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Bearish Outlook for Upstream Sector: Rising Rates and Growing Debt

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Interest coverage ratio

Interest rates are supposed to be higher in 2016 compared to 2015, which makes the outlook for upstream companies bearish. Crude oil was also trading below $38 per barrel as of December 29. Upstream companies’ average interest coverage ratio in fiscal 3Q15 was 4.9x compared to the 9x of large-cap downstream companies. Upstream companies are more likely to be impacted by the rate hike than their downstream peers.

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Total growth of debt

The total debt for EQT (EQT) and Cabot Oil and Gas (COG) grew by 19% and 52%, respectively, on a YoY (year-over-year) basis in fiscal 3Q15. However, EOG Resources (EOG) saw its debt fall by 0.5%. On the other hand, Pioneer Natural Resources’ (PXD) debt grew by only 0.45% in fiscal 3Q15 on a YoY basis. EOG and Pioneer Natural Resources have weights of 4.0% and 3.3%, respectively, in the Energy Select Sector SPDR Fund (XLE). Also, Devon Energy’s (DVN) debt fell by 6% in fiscal 3Q15.

Weighted average cost of debt

The graph above shows the upstream companies’ debt growth and the weighted average cost of debt. In fiscal 3Q15, the weighted average cost of debt for large-cap downstream companies was 2.5%. The weighted average cost of debt for these upstream companies stood at 2.9% at the end of fiscal 3Q15. Additionally, falling crude oil prices made rating agencies bearish on these companies’ stocks. If the current situation prevails, the upstream industry could experience stiffer rules and higher interest.

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