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Oil sector credit downgrades rattle a shaken industry

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  © Reuters

LONDON -- Credit ratings agencies have taken their knives afresh to the oil sector, downgrading Malaysia's state-owned giant Petronas amid growing fears that a supply glut will further batter oil prices that have already hit three-month lows.

The latest in a series of downward re-ratings in the sector came as the Brent crude benchmark price fell to a 12-year low in February at $27.50. The sovereign debt ratings of at least 12 oil producing countries in the Middle East and Africa have been downgraded by Fitch in the first six months of the year. In the latest move, Fitch downgraded Bahrain to "BB-plus" with a stable outlook on July 27, joining Standard & Poor's and Moody's in cutting the nation's debt by one notch to junk status as low oil prices undermine its finances.

On July 27, Fitch reduced the long-term foreign and local-currency issuer default ratings of Petronas to 'A-' from 'A' , citing "pressure on operating cash generation from sustained low oil prices, and the likely slow recovery of prices over the forecast period, despite a reduction in dividend payout."

Longer term trends indicate that overall global oil supplies are contracting and demand is rising, leading many analysts to predict that the market will be "rebalanced" in 2017.

But contradictory evidence is also emerging. The supply situation is not adjusting as quickly as expected in response to the lower oil prices. Meanwhile, alternative energy sourcing is continuing.

The price of Brent crude futures fell to a three-month low on July 28 for the second day running, down 1.8% to $42.70 on ICE Futures Europe.

The price slump came on the back of the latest figures from the U.S. Energy Information Administration on July 27, showing that crude stockpiles rose by 1.7 million barrels the preceding week, defying predictions of a 10th consecutive weekly drop.

The news came as the U.S. Federal Reserve on July 26 decided to keep interest rates on hold. A stronger indication from the Fed that it could raise rates before the end of 2016 would further depress prices, which have an inverse correlation to the U.S. dollar, like all commodities.

Market analysts, whose general view was that oil would remain in the $45-$55 per barrel range in the medium term, have been adjusting their oil price estimates.

"Supply continues to return from disruptions, refined products are severely oversupplied, crude demand is falling well short of product demand, and key product demand is decelerating. Our revised below-consensus gross domestic product outlook, macro risks and longer positioning in oil markets only add to downside risks," said a report from investment bank Morgan Stanley on July 24, warning that oil prices could drop as low as $34 per barrel before the end of 2016.

Vikas Dwivedi, a London-based oil analyst at Macquarie, an investment bank, recently warned of the "rising risk of a supply surge." Dwivedi noted that 1 million barrels a day of Canadian production have come back on line, and there has also been a recovery of 800,000 barrels a day in Nigeria's oil production, unusual seasonal export growth from Saudi Arabia and increased Russian exports by 500,000 barrels a day.

The resumption of the $36.8 billion Tengiz oil project in Kazakhstan has underscored the oversupply problems that continue to dog the oil sector as it tries to adjust supply to bring it in line with demand in an effort to raise prices.

Kazakhstan points the way

Kazakhstan is a good case study of how national interests can trump market supply and demand signals. The world's 15th biggest producer of oil in 2014, with production of 1.6 million barrels per day, has increased oil output annually over the last 30 years.

With reserves of 30 billion barrels of proven reserves, Kazakhstan is planning to produce 130 million metric tons per year by 2020, which would make it among the world's top 10 oil producers. Even with prices low, oil producing countries are continuing to seek market share.

In early June, Saudi Arabia, the world's third biggest oil producer, failed to convince the other members of the Organization of Petroleum Exporting Countries to agree to a production ceiling. It has since vowed to maintain production capacity at 12.5 million barrels per day.

From October 2015 to May 2016, Saudi crude inventories dropped 12% to 289 million barrels, the longest period of decline in 15 years, according to the Joint Organization's Data Initiative, a venture of six global energy and economic organizations. Inventories have fallen due to rising domestic demand, which now consumes 25% of domestic production, and a determination to maintain market share.

Many marginal producers reentered the market as oil climbed back to $50 per barrel, with recent reports showing an uptick in the number of oil rigs being deployed, a closely watched indicator of oil production.

"Activity in the Middle East has remained robust and a 2% growth is expected in 2016, consultancy Douglas Westwood reported on July 18. "Global land drilling rig market is expected to see a recovery from 2017, as commodity prices recover and drilling activity increases," it added, noting significant declines in drilling activity over the previous 18 months suggest the situation is likely to continue this year.

Oil demand forecasts have also been affected by recent geopolitical events. The Brexit vote for the U.K. to leave the European Union has created further uncertainty about global economic growth. More recently, the attempted coup in Turkey and its aftermath, featuring a harsh crackdown on dissent by President Recip Tayyip Erdogan, has sent fresh shudders through global markets.

In America meanwhile, the growing possibility that Donald Trump could emerge from scheduled November polls as the next U.S. president is depressing sentiment in commodities markets -- although some analysts believe this election outcome has not been fully priced into the market.

Economists at Credit Suisse Global Markets expect global industrial production growth to hit a trough in the next few months, and any recovery in 2017 is likely to be a relatively shallow one, broadly reflecting overall market sentiment. Falling interest rates and a stronger U.S. dollar could curb an oil rally, they noted.

In the short and medium term, there is not much cause for optimism among industry bulls -- and increasingly, even the longer term looks problematic.

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