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December Rate Hike Could Hurt Investors in Upstream Companies

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Updated

Interest coverage ratio

After the FOMC’s (Federal Open Market Committee) meeting on October 28, the probability of a rate hike in December grew. Since October 28, upstream companies’ stock fell by 18% as of December 10—compared to an ~2.5% rise in large-cap downstream companies.

Crude oil was also trading below $40 per barrel as of December 10. Upstream companies’ average interest coverage ratio in fiscal 3Q15 was 4.94x—compared to the 9x of large-cap downstream companies. Upstream companies are more likely to be impacted by the probable rate hike in December—compared to their downstream peers.

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Upstream companies’ growing 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, some companies like EOG Resources (EOG) saw its debt fall by 0.5%. 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).

Devon Energy’s (DVN) debt fell by 6% in fiscal 3Q15.

Weighted average cost of debt 

The weighted average cost of debt for these upstream companies stood at 2.9% at the end of fiscal 3Q15. 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 in order to raise the debt.

The above graph 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%.

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