eulerhermes.usa@eulerhermes.com www.eulerhermes.us

Sources: EIA, Euler Hermes Note: each quarter accounts for a rolling four-quarter sum

Sources: Bloomberg, Euler Hermes estimations

U.S. oil producers had been in a strong investment phase since 2012 but the windfall profits are still to be realized because they did not see their operating margins grow. The negative effect of leverage from debt has been “swallowing” all of it as long as the WTI oil price stays low. That’s why expect the fall in Exploration & Production (E&P) oil expenditures to be globally -13% in 2016 after -28% last year. When looking more precisely at independent U.S. oil companies, the fall should be steeper, with -26% in 2016 following -46% in 2015.

E&P Investments (i.e. Total Oil Capital Expenditures)

U.S. Oil Price (WTI Index)

What this Means for your BusinessWith likely plunge in further E&P investments coupled with low oil prices due to global oversupply, the U.S. oil industry is likely to come through hard times in corporate consolidations and insolvencies. Oil-consuming companies should enjoy the benefits of lower priced feedstocks in future. However, companies with buyers in the oil producing and oil services sectors should use caution when extending credit to these companies due to increased uncertainty. U.S. integrated oil companies are likely to better withstand a downturn because they have higher credit ratings and they benefit from downstream profitability, but just the opposite applies for smaller oil companies, especially those that are heavily leveraged and for which CAPEX exceeds their cash flow. A protracted period of low oil prices will squeeze their finances further. A credit insurance policy can help safely expand sales while managing the risk associated with the different components of each sub-sector dealing with oil.

Euler Hermes North America Headquarters 800 Red Brook Boulevard Owings Mills, MD 21117 Phone: +1 877-883-3224 Fax: 410-753-0952 eulerhermes.usa@eulerhermes.com www.eulerhermes.us

To contact us today and learn more about how Euler Hermes can help your business, visit us at www.eulerhermes.us or call 877-883-8224.

About Euler HermesEuler Hermes North America is the oldest and largest provider of trade credit insurance and accounts receivable management solutions. We offer both domestic and export credit insurance policies that insure against commercial and political risk in more than 200 countries worldwide. Euler Hermes maintains a database of proprietary information on more than 40 million companies worldwide and is rated A+ (Superior) by A.M. Best and AA- by Standard & Poor’s.

Sources: Bloomberg, Euler Hermes estimations

Sources: IHS, Euler Hermes estimations

Forecast