Royal Dutch Shell plc: Reasons Behind Moody’s Downgrade

By Micheal Kaufman on Apr 11, 2016

Moody’s Investor Service reduced Shell’s issuer rating and rating of its guaranteed debt from “Aa1” to “Aa2”, and affirmed company’s Prime-1 commercial paper. Both ratings were under review for a potential downgrade, which was initiated on January, 22, 2016. Since January, the firm expected that the global oil prices will remain weak over the medium term and hinted several downgrades in the upcoming few months.

Shell Finance Netherlands Bv, a subsidiary of Royal Dutch Shell – formed for the sole purpose of issuing debt – also had its issuer rating cut from “Aa1” to “Aa2”. Moreover, Shell’s US-based subsidiary, Shell Oil Company, also got its issuer rating cut from “Aa2” to “Aa3” and has been assigned a Negative outlook.

BG’s Downgrade

After the successful merger and de-listing of BG from the New York Stock Exchange (NYSE), the company also got downgraded by Moody’s. The firm withdrew its “A2” issuer rating and “A2” guaranteed long-term debt. While BG’s subsidiary, BG Energy Capital Plc had its Prime-1 commercial paper rating withdrawn.

The latest downgrades and negative outlook reflect Shell’s increased leverage due to the recent completion of BG’s merger. However, Moody’s is of the opinion that the merger will prove to be a strong contributor to Shell’s longer term business, but cash flows are expected to be negative till at least 2017. Shell projects capital spending of around $33 billion, which is relatively high compared to Exxon Mobil Corporation’s (NYSE:XOM) and Chevron Corporation’s capital expenditure guidance of $23.20 billion and $26.50 billion, respectively, for 2016..

Shell’s debt has increased by approximately 25% of its market capitalization following the BG deal, and analysts opine that the company will have to slash its capital expenditure to reduce debt. That said, Shell has the highest debt-to-total market capitalization of 0.41 compared to that of 0.23 and 0.12 for Chevron’s and Exxon, respectively.

Oil price slump has bought several challenges for the company as Tom Coleman, Moody’s Senior Vice President stated that, “Low oil and gas prices will compound Shell’s challenges in delivering substantial asset sales to help reduce debt and in integrating and restructuring the upstream portfolio.”

The Bottomline

Shell’s debt is under the investment grade category, reflecting low risk, which could help the company attract money. In order to reduce leverage, the company is taking appropriate measures, and is expected to reduce its capital expenditure from $33 billion to $28 billion in the upcoming Investor Day meeting scheduled on July, 7.

There is no doubt that the increased leverage is the reflection of the recently concluded billion dollar BG deal, but in the long run, it will help Shell to rapidly increase its production and cash flow. Shell will be back to more stable ratings, once the gains from BG materialize.

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