Saudi Vision 2030: Oil and gas sector expected to take a lead

Saudi Arabia's Vision 2030 aims at diversifying away from hydrocarbons, a plan which has led to significant project announcements across various corporate sectors. We understand that the country's investment needs are significant given the many government schemes, investment commitments, and private sector spending plans through to 2030. Gauging exact funding requirements and timing is not easy but we expect to see investments ramping up, albeit cautiously, in the energy sector over the medium and long term.

The Saudi energy sector is a substantial contributor to the government's revenues and its credit quality is currently benefiting from higher oil and gas prices. This windfall will help fund the government's share of investments despite its heavy capital expenditure (capex) burden.

Broadly balanced supply-demand dynamics supportive for short-to-medium-term prices. Geopolitical uncertainties, recessions, and lockdowns in China (where zero-COVID policy restrictions were only recently lifted) have translated into lower global oil demand. Even so, we assume oil prices remain supported by many factors, largely on the supply side of the equation, which in turn should provide healthy cashflows for the sector.

The Saudi oil and gas sector will attract cautious but ongoing capex. Brent crude oil prices are currently hovering just below $90/bbl, after temporarily hitting $127/bbl in March 2022, and we have seen the region's oil and gas companies reap the benefits of commodity price increases in the year to date. We expect the broadly cautious spending approach witnessed over the past few years to continue, with exploration and production (E&P) spending increasing only modestly. Saudi Aramco (not rated) has publicly announced that its 2022 capex will be at the lower end of its guidance of SAR150.0 billion-SAR187.5 billion ($40 billion-$50 billion) compared to 2021 capex of SAR119.6 billion ($31.9 billion). Saudi Aramco is reportedly focusing on upstream and downstream investments including expanding its crude oil production capacity to 13 million barrels per day (mmbpd) by 2027 and boosting gas production by more than 50 percent by 2030, in addition to the long-term goal of up to 4 mmbpd liquids-to-chemicals, all of which requires continuous capex. Credit quality in the energy sector continues to benefit from higher oil prices.

We tend to align most of our ratings on other national oil companies in the region with their respective sovereigns, for instance QatarEnergy (AA/Stable/--) or Energy Development Oman (BB/Stable/--). This reflects the national oil companies' significant role in the hydrocarbon sector and the sector's contribution to their overall economies. It also factors in their ownership structures and direct government oversight via boards of directors. Their stand-alone credit profiles (SACPs), which are in some cases stronger that the creditworthiness of their respective sovereigns, factor in how they manage their overall financial policies, their free cash flow generation for debt repayment, and shareholder returns.

Increased investments should provide some cash-flow visibility for the Saudi oilfield services (OFS) sector. To boost the Kingdom's production capacity Saudi Aramco publicly announced plans to double its offshore fleet to 90 by 2024. In May 2022 it also announced 16 jack-up contracts for 80 rig years, with most contracts lasting five years plus two option years. As a result, this provides more visibility for the backlog of OFS companies that have growing exposure to Saudi Arabia. In Q2 2022, the global jack-up market recorded the most rig years signed in a quarter for more than five years, with over 70 percent of the awards coming from the Middle East. As of August, for example, of its 11 rigs based in the GCC Shelf Drilling Holdings Ltd. (CCC+/Stable/--) had seven rigs contracted in Saudi Arabia with Saudi Aramco, with 2025 the earliest expiration date and most of the contracts benefiting from annual adjustments linked to Brent price movements. In September 2022 ADES (not rated) publicly announced plans to acquire seven drilling jack-ups from Seadrill for $628 million, with four already contracted with Saudi Aramco.

When assessing OFS companies in our rated portfolio, which are typically below investment grade (such as Shelf Drilling), we focus on liquidity management and capital-structure sustainability given the challenges of rising borrowing costs and the inflationary cost environment. The OFS sector is just emerging from prolonged pricing pressures and demand weakness dating from the oil price decline of 2014-2015. Therefore, most OFS and drilling companies started 2022 with high cash flow leverage.