On December 16, the Federal Reserve increased interest rates for the first time in almost a decade. Rates first came down from 5% in the summer of 2007 through the lows of the financial crisis in early 2009. Since then, the Federal Funds Rate has effectively been near zero in an effort to stimulate the underperforming U.S. economy. So what does the Fed’s historic decision last week mean for the energy sector?
The energy industry has undoubtedly benefited from seven years of zero-interest-rate policy. Oil & Gas firms have leveraged record-cheap money to fund the boom in unconventional resource production while the corresponding weak dollar helped elevate the nominal value of the industry’s key products, crude oil and natural gas. Utilities, on the other hand, rely on debt markets for a significant portion of their funding and took advantage of favorable debt markets to fund projects.
While the recent rate hike of 0.25% is in itself not a threat to the energy industry, the first policy change in nearly 10 years signals a major shift at a delicate time for the energy sector. Here's what that could mean:
1. Decreased Access to Capital
High yield (HY) debt markets, of which energy comprises roughly 15%, have been in turmoil in recent months. Average rates in HY are now above 9% and a number of major funds specializing in this space have recently shut their doors and/or barred investors from withdrawing money. Upstream O&G has relied significantly on these markets to fund operations over the latter part of the past decade. The Fed’s rate hike will push yields up and increase the pressure even more on upstream companies that have been struggling to rollover debt or raise new money in 2016. Utilities attempting to raise new money in 2016 will also see increased pressure and higher yields.
2. Strengthening Dollar and Weakening Crude Prices
By raising rates in the U.S. at a time when most central banks are cutting them, the Fed will attract dollar deposits into the country and strengthen U.S. currency even further. An even stronger U.S. dollar will put further downward pressure on crude oil prices, even as it also produces marginal procurement savings opportunities for purchases of goods from abroad.