Latest Industry Risk Actions

Policymakers and investors worldwide have been more focused on the energy transition. This is understandable given that many European countries have committed to net zero carbon emissions by 2050, China has now also committed to carbon neutrality by 2060, and the U.S.--under the new Biden administration--has rejoined the Paris Agreement with the intention to establish an enforcement mechanism to achieve net-zero emissions no later than 2050. The COVID-19 pandemic has further added to the increased importance of sustainability and societal considerations. Because of these developments, our latest review of our industry risk assessments focused on ESG-related issues, particularly how they're driving secular changes and affecting growth and profit margins. Our analysis of competitive risk and growth for each industry is a prospective analysis and is one of the ways we capture long-term trends and uncertainties to our ratings.

Our ratings and industry scores have always factored in environmental and social risks. Nevertheless, our latest industry review resulted in changes to 10 of the 38 corporate and infrastructure sectors. Whereas most changes reduce headroom within our industry assessments, the overall industry scores effectively changed for the midstream and oil and gas (O&G) exploration and production (E&P) sectors. For the O&G E&P sector, we placed our ratings on several investment-grade companies on CreditWatch with negative implications, and we revised our outlooks on some others to negative from stable (see "S&P Global Ratings Takes Multiple Rating Actions On Major Oil And Gas Companies To Factor In Greater Industry Risks," Jan. 26, 2021). For the midstream sector, we do not anticipate any resulting near-term rating actions, as the ratings on this sector's investment-grade entities generally are supported by long-term contracts and long-lived assets (see "The Change To The Industry Risk Assessment For Midstream Energy Companies And What It Means For Credit Quality," Jan. 27, 2021).

Below we outline all industry subfactor changes. Some industries represent an aggregate view of sometimes heterogeneous subsectors, such that ESG related influences may be captured through our competitive position analysis at the entity level, rather than at the broad industry assessment (see "Industry Risk Assessments Update: Jan. 25, 2021" and "Industry Risk Assessments Update: Jan. 27, 2021," for a full overview of all industry risk assessments).

What Is Behind The Changes For Each Sector?

O&G integrated E&P:  We revised the industry risk for this sector to moderately high (4) from intermediate (3). This was partly because of the increased environmental threat posed by greenhouse gas (GHG) emissions, evolving government policies and emission standards, and the rising share of renewables, supported by their cost-competitiveness. We believe the structural changes for fossil fuels increase product "substitution and growth trend risks". Our overall industry score for O&G E&P is now the same as for O&G refining and marketing and oil field services. Another driver behind the change is the heightened investor demand to focus on ESG, which could make future market access more challenging. We believe as clean energy becomes an increasing part of the energy landscape, it poses a medium- to longer-term threat to oil and natural gas demand growth, even if we project that the energy transition would be spread over several decades. Moreover, average returns on capital for the industry have been declining over the last decade. This reflects both high historical development costs and generally lower and more volatile prices, which we believe could persist. We therefore revised the risks to "profit levels and trends" to high from medium.

Midstream energy:  We revised the overall industry risk score to intermediate (3) from low (2) because of increasing environmental risks posed by climate change and GHG emissions as well as the threat these risks pose to the future production and use of hydrocarbons over the long term. Contributing to this change was our reassessment of "secular change and substitution risk" to medium to reflect the increased risk that higher renewable penetration and the gradual pace of the energy transition could pressure the midstream industry over time. We'd already assessed industry growth trends as a medium risk because we expect organic growth to slow considerably given the decades-long energy infrastructure buildout and slowing production trends. The latter might also result in lower profitability when rates and fees are renegotiated. Therefore, we've also revised our score for "level and trends of profit margins" risk to medium. Nevertheless, we recognize that many of the more highly rated industry players benefit from long-term contractual protections, with no exposure to oil- or gas-price fluctuations.

Unregulated power and gas:  Our higher risk assessment for "secular change and substitution" as medium reflects the rapidly evolving energy transition policies across the globe, combined with proactive environmental corporate strategies. These are driving an accelerated shift in energy sources to decarbonize the power sector, which remains by far the largest emitter of carbon. The more global trend toward the greening of the power and gas sector, coupled with increasingly competitive renewable energies, is increasing the risks for both fossil-based and nuclear power. We believe this transformation will be driven by the sector itself to an extent but also increasingly by other industrial and institutional players entering the green economy.

Transport (cyclical):  We raised the risk of "secular change and substitution" to medium, as we foresee increasing transition risks for the transportation sector. This has already been the case for shipping, with IMO 2020 limiting sulphur content in fuels. For airlines, the potential for environmental taxes on consumers and tighter emission restrictions that would require technological change of engines or fuels are likely medium- to long-term risks. Airlines also are highly sensitive to health and safety issues and we already assessed the growth outlook as medium risk with air traffic likely to recover from the pandemic only by 2024. The reasons for not raising our assessments further are the fact that we see the COVID-19 pandemic as an exceptional event, as well as the heterogeneous nature of the industry, which covers not only airlines but also shipping and trucking.

Metals (downstream):  We revised our assessment of "secular change and substitution" risk to medium from low. This is because end users of steel and aluminum are continually incentivized to seek more efficient strength-to-weight properties in final products, a good example of which is the shift to composite materials in aerospace or lightweight plastics in autos. And even if few immediate cost-efficient alternatives are available, there are increasing energy transition risks, notably from higher carbon taxes, that represent a risk of secular change and equally contributed to the our high risk assessment of "profit margin levels and trends".

Mining:  We revised our score for risk in "growth trends" to medium. The capital and operating costs of mines have risen significantly as low-cost reserves have depleted and high-quality new deposits in attractive jurisdictions become more scarce. Moreover, the sector's operational footprint faces elevated scrutiny as ore deposits become increasingly difficult to develop, which might entail greater land use, more waste, or more toxic emissions. In addition, environmental regulations and social opposition increasingly delay permits to start new projects, potentially reducing growth (but also elevating barriers to entry and supporting the competitive positions of existing assets). Finally, our medium growth outlook also factors in potentially slowing increases in metals intensity as emerging economies mature. With the obvious exception of thermal coal, we continue to view the risk of "secular change and substitution" as low on average. Most miners have shifted their investment plans to support materials for renewable power like copper, cobalt, and lithium.

Auto OEM:  We raised the industry's "substitution and secular risk" score to medium because the accelerated transition to electrified mobility, connectivity, and autonomous driving is opening up the competitive arena to new technologies and players. These are challenging legacy business models, brand management, and commercial practices. The gradual displacement of the industry profit pool, which includes both from hardware to software, is resulting in large investments in IT and software, which will be the keys for automakers to gain a competitive advantage. Moreover, while automakers have developed a strategy to grow electric vehicles, this entails increased R&D and capital expenditures. This will make it difficult for them to sustain a track record of profitable growth/solid cash flow amid evolving consumer demand and tightening government policies. These energy transition risks are equally captured in our assessments of "secular change risk" as medium and "level and trend of profit margin risk" as high.

Building materials:  We raised the "substitution and secular risk" score to medium, as we foresee increasing transition risks for cement companies and other heavy-side producers due to growing environmental regulation to reduce GHG emissions. This could result into higher carbon taxation, particularly in developed markets. While there are no immediate cost-efficient alternatives available, some large players are working on new technologies to cut emissions. Over the next five to 10 years, this could affect the competitive profile within the industry, likely harming smaller and less-innovative players. Also, companies might not be able to fully pass through rising carbon costs to final clients, which we capture in our existing assessment of "profit margin trend" risk as medium. However, building material distributors are significantly less affected by risks related to GHG emissions.

Containers and packaging:  We raised our assessment of "secular change and substitution" risk to medium. This reflects the move away from plastic packaging or to so-called sustainable plastic packaging, such as through the increased use of recycled resins in the plastic production process or the implementation of recycling loops. Regulators, consumers, and investors have supported such initiatives. In certain segments, this might lead to lower demand for plastic packaging; in other areas, it will trigger additional investment needs. This could benefit some paper and metal packaging producers, even if we believe that environmental awareness of and need to reduce waste will likely become a consideration for the broader packaging industry. This is also reflected in our assessment of "growth risk" as medium.

Retail and restaurants:  We raised the risk in "growth trends" to medium because we believe the industry will continue to grow near or slightly below GDP levels in the face of increasing competition for a share of consumer spending. Consumer behavior during the pandemic illustrated the sensitivity of some subsectors to health and safety concerns, such as with the shift of spending from goods and services focused on activities outside the home to goods and services that improve life at home. This had a very negative impact on restaurants and pubs, but it benefitted grocers. As an average for the industry, we believe such risk of secular change (including the accelerated industry trend of more online shopping) is captured in our existing risk score of medium. Given the heterogeneous nature of the industry, we capture risks of different subsector dynamics within a firm's competitive position.

How We Capture Environmental And Social Risks In Related Sectors

Below we comment on eight industries where we made no changes to our risk assessments, as we believe their ESG credit risks were already sufficiently captured.

Commodity chemicals, including fertilizers:  We expect the focus on environmental regulation for commodity chemicals to remain, but our medium risk assessment for both "secular change and substitution" as well as for "growth" also recognizes that companies have adjusted to longstanding regulations, such as REACH. Products facing these risks include disposable plastics for food and beverage packaging and some fertilizers (as ammonia production has a very high CO2 emission footprint). We consider the sector's ability to generate alternate products and certain secular trends, such as the rising global demand for food, to be potential mitigants to these risks. In addition, the rising risks posed by CO2 emissions and the related costs (including those related to regulation and assuaging public concerns) are captured in our medium risk for "secular change" and high risk for "profit margin trends."

Autosuppliers:  "Secular change and substitution risk" was already medium, and now auto OEMs also have that score. Subsititution risks for auto suppliers are twofold, with competition from both new players (battery cell producers) and tech companies (as a considerable share of investments will go into software development).

Forest and paper products:  Industry players are making increased investments to reduce pollution and exposure to CO2 carbon taxes while trying to mitigate their exposure to climate change (notably for forestry). These environmental and social risks are reflected in our assessment of "profit margin trend" risk as high. The demand for paper is also changing, with lower demand for graphic paper due to the digitalization and growing demand for packaging and specialty paper (such as labels). This is reflected in our assessment of "growth trend" risk as high. The structural shift to more digitized products is an industry trend (rather than ESG factor) captured in our medium "secular change and substitution" risk assessment.

Agribusiness and commodity foods:  Environmental and sustainability risks have become more pronounced for the agribusiness sector, but our intermediate "industry risk" assessment remains unchanged, as these risks are already reflected in assessment of "profit margin trend" risk as high. The impact of climate change on profit volatility from continued increases in land and water use will likely keep margin pressure and profit volatility high. Still, substitution risk remains low, as demand for food is not discretionary. Disease mitigation remains an important social health and safety factor, but in in aggregate, environmental risks are most relevant to the industry.

Transportation infrastructure:  We didn't revise our assessment of "substitution risk" from low. We believe it continues to reflect the essential monopoly nature of most infrastructure assets as well as the heterogeneous nature of the industry comprising of airport, road, ports and rail transportation modes. We recognize the severe disruption of the pandemic on the airport subsector as well as on mass rail, but we consider such a pandemic to be a low-probability event that's unlikely to recur with the same severity. Accordingly, we assume traffic will generally recover over the next five years. At the same time, there could be some switching between industry modes of transport (for instance, to high-speed rail for short-haul flights in Europe), a moderate negative impact on growth because of virtual meetings, and more environmental regulations and CO2 costs in the case of airlines, albeit the opposite for rail. Overall, we expect industry growth rates to be lower than historical trends (when they were supported by globalization, rising mobility, and a drop in costs), as reflected in the existing medium risk growth assessment.

Regulated utilities:  Regulation acts as a key mitigant for the industry, protecting revenues, margins, and cash flows. Also, the sector is somewhat heterogeneous: The low "secular change" risk reflects that of the broader industry, with gas networks somewhat more exposed to the energy transition than electric and water.

About Industry Risk Assessments

S&P Global Ratings currently maintains 41 industry risk assessments based on the criteria in "Methodology: Industry Risk," Nov. 19, 2013.

The risks entities face because of the industries in which they operate are critical factors in our analysis of their business risk profiles and our assignment of issuer credit ratings. The methodology distills this sectoral analysis into a single global industry risk assessment that reflects the risk and return potential for a company in the markets in which it participates. We have industry risk assessments on 38 nonfinancial corporate industries, all based on the criteria. These assessments classify industries on a scale from very low risk to very high risk (see "Industry Risk Assessments Update: Jan. 27, 2021," Jan. 27, 2021). Our industry assessments are an important component of our corporate criteria (see "Corporate Methodology," Nov. 19, 2013). The criteria organize the analytical process according to a common framework and articulate the steps in developing the stand-alone credit profile and issuer credit rating for a corporate entity.

The industry risk criteria are intended to help market participants better understand our approach to evaluating the risks that entities (nonfinancial corporate entities and U.S. public finance and international public finance enterprises) face in their respective industries. The criteria are also intended to enhance the comparability and transparency of ratings across sectors by comparing and scoring interindustry risk.

The industry risk assessment combines an industry's cyclicality assessment, using the stress scenarios in "Understanding S&P Global Ratings’ Rating Definitions," June 3, 2009, and our assessment of a sector's overall prospective competitive risk and growth environment. We combine these assessments to determine the global industry risk assessment.

Related Research

• Industry Risk Assessments Update: Jan. 27, 2021, Jan. 27, 2021
• Industry Risk Assessments Update: Jan. 25, 2021, Jan. 25, 2021
• ESG Pulse: Reimagining Accounting To Measure Climate Change Risks, Dec. 22, 2020
• The Energy Transition: COVID-19 And Peak Oil Demand, Sept. 24, 2020
• The Energy Transition: The Effect Of COVID-19 Economic Recovery Policies, Sept. 24, 2020
• Write-Downs, While Eye-Catching, Are Not The Largest Issue Facing Oil And Gas Supermajors, Aug. 3, 2020