Oil and gas operations are very capital-intensive, yet most oil and gas companies carry relatively small amounts of debt, at least as a percentage of total financing. This can be seen in debt-to-equity (D/E) ratios. Keep in mind that not all oil companies are involved in the same operations. A company's position along the supply chain influences its D/E ratio.
The Debt-to-Equity Ratio
A company's D/E ratio is calculated by dividing total owner's equity by total liabilities. Publicly-traded companies have this information available in their financial statements.
The D/E ratio reflects the degree to which a company is leveraged. In other words, it shows how much of the company's financing results from debt as opposed to equity. Generally speaking, higher ratios are worse than lower ratios, though these higher ratios may be more tolerable for large firms or certain industries.
Trends in the Oil and Gas Industry
Many oil companies shrank their D/E ratios during the mid-2000s on the back of ever-rising oil prices. Higher profit margins allowed companies to pay off debt and rely less heavily on debt for future financing.
Starting around 2008-2009, oil prices dropped dramatically. There were three main reasons:
- Fracking allowed companies to reach new oil reserves in an economical way
- Oil and gas shale production exploded, particularly in North America
- A global recession put downward pressure on commodity prices
Profit margins and cash flow fell for many oil and gas producers. Many turned to debt financing as a stop-gap; the idea was to keep production flowing through low-interest debt until prices rebounded.
As a result, this pushed up D/E ratios across the industry. Before the financial crisis of 2008, common D/E ratios among oil and gas companies fell in the 0.2 to 0.6 range. As of 2018, the range clusters within 0.5 and 0.9 with crude oil prices trading in a range between $50-70 per barrel.