Saturday, March 14, 2020

Bond investors say some energy companies ‘will not survive’ oil rout slamming markets
‘I honestly don’t know how this will ultimately shake out, but it is brutal,’ says one portfolio manager

March 10, 2020 By Sunny Oh and Joy Wiltermuth

An oil well in the Permian Basin in Garden City, Texas. Getty Images


Debt-laden U.S. shale-producing companies saw their bonds pummeled in Monday trading as an oil price war delivered a severe blow to the energy sector.

In the shale patch, U.S. crude producers have loaded up on debt to finance their capital-intensive fracking operations, often at a higher cost than those with larger multinational reach, and even as recently as January. But that also makes them vulnerable to the kind of slide crude prices saw on Monday, with the U.S. oil benchmark finished at a four-year low of $31.13 a barrel.

“There is a certain subset of energy companies like Chesapeake that will not survive,” predicted Bill Zox, chief investment officer of fixed income for Diamond Hill Capital Management, in an interview with MarketWatch.

Chesapeake Energy Corp. CHK, +95.95% saw its most-active 2021 maturing bonds tumble to an average $11.44 price on Monday, down from $41.18 on Friday, according to bond trading and pricing platform MarketAxess.


But the session’s most actively traded speculative or “junk” bonds came from shale producer Oasis Petroleum Inc. OAS, +169.68%, which saw the average price of its most-active bonds that mature 2022 plunge to $31.70 on Monday, from $74 on Friday.

On a yield basis, that translates to a more than 300%, and 79% yield, respectively for the pair of bonds, according to MarketAxess data, or a sign that traders feel there is little hope of bonds getting paid back in full.


To put things into perspective, bonds are typically issued with a value at $100, plus a spread over a risk-free benchmark, but shift with investor sentiment. Bonds that trade below $70 prices are considered distressed. Chesapeake and Oasis didn’t immediately respond to a request for comment.

Analysts at Deutsche Bank underscored that even before Monday’s rout in oil, about two-thirds of high-yield exploration and production companies were trading at distressed levels, and that their earlier 2020 forecast of a 15% high-yield default rate will likely now “go materially higher above that,” in a client note Monday.

The sharp leg down comes as shale producers have been known as a potential weak spot in the debt markets for some time, even when oil prices briefly shot above $60 a barrel earlier this year.

Read: Why weak energy companies won’t likely get a lifeline from higher oil prices

Yet their fortunes have become increasingly important to a broader base of debt investors, since energy companies currently represent the biggest part of the roughly $1.5 trillion U.S. junk-bond market.

The nascent price war between oil-producing giants Saudi Arabia and Russia, which left global equity markets awash in losses on Monday, is expected to be particularly punishing to U.S. shale producers, whose business models already were stretched thin by the tumbling crude.

“I think they are looking to accelerate the demise of that business model,” said Ken Monaghan, Amundi Pioneer Asset Management’s co-head of high-yield, amid reports that Saudi Arabia plans to cut prices and hike crude-oil production after its talks with Russian broke down over the weekend to implement crude output curbs.

“Of course, the problem is that you have collateral damage across other parts of the market,” Monaghan said. “This is kind of like the last straw that broke the camel’s back.”

See:Why U.S. shale oil producers are the real target in the Saudi-Russia price war

The Dow Jones Industrial Average DJIA, +9.36% fell more than 2,000 points on Monday, while the 10-year Treasury note yield TMUBMUSD10Y, 0.981% carved out a new historic low at 0.5%.

Check out: Here’s why cratering oil prices and the coronavirus outbreak will ripple beyond the U.S. junk-bond market

“Thirty percent of the shale patch producers may not be able to service their debt” if oil continues to trade at current levels, said Michael Kelly, head of multi-asset strategy for PineBridge Investments, in an interview.

At the same time, Zox said some of the higher-rated oil producers are better insulated from the shock and likely have enough capital to sit out any freeze in the capital markets because they rolled over their debt far enough into the future to avoid tapping jittery bond investors for funding.

Meanwhile, the iShares iBoxx $ High Yield Corporate Bond ETF HYG, +3.14% and the Bloomberg Barclays U.S. Corporate High Yield ETF JNK, +3.21% both settled down more than 4% on Monday. Highly liquid credit derivatives tracking the performance of corporate bonds also came under pressure.

“I honestly don’t know how this will ultimately shake out, but it is brutal. People are scared,” said Michael DePalma, managing director at MacKay Shields, who oversees The High Yield EFT, HYLD, +0.57% at the fixed-income management firm and subsidiary of New York Life Investment Management.

The decline in oil prices also comes as COVID-19 infections have risen globally, which already threatened to dent demand from China, the epicenter of the illness, as the second-largest economy and the biggest importer of oil attempted to contain the epidemic. Now that the spread of the pathogen is accelerating outside of Beijing, fears of a broader, global slowdown and a possible world-wide recession, have intensified.

Those scenarios bode ill for industries broadly but could significantly whack the energy sector, experts say.

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