Oil companies may keep up output to repay debt, says BIS

[BASEL] Energy companies may be slow to cut oil production after a 50 per cent price drop because they need to service debt that has risen fourfold since 2003, according to the Bank for International Settlements.

"Debt-service requirements may induce continued physical production of oil to maintain cash flows, delaying the reduction in supply in the market," the Basel, Switzerland-based institution said in a report Saturday.

Energy companies' outstanding debt rose to more than US$800 billion this year from less than US$200 billion in 2003, said BIS, which is owned by central banks.

Sinking oil prices weakened the value of assets used as collateral by producers and compelled them to sell more of their output on futures markets, it said. Oil's role as a financial asset may have contributed to the price drop and the most volatile swings in prices in more than six years.

Brent crude oil, a global benchmark, has tumbled as members of the Organization of Petroleum Exporting Countries refused to cut oil production in response to the highest US output in three decades. Lower prices increases the risk of companies failing to meet interest payments, the BIS said.

Tumbling oil prices have increased borrowing costs among energy companies, with spreads on high-yield bonds issued by energy firms soaring to 800 basis points, or 8 percentage points, as of January, from 330 points in June, according to the BIS. The spread measures the additional interest costs paid by a borrower compared above a benchmark rate.

Brent for March settlement increased 32 cents, or 0.6 per cent, to US$58.12 a barrel on the London-based ICE Futures Europe exchange at 12.20 pm. Singapore time. The contract gained 9.1 per cent for the week ended Feb 6. Even after the recent rally, Brent has still fallen about 50 per cent from its June 19 high of US$115.71.

The expansion in borrowing by energy firms outpaced total debt issuance since 2003, which has tripled in the period to about US$6 trillion, according to the report.

This encouraged energy companies to both lock in forward prices, adding to the selling pressure, and to keep production levels elevated to sustain revenues, prolonging an oversupply, the BIS said. Supply will exceed demand by 2 million barrels a day in the first half of 2015, according to Iranian Oil Minister Bijan Namdar Zanganeh.

US oil production is up 8.7 per cent since the end of June, even amid tumbling prices. Production reached 9.213 million barrels a day the week of Jan. 23, the highest level in weekly Energy Information Administration data going back to 1983.

The level of borrowing in dollars by energy companies outside the US may also push prices lower, as a strengthening dollar makes it harder for firms based in emerging nations to pay off their debt, the BIS said.

Oil's role as a financial asset may have played a role in the price drop. West Texas Intermediate and Brent futures contracts representing nearly 2 billion barrels of oil traded hands on Friday on the New York Mercantile Exchange and ICE Futures Europe exchange in London. The world consumes a little more than 90 million barrels of physical oil a day.

WTI has seen price swings of more than 5 per cent in three of the past six trading days. The CBOE Crude Oil Volatility Index, which measures price fluctuations using options of the US Oil Fund, rose to the highest level since 2009 on Thursday. The US Oil Fund, the biggest US-listed oil exchange-traded fund, holds WTI futures.

"The steepness of the price decline and the very large day-to-day price swings are reminiscent of a financial asset," the BIS said. "As with other financial assets, movements in the price of oil are driven by changes in expectations about future market conditions."

BLOOMBERG