In the ever-volatile world of commodities, the plummeting oil prices serve as a testament to the intricate and sometimes unforgiving dynamics of the global market. Offshore drilling contractors, forming the backbone of the oil industry, are among the hardest hit. This paper delves into the story of one such contractor that, caught in the downward spiral of oil prices, found itself trapped in the throes of bankruptcy. At its core, this tale is a study of credit risk and the undeniable significance of proactive measures, specifically the essentiality of supply chain analysis and scenario planning.
Challenge
We track the story of Noble Corporation PLC1, an offshore driller who filed for bankruptcy in July 2020 before restructuring its balance sheet and ultimately emerging from legal proceedings in February 2021. For Noble, the challenge was more than just facing the immediate pressures of sinking oil prices. The larger predicament lay in the cascading ramifications that extended throughout their financial ecosystem. Lenders, suppliers, and stakeholders, all accustomed to a predictable risk framework, suddenly found themselves grappling with mounting uncertainties. While the commodity price drop acted as the catalyst, the firm’s downward spiral impacted customer supply chains. A lack of preparedness and the absence of a robust credit risk strategy amplified the consequences. This dire situation underscores the essential question: How can organizations effectively anticipate, measure, and mitigate risks in such a mercurial environment?
Insights
Drawing insights from Noble’s experience, it is clear that understanding credit risk is not solely about gauging a company’s financial health in isolation. Rather, it requires a comprehensive view that encompasses the entirety of its supply chain and dynamics within a firm’s industry. By integrating supply chain analysis and scenario planning, organizations can anticipate potential disruptions, weigh their implications, and devise strategies to circumvent them. In the case of offshore drilling contractor customers,had they undertaken a thorough examination of their supply chain’s vulnerabilities to fluctuating oil prices and conducted scenario planning for possible downturns, they might have been better equipped to weather the storm. As the saying goes, “forewarned is forearmed,” and in the realm of credit risk, these tools are the armor that companies need.
Noble’s recent emergence from bankruptcy is the capstone on a tumultuous decade, one in which the firm struggled to overcome economic and legal obstacles. The rise of fracking and other inland shale extraction technologies boosted global oil supply and weighed on prices through late 2014 and early 2015:
Noble was caught flatfooted; its business model hinged on higher prices to support the capital investment and maintenance costs required for offshore drilling. Noble quickly came under pressure—revenue growth declined in 2014 and then again in 2016, 2017, and 2018—and the firm operated at a loss as oil prices remained low. However, while Noble struggled, the influx of fracking-related supply also disrupted the broader energy market. As a result, while EDF-X signaled Noble’s rising credit risk starting in 2015, the firm was still considered safe relative to economically similar firms, as measured by its peer group based trigger, a component of EDF-X’s Early Warning System (EWS):
Developments worsened soon after. Noble spun off a share of its fleet into the separate entity—Paragon Offshore—in 2014. However, Paragon was also impacted by declining oil prices and ultimately failed before emerging from bankruptcy in 2017. The firm’s creditors filed suit against Noble in the same year, claiming Noble overstated Paragon’s prospects and the value of its assets while also leaving it a significant debt burden. The resulting legal entanglement weighed on Noble’s prospects, and investors began to pull back; the stock price collapsed, and Noble’s PD pushed beyond the EWS trigger in May 2017, indicating a higher level of credit risk relative to similar firms. Further, Noble’s performance continued to trend away from that of its competitors in the following months. Credit stress in the broader oil and gas extraction industry peaked in 2016 before gradually declining through 2018 as oil prices stabilized. This dynamic, captured in Figure 3, is evident across firms at differing levels of credit risk. However, Noble’s credit risk started increasing in 2016 and remained elevated through 2018, suggesting deterioration specific to Noble’s business, not a reflection of broader market trends.
This dynamic is also captured in Noble’s PD-Implied Rating, which translates EDF-X PDs into the language of credit ratings. Credit deterioration between 2014 and 2016 can be attributed to the decline in oil prices and general disruption in the non-fracking segment of the oil and gas industry. However, Noble’s rating continued to fall, ultimately reaching Caa/C in mid-2017.
Oil prices stabilized in 2018, but at roughly $60 per barrel, Noble’s operating and profit margins remained under pressure. Disaster struck two years later as the COVID-19 pandemic led to a collapse in global oil demand. Facing significant obstacles, Noble filed for bankruptcy in July 2020, aiming to restructure its capital base and streamline operations. The firm reached a settlement with Paragon creditors in August, remained in operation, and ultimately emerged from bankruptcy in February 2021 with an improved balance sheet position.
While Noble is currently in the midst of a turnaround, its prior struggles were identified well in advance of default. The EDF-X EWS synthesizes two measures—PD relative to trigger and changes in implied rating—into an actionable signal that identifies firms as “severe,” “high,” “medium,” or “low” credit risks. With a PD above trigger and an implied rating of Caa-C, Noble was flagged as a Severe credit risk during the fourth quarter of 2018, 18 months before the firm filed for bankruptcy in July 2020.
Further, Noble’s risk profile ran against the trend in the broader oil and gas extraction industry. Between 2017 and 2018, when Noble was first flagged as a Severe credit risk, the share of firms identified as Low risk increased from 38% to 47%, while the share of Severe risk firms fell from 26% to 20%:
The EDF-X EWS identified Noble as a vulnerable credit well before bankruptcy, allowing firms dependent on the offshore driller to prepare for supply chain disruptions. Looking ahead, the EDF-X Scenario Conditioned PD Model allows users to quantify changes in firm-level credit risk across different macroeconomic scenarios. This framework links macroeconomic forecasts to firm-level PDs and provides insights into how a given company’s credit risk will change, given varying economic assumptions. Further, the scenario conditioned PDs are incorporated within the EDF-X EWS, allowing users to identify the firms most vulnerable to changing economic conditions.
LLOG Exploration Company2—a deepwater exploration and production firm that contracts with Noble for offshore rig logistics—highlights the insights scenario conditioned PDs provide. Using economic scenarios at the 50th and 90th percentile (‘Baseline’ and ‘S3’ respectively) as an example, the EDF-X Scenario Conditioned PDs provide a view of evolving credit risk:
Scenario conditioned PD values are presented alongside the firm’s PD trigger; this peer group based trigger is also scenario conditioned, ensuring changes in relative risk between a firm and its peers are consistent across macroeconomic assumptions. Firm-level PD-implied ratings also vary by scenario:
The combination of relative and absolute credit risk metrics—firm PD relative to the peer group based trigger and the annual change in a firm’s PD-implied rating, respectively—are used as inputs to the EDF-X EWS. The quadrant view highlights firms most impacted by a shifting economic environment:
Conclusion
The early detection of credit deterioration is a critical element of risk management for lenders, investors, and counterparties in any transaction. A robust process includes multiple data sources—economic projections, financial statements, sentiment, and other indicators—and provides an intuitive set of decision-making rules for identifying at-risk names. EDF-X includes these elements and centralizes them in a single location, streamlining your workflow and allowing for greater coverage.
In the case of Noble, firm-specific risks left it vulnerable when oil prices collapsed in the middle part of the last decade. While many oil and gas firms outside the fracking segment struggled with falling revenues, Noble’s legal entanglements and falling favor among investors accelerated its demise. EDF-X highlighted these risks in real-time—Noble’s risk relative to its peers only became apparent after the lawsuit by Paragon’s creditors—and the EDF-X EWS flagged the firm as a Severe credit risk well before its bankruptcy in 2020.
Key Takeaways
- Credit risk can be driven by a number of factors, both macro and firm-specific. Disentangling these factors allows for a more accurate assessment of the threats to any one firm.
- Understanding linkages between a given firm and its counterparties enhances a view on credit risk—identifying vulnerable suppliers and customers beforehand allows a firm to prepare for a downturn.
- Scenario conditioned credit risk analytics can be used to identify firms vulnerable to changes in the economic environment.
1 Bvd ID GB08354954
2 BvD ID US131601607L
