Oil Bonds Lose Investors $7 Billion in 10 DaysSridhar Natarajan and Elliott Stam
Investors lured back into junk-rated energy bonds by their juicy yields are getting burned.
Oil prices have fallen more than 15 percent since March 4 to a six-year low of $42.3, wiping out $7 billion of market value of high-yield debt issued by energy companies. Prices on $1.45 billion of notes sold less than two weeks ago by Energy XXI Ltd., an oil producer that was being squeezed by its lenders, have fallen by as much as 10 percent. Comstock Resources Inc.’s $700 million of securities have declined by more than 7 percent since March 6.
The latest slump in crude is rekindling concern that oil companies will struggle to service the $120 billion of high-yield, high-risk debt they took on in the past three years amid the U.S. shale boom. That’s a sharp reversal from February when yield-starved bond investors were loading up on the debt again, pushing down borrowing costs to a two-month low.
“We had a whole month where prices were at a level that it seemed to have bottomed and provided a false sense of security for investors,” Jody Lurie, a Philadelphia-based corporate credit analyst at Janney Montgomery Scott LLC, said in a telephone interview. “They are constantly hunting for yield and the short-term opportunity in this low-rate environment.”
Junk-rated energy borrowers have sold about $9.4 billion in bonds this year, doubling the amount issued during the last three months of 2014, according to data compiled by Bloomberg. The companies raised more than $17 billion during the third quarter of last year.
Oil prices are plunging as U.S. output climbs to the highest in three decades even as explorers idle drilling rigs. The drop to less than $43 a barrel follows a month of relative stability, when prices hovered around $50 after sliding from as high as $107 in June.
The slump has eaten into February’s 2.3 percent gain in junk bonds, which was the biggest advance in 16 months, Bank of America Merrill Lynch index data show. The average speculative-grade rated note has tumbled 1.4 percent in March.
“Oil prices are having an impact again in the high-yield market,” Jim Kochan, chief fixed-income strategist at Wells Fargo Funds Management, said in an interview. “There were a lot of experts who thought that oil prices had fallen too far and that they would correct. Instead, now we’re seeing a downdraft.”
The extra premium investors demand to hold speculative-grade energy debt instead of government securities has surged to
9.5 percentage points from 8.4 percentage points earlier this month, according to data compiled by Bloomberg. The spread is below the high of 10.7 percentage points reached in January.
The reversal is punishing investors who snapped up energy-company bond offerings in the past month. Oil producer Energy XXI’s second-lien bonds, issued on March 5 to repay borrowings under its line of credit, slid below 90 cents on the dollar on Tuesday after trading as high as 99.9 cents, according to Trace, the bond-price reporting system of the Financial Industry Regulatory Authority.
The Houston-based company attracted investors by selling the 11 percent notes at a discount to yield as much as 12 percent. That’s almost double the average yield on all U.S. junk bonds, according to a Bank of America Merrill Lynch index.
Greg Smith, vice president of investor relations at Energy XXI, didn’t return a phone call and an e-mail seeking comment.
Comstock Resources, which sold its bonds at par, has seen the debt tumble to 92.75 cents, Trace data show. The notes for the Frisco, Texas-based energy explorer also repaid borrowings under a credit line.
Gary Guyton, director of planning and investor relations at at Comstock Resources, didn’t return a phone call seeking comment.
“There probably were some buyers that felt that at these levels the high-yield energy names represented some good value,” Kochan said. “In the long run, they’ll probably be correct. There’s going to be some aversion to owning them here but it’s not going to be anything like the correction we saw last year.”
The market capitalization of energy junk bonds has slid from $203 billion the last time oil closed at more than $50 on March 5 to $195.7 billion as crude fell, Bloomberg bond index data show.
Souring sentiment poses a challenge for energy companies still in need of cash because banks may deny them the ability to draw additional funds from their credit lines, according to Kevin Smith, an energy analyst at Raymond James & Associates Inc.
Banks typically gauge a company’s borrowing base by valuing its assets twice a year. The collapse in oil prices since June means these credit limits could be cut by as much as 30 percent in some cases, according to Smith.
Some of those issuers may find themselves without another way to raise money now that the junk-bond market has turned.
Moody’s Investors Service said Tuesday that the default rate on speculative-grade corporate bonds globally rose to 2.3 percent in February from 2.1 percent the month before. The ratings firm projects the measure will rise to 2.5 percent by the end of the year, which is below its 4.5 percent historical average.
The recent move in oil prices “will result in financing drying up for a lot of the lower-rated names again,” Janney Montgomery’s Lurie said.
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