Where is the money coming from?

With the low oil price, it’s no secret that oil companies are facing a strain on their cash flows. Oil companies, large and small, need to adjust their cash outflows to adapt to the decrease in revenue that we’re all experiencing.

TAG Oil has been fortunate to sustain strong working capital, while avoiding taking on any debt. We’ve used the slump as an opportunity to cut down on costs and to make strategic operational decisions that enable us to maintain production levels. Looking forward has been our priority.

Other companies haven’t been as fortunate – or as strategic – while coping with the continued low price of oil. Large oil companies, including ExxonMobil, Chevron, BP, and Shell have been taking on more and more debt as a way to manage the low crude price. In addition to taking on more debt, these companies have made drastic cuts to current operations and new projects for growth. One area they haven’t yet cut, however, is their dividends payments. While their dedication to compensating shareholders with dividends can be applauded, it may not be the most prudent course of action, since these dividends are essentially being paid with debt as opposed to cash generated from operations. Debt that’s accruing interest, and that has a negative effect on debt-to-equity ratios.

WoodMackenzieDebtRatioIncreasing debt has a negative effect on a company’s debt-to-equity ratios.

The debt-to-equity ratio measures the amount of debt compared to equity used to finance a company. An increase in the debt-to-equity ratio is indicative of higher risk. Higher risk may deter future investors and cause current investors to cash out. In addition, high debt goes hand in hand with high interest payments, which means cash that otherwise could have been invested back into company operations and expansions is instead being used to pay interest.

The effects of taking on more debt may not have a great immediate impact on the super majors in the oil industry, but how will they be affected in the long run? How much debt will these giant corporations take on, and how much pain will they suffer digging themselves out of debt when the price of crude increases?