Asian Companies in Nonfinancial Industries See Negative Ratings Trend

Downgrades and negative ratings for Asian nonfinancial businesses are set to continue in the near term, with Chinese companies in the property development and transportation industries dragging down the overall outlook.

Some 40% of Asian firms rated by Moody’s Investors Service and 31% of Moody’s-rated companies in Japan had ratings with negative implications in the third quarter, said Clara Lau, a Moody's Investors Service group credit officer. On the other hand, firms with stable outlooks were at 53% and 64%, respectively, the lowest levels since the first quarter of 2014.

In the Asia Pacific region, ratings for nonfinancial corporates have been trending negative, with 26 negative ratings versus 15 positive rating actions during the third quarter of 2016.

"By region, China remained the major driver of the negative actions, accounting for 12 of the 26 actions during 3Q 2016," said Lau. "And, by industry, companies in the property development, REIT and transportation sectors each accounted for four negative actions."

Businesses in construction and engineering, and metals and mining, saw the most pressure in the third quarter, with about 65% of rate issuers in these sectors showing ratings with negative implications, Moody’s said.

An exception to the sector trend was seen in Australia, where ratings for companies stayed mostly stable, as the portion of ratings with stable outlooks rose to 78% in the third quarter from 75% at the end of the second quarter, Moody’s analysts said.

– Nicholas Stern, editorial associate

Hanjin Bankruptcy Exposes Potential Risk for U.S. Ports Through Terminal Operators

The bankruptcy of South Korea-based global carrier Hanjin has highlighted the potential risk that terminal operating companies, which are often set up as joint ventures between shipping counterparties or private equity firms, aren’t always remote from the financial status of their owners.

Take the example of Pier T at the Port of Long Beach, which is leased by a joint venture—dubbed Total Terminal International (TTI)—between Hanjin and Terminal Investment Limited (TIL), noted Rob Rowan, senior analyst with Fitch Ratings, in a new report. The port saw TTI’s structure as distinct from Hanjin and believed at the beginning that the shipping firm’s bankruptcy would not impact lease payments. But Hanjin’s ability to post its portion of the joint venture as collateral to obtain funding from Korean Air so that stranded cargo could be processed suggests “…that terminal [joint ventures] are not always remote from the financial situations of their owners,” Rowan said.

“While lease terms are often confidential, scrutiny of [joint venture] structures for lease and concession partners is warranted given ports' potential exposure to shipping counterparties, which are typically of lower credit quality than their port operator landlords in the U.S.,” he continued. “As mergers between some of the world's largest shippers increase and alliances morph to include different carriers with varying bases of operation, ports may be exposed to similar strategic shifts. Careful consideration of the costs and benefits of such concessions, as well as scrutiny of termination provisions, can provide protection as ports consider taking on these agreements.”

– Nicholas Stern, editorial associate

Latest Credit Managers’ Index Maintains Gains on Service Sector Surge

U.S. companies have plenty to be optimistic about in view of NACM’s Credit Managers’ Index (CMI) for October. Retailers gearing up for a better holiday shopping season, more credit applications coming from seemingly worthy customers and top clients asking for substantial levels of credit to buy machines and inventory are just some of the reasons.

Lingering concerns in other areas, however, leave the overall economic picture “jumbled” at least until the U.S. election passes, noted NACM Economist Chris Kuehl, Ph.D.

The latest CMI tracks well into expansion territory at 53.5, although it is slightly off from the September total that came from the biggest one-month improvement in 2016. It shows more strength than the summer months or last year’s holiday season. Much of the hope seems to be driven by a quicker-than-expected rebound by the service sector.

“The gains in the service side this month appear to be in retail, as there is some sense that consumers may be in the mood to spend again,” Kuehl said. “There was also some movement in construction, as there has been renewed strength in the residential category as well as minor growth in the commercial side.”

Kuehl believes credit managers also should be hopeful because the latest CMI data reflect that fewer companies are distressed and “are getting their credit affairs in better order.” Most unease or negativity in October’s data comes from the manufacturing side.

– Brian Shappell, CBF, CICP, managing editor

For a complete breakdown of the manufacturing and service sector data and graphics, view the October 2016 report by clicking here. CMI archives may also be viewed on NACM’s website.

Trading Strategies for Those Entering Into the Growing Chinese Marketplace

As China remains an economic hotspot in a stagnating world economy, companies everywhere remain interested in the possibility of trading into the country.

Aside from figuring out where to find accurate economic data about a country that keeps a close lid on how it obtains official information, foreign suppliers need to understand some of the practicalities of conducting business in China, note analysts with credit insurer Atradius in a new report about trading in China.

Atradius analysts provided the following list of factors to help inform commercial credit professionals attempting to mitigate and optimize rewards when selling into China. (See NACM’s eNews piece that lists more tips for trading into China.)

Understand Chinese business culture. Formality and respect for hierarchy are crucial in Chinese business matters, including the concept of “face,” which Atradius defines as a “…combination of actions and perceptions that can either help or hinder business relationships.” Bad or rude behavior during a meeting can serve to lose face, while having a CEO attend a fruitful business meeting can enhance it. Also, note that obtaining an appointment for a meeting, sometimes as much as a month or two in advance, is essential in China.

Protect intellectual property (IP). A reputation of producing pirated or fake goods is widespread in China, and despite efforts to protect IP in the country, companies will want to register copyright in the country. Copyright protections for written or published works last for 50 years from the author’s death. For commercial inventions, patents in China give protection for up to 20 years and are issued on a “first-to-file” basis. Trademarks are also protected on a first-to-file basis in China. “Apart from recording your registered IP rights, there are several ways that you can protect your IP,” Atradius analysts said. “Regular risk assessment checks, advice from local agents or others already trading in China, and IP-related clauses in your employment contracts can all help.”

Select the correct payment method. Atradius is seeing the possibility for a delay in payment in the durable goods, retail and E-commerce sectors, among others, so pick the payment method wisely. Chinese customers must have significant trust in order to accept a cash-in-advance situation. A letter of credit (LC), especially a Confirmed Irrevocable LC, provides security, though beware of some of the drawbacks. These include shifting the liability for payment to a customer’s bank and the fact that LCs can be expensive to arrange, particularly for low-dollar transactions. Open account terms will be attractive for your customers, but be wary of risks of delayed or renegotiated prices to overseas traders, particularly for perishable goods.

– Nicholas Stern, editorial associate

Department Stores Need to Find Right Mix of E-Commerce, Physical Space to Compete Online

U.S. department stores will have to figure out a way to improve inventory management and take other steps to compete in the face of customers’ growing preference for off-price retailers and online shopping options. Department stores could see a roughly 11% decline this year in aggregate operating income, predicted Moody’s Investors Service analysts.

"Consumers today have access to a broad array of goods at the most competitive prices, which has spurred retailers across the industry to accelerate their efforts to compete more effectively," said Moody's Vice President Christina Boni. "Department stores have been the hardest hit, with relatively slow supply chains their biggest Achilles' heel."

When consumer demand suddenly changes, department stores can pay the price with inventory backlogs, Boni added. Highlighting the stores’ supply chain issues is consumers’ unwillingness to pay full price for goods that have had bigger markdowns in order to clear merchandise. “Unlike department stores, the off-price incumbents continue to achieve impressive results thanks to their ability to purchase high volumes of disparate goods closer to the time they're likely to be purchased,” Boni said.

Also, some department stores, such as Nordstrom and Neiman Marcus, have been more successful at growing online sales than others by investing in technology platforms and fulfillment capabilities to increase e-commerce to between 20% and 25% of total sales, respectively, Moody’s said. Other regional players have been falling behind with less than 10% of total sales in e-commerce.

These challenges place a greater importance on maximizing the use of physical space; Moody’s believes having a brick-and-mortar location makes product pickup and returns more efficient, but predicts owners may have to shingle some locations or reduce size to maintain good results.

In the near term, department stores’ operating income should see about 4% growth next year as trimmed inventory places them in good position to take advantage of holiday season sales and better inventory management positions them to take advantage of improved margins, Moody’s said.

– Nicholas Stern, editorial associate

Corporate Liquidity for Speculative-Grade Firms in Better Shape During First Half of October

Corporate liquidity for U.S. speculative-grade companies as tracked by Moody’s Investors Service’s Liquidity-Stress Index (LSI) improved by mid-October from the end of September, benefitting in part from reduced volatility in the energy sector.

The LSI decreased to 6.8% from 7.1%, extending the index’s six-month decline from a recent peak of 10.3% in March, and matches its long-term average, Moody’s analysts said.

"The LSI is now sitting exactly at its long-term average, indicating that the liquidity pressures that fueled so much volatility in the energy sector are moderating," said John Puchalla, senior vice president at the ratings agency. "Even so, liquidity risks remain elevated among energy companies, with cash flows mismatching debt load at many firms that were largely capitalized before the oil price slump."

Also, U.S. speculative-grade firms are being aided by a favorable primary market to meet their liquidity needs. Meanwhile, “Investors' quest for yield rather than a meaningful improvement in corporate fundamentals is aiding market access, suggesting that liquidity could be vulnerable to sudden shifts in investor sentiment,” Puchalla said.

In the first half of October, Moody’s made no speculative-grade liquidity rating downgrades. It did make three upgrades, as upgrades are now close to overtaking downgrades for the fifth consecutive month, with companies benefitting from refinancing and liquidity gains that accompany distressed exchanges and asset sales, the ratings firm said.

Also of note, Moody’s Covenant Stress Index, which measures the extent to which speculative-grade companies are at risk of violating debt covenants, improved to 4.4% in September from 5.0% in August, carrying on a decrease from April’s peak of 7%, analysts said. Moody’s dropped five companies from the list of those firms with the weakest covenant quality score, and none were added to the list.

– Nicholas Stern, editorial associate

Industrial Production Rises in September

Industrial production saw an increase of 0.1% in September after falling 0.5% in August, according to the most recent Federal Reserve report. This marks a rise in the third quarter of 1.8% at an annual rate, the first quarterly increase since the third quarter of 2015.

September also saw an increase in manufacturing output of 0.2%, at an annual rate of 0.9% in the third quarter, while mining posted a gain of 0.4%, which partially offset a decline in August. Total industrial production in September was 1% lower than its level a year earlier. Capacity utilization for the industrial sector inched up 0.1% in the month to 75.4%, meaning that factories are running at three-quarters capacity, a level that is 4.6 percentage points below their long-run average from 1972 to 2015.

In a Bloomberg survey of economists, the median forecast called for a 0.1% gain for factories. Estimates for factory output in the survey ranged from a decline of 0.2% to an increase of 0.4%. Several forces have been a drag on manufacturing output, including lower oil prices and a strong dollar, but there are signs of hope for modest growth, sources have indicated.

September marked increases in other sectors. Output of consumer goods rose 0.2%, as did the index for consumer nonenergy nondurables, indicating gains for chemical products and clothing. The production of nondurables increased 0.5%.

Declines in September included a drop in consumer energy products of 1%. Business equipment was down 0.2% from decreases in both transit equipment and information processing equipment. The production of materials fell 0.2%, reflecting that declines in durable and energy materials outweighed gains for nondurable materials.

– Adam Fusco, editorial associate

Global Unregulated Utilities Face Risks, Opportunities in More Regulated Market

As the Paris Agreement signatories ready themselves to deal with greenhouse gas emissions mitigation, global unregulated utilities and power companies that contribute the largest share of carbon emissions in developed countries will face growing credit risks, a new Moody’s report asserts.

"We expect to see a continued rise in renewable energy, more distributed generation, and overall lower growth in the demand for energy as a result of efficiency improvements,” said Graham Taylor, a Moody's vice president, senior analyst and one of the report's authors. “Disruptive technologies, including energy storage, could also challenge the economics of power-generation businesses. These trends have already had a material impact on the credit quality of some utilities, particularly in Europe, and will pose an increasing challenge for those with material exposure to higher-cost generation," he said.

But those utilities with flexible generation, a competitive advantage in developing renewables, or innovative offerings may be more likely to survive the new regulatory environment, Moody’s analysts said.

As Moody’s looks to rate the credit quality of these utilities going forward, the ratings agency expects to see revenues decline for power generators currently earning significant profits from selling electricity at market prices as low-cost or subsidized renewable generation weighs on wholesale prices. More carbon-intensive plants may not be able to recover higher costs from carbon taxes.

“Moody's recognizes that disruptive technologies are likely to transform the electric system over time,” analysts said. “Broader deployment of renewables, as well as smart meters and appliances, distributed generation, energy storage, and smart grids, will challenge companies focused on centralized energy generation.”

Those utilities with regulated transmission and distribution networks, however, may be more resilient, though this staying power could diminish over time as “…distributed generation shifts the burden of network costs,” Moody’s said.

– Nicholas Stern, editorial associate

Battery Technology Possible Disruptor to Credit

Advancements in battery technology could have significant implications for global credit markets, according to Fitch Ratings. Disruption may occur across sectors that account for close to a quarter of all outstanding corporate bonds.

A leap in battery technology could increase the viability of electric vehicles (EVs) over internal combustion engines, resulting in a negative effect on credit in the oil sector. Transport accounts for 55% of oil consumption, according to Fitch. Rapid advancement in battery technology may cause a polarization between electric utilities and the automotive industry. Companies dealing in renewable technology could increase their market share if batteries could solve supply problems. These conclusions are found in the first in a series of Fitch reports that examine the effects of advancements in disruptive technologies.

The transition to electric vehicles, however, would remain slow, even in the face of rapid change. Infrastructure investment and the long lifespan of new vehicles will create a barrier to the transition. Fitch estimates that it would take 20 years for EVs to comprise a quarter of the global car fleet.

Even so, the oil market could go from growth to contraction earlier than anticipated, brought on by reduced fuel demand. Oil companies will need to react early in anticipation of coming changes. Many have already begun the process of diversifying into batteries or renewable technology. Capital may act before the transition occurs, which could reduce oil companies’ access to equity and debt capital.

– Adam Fusco, staff writer

Natural Gas, Crude Petroleum Price Increases Impact Nonresidential, Overall Construction Prices

Nonresidential and overall construction input prices ticked up in September, buoyed by rebounding natural gas and crude petroleum price increases. According to an analysis of U.S. Bureau of Labor Statistics’ (BLS) Producer Price Index data by Associated Builders and Contractors (ABC), nonresidential input prices increased 0.3% in September from August, while overall construction prices increased 0.3% on the month, after declining by 0.2% in August.

The monthly uptick in nonresidential input prices marked the first such rise since November 2014, noted ABC chief economist Anirban Basu.

“For roughly two years, declining energy prices had wrung much of the inflation out of the economy, allowing interest rates to remain low and the Federal Reserve to remain fixated on guiding the nation toward full employment,” Basu said. “Energy prices are no longer falling. Moreover, wage and healthcare inflation are building, which could drive interest rates higher next year. That scenario is not good for real estate valuations and nonresidential construction.”

Increased prices come on the back of many additional price pressures contractors say they are facing, he noted, including buyers demanding lower construction charges, higher labor costs and other rising expenses.

“The challenge for many contractors is to pass materials cost increases along to users of construction services in an effort to sustain margins,” Basu said. “Evidence suggests that this was not a major issue for construction firms prior to the Great Recession, but purchasers of construction services are now much less likely to accept significant cost inflation. The good news is that with the U.S. dollar strengthening recently, sharp month-over-month increases in many construction materials prices are unlikely in the near term.”

- Nicholas Stern, editorial associate

Global Liquidity to Remain, while Growth Declines This Year and Next

Global liquidity should stay abundant the remainder of the year and into 2017, while growth throughout the world should drop to 2.4% this year and stay below 3% in 2017 for the seventh year in a row, propped up mainly by the U.S .and emerging markets.

“Global liquidity should remain abundant due to further monetary easing by major central banks, despite the U.S. Fed hikes,” said Ludovic Subran, chief economist at Euler Hermes. “However, low rates and monetary policies are far from uniform, so liquidity can move rapidly across the regions, generating volatility and turbulences.”

In the U.S., the economy is set to benefit from the staying power of the U.S. consumer, with stronger economic activity providing some relief on suppliers in the industrial sector, Subran predicted.
In China, macro policies targeted to support growth should keep it at 6.5% this year and 6.4% in 2017, though lower demand for foreign goods, negative prices pressures and financial stress could mar the economic vitality, Euler Hermes analysts said.

European growth should stay stable at 1.6% because of an improved policy mix, including the ECB’s Quantitative Easing program and the Juncker plan that doubled to €630 billion. Political uncertainties including Brexit, upcoming elections and other points of tension could weigh on the region, Subran said.

Emerging markets could see growth of 3.8% this year and 4.4% in 2017, as Russia and Brazil are expected to exit recession, but tough credit conditions and the exchange rate crisis are likely to negatively impact countries like Mexico, Turkey and Venezuela, analysts said.

Subran sees three other significant factors impacting the global economy in the near term:
- An expected rise in insolvencies in most emerging countries and in the U.S. Payment terms are also not improving on a global scale, with one in four companies being paid after three months, Subran said.

- Ongoing low commodity prices, though commodity exporters may see some economic stabilization, he said.

- Reduced global trade well below the pre-crisis average of 7%, driven by demand shocks, structural adjustment in demand from China’s rebalancing and energy autonomy in the U.S. and tighter U.S. monetary policy and depreciated currencies, higher import costs and protectionism. “More than 350 protectionist measures have been recorded worldwide in H1 2016, related to both trade in goods and in services,” Subran said. “In addition, the overall electoral calendar, combined with some political and social hotspots will continue to generate turbulences until the end of 2017.”

- Nicholas Stern, editorial associate

Drag from Import Prices Fading

Import prices edged up 0.1% last month, according to Wells Fargo. Overall, prices are now down 1.1% over the past year.

“The deflationary impulse from import prices continued to moderate in September …,” the firm noted. “Exporters are also feeling less pressure to cut prices, with price declines easing on a year-ago basis.”

A 1.2% rebound in petroleum prices was credited for the uptick. The moderate pace of the dollar strengthening, however, has eased pressure on nonpetroleum import prices, the firm said. “Pressure on exporters to cut prices in order to stay competitive amid sluggish global demand and the strong dollar is also easing somewhat.”

Total export prices went up 0.3% last month. Higher fuel prices and gains in consumer goods and auto prices fed the increase. Agricultural export prices fell 1% “and look likely to remain a drag on total export prices amid strong yields.”

- Diana Mota, associate editor

Chinese Financial Institutions Help Global Private Debt Issuance Rise on a Yearly Basis

Chinese issuers, Japanese primary market volumes and European nonfinancial corporations helped contribute to a 28% rise in global private debt issuance to some $1 trillion compared with the same time a year ago, though the figure is slightly down from the previous three months.

Advanced economy issuers increased new bond supply by 22% year-over-year to $664 billion, but the total was 10% lower on the quarter, said Rahul Ghosh, vice president and senior credit officer with Moody’s Investors Service, in a new report.

"Over the third quarter, total issuance grew in emerging markets, but was 10% lower in advanced economies on the quarter," Ghosh said. "Primary market volumes in North America were broadly at levels seen a year ago, with muted issuance by nonfinancial corporations in Q3 after a busy second quarter offset by stronger activity from financial institutions. In contrast, Europe primary markets saw higher placements from the non-financial sector, boosted by United Kingdom issuers returning to primary markets after a referendum lull."

In North America, nonfinancial corporate issuance was 6% lower year-over-year and down 30% from the second quarter, mostly because of subdued investment-grade volumes, Moody’s analysts said. Financial institutions, however, saw issuance rise yearly by 20% and 2% on a quarterly basis.

In the UK, deal volumes from nonfinancial companies doubled in dollar terms, while financial institutions raised most of their new bond debt in the third quarter of this year, Ghosh said.

Meanwhile in emerging markets, total issuance increased by 43% year-over-year and 16% by the quarter to $342 billion. “One of the key drivers behind this rise was higher Chinese issuance, particularly from financial institutions,” he said.

- Nicholas Stern, editorial associate

Airports, Ports and Toll Roads to See Slowed, but Ongoing Growth in 2016

The transportation sector should see growth for the remainder of the year, albeit at a slower rate than the first half of 2016, thanks in part to increased traffic, a strong dollar and low fuel prices.

Seth Lehman, Fitch Ratings senior director, expects to see passenger traffic grow by about 3% during the second half of the year, with much of the air passenger traffic coming from international hub airports. So far this year, all major U.S. carriers have experienced positive growth with the exception of United Airlines.

The nation’s ports should continue to take advantage of the stronger dollar driving imports as 20-foot equivalent units—a measure of cargo capacity—have been increasing at a higher rate than the GDP for the first half of 2016, Fitch analysts said. And while the industry focuses on big ship readiness in light of the expanded Panama Canal that opened for commercial traffic this year, “large-scale shifts in cargo are not expected, but some adjustments are possible,” Lehman noted.

Low fuel prices have worked to increase traffic to the US’s toll roads by some 6.3% as revenue has jumped by 7%, Fitch says. “The higher rate of growth in revenues is reflective of typical inflationary toll rate increases, which Fitch expects to average roughly 2% over time.”

- Nicholas Stern, editorial associate

European Car Parts Suppliers Outlook Dinged to Stable on Weakening Growth

European car parts suppliers could face headwinds next year as growth regions like Europe, China and the U.S. will begin to weaken or fall to minimal positive growth.

The situation led Moody’s Investors Service to drop the sector’s outlook from positive to stable. The ratings agency previously reduced its growth forecast for global car sales to 2.7% this year and 1.1% for 2017 from 3% and 1.8%, respectively. However, as the value-per-car continues to increase, Moody’s anticipates the revenue growth for European car suppliers will continue to surpass global car production.

Aggregate organic revenue growth for the sector could thus slow to between 3.5% and 4% in 2017 following this year’s rate of 6%, putting the average rate of 4% to 4.5% over the next year and a half, which is below Moody’s threshold of at least 5% organic growth for a positive outlook.

“Moody's would consider changing the outlook to positive if it expects aggregate organic revenue growth to exceed 5% over the next 12 to 18 months and sees an increase in EBITA margins and stronger free cash flow generation,” the firm’s analysts said.

- Nicholas Stern, editorial associate

Insolvencies and Late Payments Up in Survey of NAFTA Nations and Brazil

From Canada to Brazil, businesses are experiencing increased pressure from insolvencies, as some 93% of respondents to an Atradius survey reported late payments from business-to-business (B2B) customers during the past year.

One of the major factors contributing to rising insolvencies in the region is low commodity prices, albeit to a greater (Canada at 4%) or lesser (U.S. at 2%) extent depending on the nation, note analysts with trade risk insurer Atradius in a new report. Other factors leading to growing bankruptcies: dampened demand for exports in the U.S.; low oil prices and slow productivity growth in Mexico; and a recession in Brazil.

Respondents said, on average, 47.1% of the total value of domestic B2B sales on credit were paid late, up from 46.1% the prior year; late payment amounts for sales on credit from foreign sources came to 49.6%, the same as in 2015. The domestic customers of U.S. and Mexican companies with past due invoices were the slowest to finally pay in the region, at 34 days late each, on average. Brazilian firms paid 28 days later and Canadian companies paid the quickest, at 23 days after the due date.

More than 44% of Atradius survey respondents said the most common reason domestic customers pay late is liquidity concerns. About a quarter of respondents said late payments were caused by customers’ bankruptcies, up from 24.2% in 2015. Slightly fewer companies (30% in 2016 compared to 32.8% in 2015) believe their customers stretch out payment as a strategy to finance their businesses.

About 20% of businesses surveyed in the U.S., Canada and Mexico said cash flow was the biggest challenge to profitability, though the U.S. and Canada reflected concern about a likely fall in demand for products and services this year. In Mexico, cash flow concerns stemmed more from inefficiencies in receivables management, while in Brazil, difficulties in collecting outstanding invoices and opaque bank lending in the domestic market created more of a concern for cost containment according to Atradius.

As a result of slipping conditions, most survey respondents said they planned on increasing the tools they use to secure credit, from requesting secure forms of payment to checking the creditworthiness of their customers more often over the next year.

Overall, the percentage of uncollectable receivables decreased this year (1.4% on average) from 2015 (1.8%), with the U.S. slightly above the average at 1.5% and Canada below it at 1.1%.

By sector, the construction industry saw the largest proportion of overdue payments and the poorest B2B payment performance in 2016, with about half of construction invoices being paid late, Atradius said. The machine and paper industries had the most generous payment terms, averaging about 36-day invoice due dates and the food sector had the tightest terms with about 15 days from the invoice date.

- Nicholas Stern, editorial associate

The Oil and Gas Sector Could Stabilize with Crude Price Increase, Lean Operating Strategy

As oil breached the $50-per-barrel mark today for the first time since August following an OPEC deal last week, Moody’s Investors Service sees stable earnings in the oil and gas sector over the next year-and-a-half thanks in part to higher oil prices and lower operating costs.

"Over the last year, integrated oil and gas companies have accelerated reductions in their operating costs to adjust to earlier oil price declines,” said Elena Nadtotchi, a Moody's vice president, senior credit officer and author of a recent report on the topic. “As a result, most companies' upstream operations returned to positive net income generation in the second quarter of 2016, while also benefiting from an uptick in the price of crude."

Still, Moody’s analysts expect slower upstream cost reductions going forward after the industry realized a 26% cut in average production costs per barrel of oil equivalent in 2015. “Volume growth in the sector will remain flat as companies continue to cut capex to pay dividends, and investment returns remain low at the current level of oil prices,” Nadtotchi said.

Also, the oversupply of refined products in Europe and North America leading to weaker downstream performance in 2016 likely will slow the sector’s earnings before interest, taxes, depreciation and amortization. Moody’s predicts the sector should generate roughly $65 billion in negative free cash flow this year and next, though some firms should create positive free cash flow. The ratings agency also anticipates integrated companies will continue to fund deficits by selling off assets, issuing new debt and cash balances over the next year-and-a-half.

- Nicholas Stern, editorial associate