To ensure it can meet future demand, the energy sector is constantly making projections of future production levels and commodity prices.
But financial analysis, particularly in upstream companies, can be challenging compared to other industries because of three key factors: energy companies cannot control prices or revenues, but follow commodity price cycles; their assets are constantly depleting; and they’re balance sheet-centric.
Key fact: Oil holds the largest share of global energy consumption at 31.2%
Also working against energy companies is their capital intensity, which jeopardises their credit ratings and ability to invest in new equipment or projects by creating debt.
Because this is almost unavoidable in the energy sector, four leverage ratios are used to assess the financial health of a company: Debt/EBITDA, EBIT/Interest Expense, Debt/Cap, and the Debt-to-Equity Ratios. These illuminate how a company is handling its debt, which, when done properly, can actually increase shareholder returns as it’s cheaper than the cost of equity.
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