As Energy Bonds Shed Distressed Tag, Some Investors Sound Alarmby
Risk premiums for junk energy credits are just above 10%
"Investors aren't really focusing on the fundamentals"
The market for debt sold by junk-rated U.S. energy companies is stepping away from the abyss.
For the first time since August, a measure of credit risk for high-yield energy bonds is close to falling below a threshold that’s deemed distressed, according to data compiled by Bloomberg. That’s making some investors worry that traders are ignoring risks that continue to rise in the market.
The rapid shift may be evidence that oil and gas notes have risen too far, too fast, said Sabur Moini, a portfolio manager at Payden & Rygel Investment Counsel, which manages $100 billion of assets. After the Federal Reserve’s decision in March to slow the pace at which it raises rates, some investors are chasing yield, instead of giving a sober assessment of companies’ creditworthiness, he said.
"In the last two weeks mutual funds and insurance companies have said ‘oh, maybe this thing is real,’" Moini said. "Investors aren’t really focusing on the fundamentals. There are still challenges."
For energy companies those headwinds include the price of oil, which has fallen nearly 60 percent from mid-2014, even with a recent rally. Crude inventories are at their highest levels since 1930 in the U.S., according to data from the Energy Information Administration. Officials from 18 oil exporters meeting in Doha failed on April 17 to come up with an agreement to freeze production.
At the end of March, JPMorgan Chase & Co. strategists said that oil and gas companies are likely to experience a 20 percent default rate over the next two years.
Even with these challenges, crude reached a five month high on Wednesday, and energy bonds have been able to perform better than the broader high-yield universe. Yields for oil and gas speculative-grade notes are now just 4.61 percentage points higher than the broader sub-investment-grade sector, the smallest gap since December, Bank of America Merrill Lynch index data show. The debt has returned 12.3 percent this year, compared with 6.6 percent for the broader junk market.
Junk bonds have broadly rallied since mid-February, helped by the price of oil and the Fed having said it would be slower to raise interest rates. The average extra yield investors demand to hold high-yield energy bonds is close to falling below the 10 percent threshold that’s deemed distressed, according to data compiled by Bloomberg.
With that rally, a trickle of energy companies have been able to issue junk bonds again, after having been largely shut out of the market since October. Fuel distributor Sunoco LP raised $800 million this month, $300 million more than it initially offered. Oil refiner Calumet Specialty Products sold $400 million of bonds. Next week, Corral Petroleum Holdings AB, a Nordic oil refiner owned by Saudi billionaire Mohammed Al Amoudi, plans to sell $700 million worth of payment-in-kind notes. It’s marketing the debt in the U.S. next week after a series of appearances in Europe.
"It feels like there’s potential for energy names to test the market,” said Alex Barth, co-head of high-yield capital markets at Deutsche Bank AG in New York.
Some investors are willing to take more risk in energy junk bonds, but others remain cautious.
“If an energy company were to issue a new bond deal in the high-yield market, we would approach it as a potential opportunity, but we would be very price sensitive,” said Carol Embree at Loomis Sayles & Co., which has $229 billion of assets under management.