Oil Plunge Deepens High-yield Gloom

US crude fell to a more than six-year low this week, clouding the picture for a high-yield energy sector that already faces a significant cull when credit lines are reevaluated in autumn.

 

Lower-quality names, especially in exploration and production, are already struggling to stay afloat, and with crude dipping below US$38 per barrel, a bad scenario has got worse.

 

According to CreditSights, E&P companies typically obtain credit lines worth around 55%-65% of the estimated value of their reserves, which is redetermined by banks semi-annually.

 

Since the last one in spring, US crude prices have fallen by nearly a third - meaning many companies now face steep cuts to the amount they can borrow.

 

Many are likely to default, and some could well go under.

 

"We expect it to be another challenging borrowing base season for the sector," CreditSights analyst Brian Gibbons told IFR.

 

"Very few E&P companies in high-yield can withstand $40 oil for a prolonged period of time. Only the best credits will be able to access the capital markets."

 

During the last redetermination, several companies were able to access the equity and debt capital markets to shore up liquidity and offset the decline in their borrowing bases.

 

But that option is likely to be reserved for only a select few this time around.

 

Borrowing costs have jumped on a huge move wider in spreads, and appetite for energy paper has dried up after a small recovery in oil prices earlier this year proved short-lived.

 

"People are getting very concerned about where oil prices bottom out," said John Addeo, deputy chief investment officer for US fixed income at Manulife Asset Management.

 

"Most of these (companies) are burning cash, and they don't have hedges in place for 2016."

 

The average yield on US junk-rated energy companies shot up to over 12% Monday, according to Bank of America Merrill Lynch data - the highest level since the financial crisis.

 

In spread terms, the sector ended that session at 1054bp over Treasuries and has remained above 1000bp since then - even when US crude briefly recovered to around US$43.

 

The bounce in prices was not matched in bonds - a sign that many in the market do not believe the rebound is here to stay.

 

"Energy bonds (are) starting to underperform oil," said Alberto Gallo, head of macro credit research at RBS.

 

"Oil prices are not likely to improve in the medium term, as over-supply, high inventories and weak demand will keep prices low."

 

Analysts at UBS said that if the price of West Texas Intermediate, the US benchmark crude, keeps falling to US$30, spreads would gap out to some 1226bp.

 

At US$20, they said, high-yield energy bond spreads would blow out to 1805bp - nearly double their current 30-day average.

 

With capital markets shut, negotiated exchanges with bondholders, debt-for-equity swaps or prepackaged bankruptcy may be the only options for many companies in the sector.

 

Houston-based Halcon Resources announced plans Thursday to exchange US$1.57bn of existing unsecured debt for US$1.02bn of secured 2022s that will pay a hefty coupon of 13%.

 

S&P regarded the move - which will reduce the company's leverage by nearly a full turn - as a selective default.

 

Gershon Distenfeld, director of high-yield fixed-income at AllianceBernstein, urged caution when looking at the - on the surface - juicy average yield now on offer in the sector.

 

He reckons that around two-thirds of high-yield E&P and oil services companies are at risk of default over the next two or three years.

 

"You are not going to realize that yield any more, because you are going to see a lot of defaults over the next couple of years," he told IFR.

 

"I don't think it is about yields any more."