By Caleb Mutua
“We haven’t seen new energy deals getting done in the first seven months of the year for anything rated lower than B,” Eric Rosenthal, senior director for leveraged finance at Fitch Ratings, said in a telephone interview.
Wary investors are more than ever pushing shale explorers to shift from the growth-focused novelty they once were to better-managed, cash-generating businesses. While they’re sitting on a wealth of crude in regions like the Permian Basin of West Texas and New Mexico, constantly tapping those resources with high-tech rigs and fracking technology can be a money drain that some have handled poorly.
And while oil has more than doubled from the 2016 low, trading has been erratic. Earlier this month one oil benchmark suffered the steepest one-day drop since February 2015, as the escalating trade war between the U.S. and China roiled financial markets. Falling crude prices hurt revenue and make it difficult for companies to continue spending as much money on projects.
“Ultimately, investors are also becoming a little more disciplined, if you will, and part of it may be just because of volatility on the commodity side,” said Mark Freeman, Founder and Chief Investment Officer at Socorro Asset Management LP.
On Monday, West Texas Intermediate oil futures were trading around $55 a barrel.
The energy sector, which makes up the biggest chunk of the U.S. high yield bond market, has been the laggard this year in the Bloomberg Barclays high-yield index as defaults ratcheted higher.
At current levels for crude, some companies are struggling to pay creditors. Recent Chapter 11 filings from Sanchez Energy Corp. and Halcon Resources Corp. have taken the U.S. high-yield energy default rate to 5.7% from 4.1% at the end of July, according to Fitch.
Sanchez cited “the prolonged and continuing period of commodity price decline and volatility now lasting nearly a half a decade, and the resultant and related financial difficulties associated with managing high levels of debt under such market dynamics,” as contributing to its bankruptcy, according to court documents.
Junk bond default rates in the energy sector are likely to rise toward 10%, UBS strategists led by Matthew Mish wrote in a recent note. While dovishness from the Federal Reserve has driven a drop in interest rates, that hasn’t been enough to offset widening credit spreads for the debt of risky companies.
Natural gas prices have fallen as well, hurting major players in the Marcellus and Utica basins, Bernstein analysts led by Jean Ann Salisbury wrote in a note last week.
The movement in Chesapeake Energy Corp. and Southwestern Energy Co.’s credit default swaps, or the cost to protect the company’s debt against default, suggests the risk of insolvency over the next 5 years has doubled from about 5% to 10%, the analysts said.
At the same time, access to the debt market has become increasingly important for energy companies, according to Noah Barrett, a research analyst at Janus Henderson Investors.
“If you are an energy company looking to tap the equity market to fund growth, your stock price will get clobbered or you just can’t get an equity issuance done,” Barrett said in a telephone interview. “That kind of leaves the debt market as sort of the last resort of potential capital.”