Moody’s Investors Service today changed to negative from stable the outlook on the senior unsecured debt ratings of Total S.A. (Total) and its guaranteed subsidiaries.
The rating action reflects Moody’s concern that the significant increase in investments made by Total in the past two years to give fresh impetus to its upstream growth strategy, has constrained the recovery in its credit metrics relative to pre-2009 historical levels despite the buoyant oil price environment, and reduced headroom at the rating level.
In support of its strategic efforts to further strengthen and diversify its hydrocarbon resource base, Total has significantly stepped up investments in its upstream business since mid-2010, including the launch of major organic projects and a series of acquisitions involving in several cases the formation of new partnerships with independent exploration and production companies. In the last twelve months (LTM) to June 2012, Total’s upstream investments amounted to $26 billion compared to $15 billion in the LMT to June 2010.
Despite the high oil price realisations achieved by the group in the past eighteen months, this increase in capital spending has led to some erosion in its upstream efficiency measures such as finding and development costs (F&D) and return on capital employed (ROCE). In particular, this has reflected Total’s growing participation in capital intensive, long cycle projects such as liquefied natural gas (LNG) and unconventional plays (e.g. shale gas, heavy oil) resulting in a higher allocation of capital towards unproved, not yet producing assets.
On a more positive note, Moody’s acknowledges that the active portfolio management undertaken by Total has helped free up capital and mitigate the impact of heightened upstream investment activity on its financial profile. Since the end of 2009, the group has raised aggregate cash proceeds of $18 billion from the disposal of various non-strategic oil and gas properties and downstream businesses such as its 48.8% stake in CEPSA, Mapa Spontex, and the gradual sell-down of its Sanofi shares. This has allowed Total to remain broadly cash flow neutral in the two and a half years to June 2012.
However, despite the positive effect of a strong oil price environment on operating cash flow generation, Total has failed to rebuild any meaningful headroom within its financial metrics relative to Moody’s guidance for the current rating. In 2011, the group reported retained cash flow (RCF)/net debt of 58%. This leaves the same ratio at 52% on a three-year average basis compared to the minimum level of 55% set for the rating.
Looking ahead, Moody’s expects Total’s operating cash flow to benefit from the start-up of several upstream projects which, according to management’s guidance, should not only help raise production to around 2.7 million barrels of oil equivalent per day (boepd) by 2015 but also yield higher margin barrels.
That said, in the near to medium-term, Total will be required to sustain high levels of capital expenditure in order to bring to market the resources it has added to its portfolio in recent years, while inflationary pressures may further impact capital and operating costs across the industry. In addition, contributions from the group’s downstream business to its cash flow are likely to remain constrained given the challenging operating environment facing the European refining and petrochemicals sectors. Therefore, the negative outlook reflects Moody’s belief that Total’s ability to achieve cash flow neutrality and reposition its credit metrics more solidly relative to the rating category within the next 18 months, will largely depend on the continuation of a strong oil price environment and the timely execution of further asset disposals.
A stabilisation of the outlook would be predicated on Total’s ability to enhance its operating cash flow generating capacity by completing its major upstream projects on time and within budget, while successfully executing the portfolio initiatives required to help maintain cash flow neutrality. In turn, this should lead to some strengthening in the group’s financial metrics, with RCF/net debt more comfortably positioned in the high 50s and total debt to proved reserves below $4.5 per barrel.
Conversely, negative rating pressure could develop should Total fail to maintain cash flow neutrality and reposition its financial metrics more solidly within the rating as a result of (i) significant delays and cost overruns affecting its major upstream projects, (ii) a severe and extended correction in the oil price and/or (iii) its failure to complete asset disposals.