Busted E&P Bonds Lead Sector Gains, Pumped Up by Oil Reboundby
Distressed and bankrupt firms regain ground in second quarter
Ultra Petroleum’s 2024 notes led sector with a 623% increase
The worst came in first in oil exploration and production as debt of bankrupt and distressed companies posted the sector’s best second-quarter returns.
At least a dozen bonds from deeply troubled oil E&P companies more than doubled amid a rebound in crude prices that took hold just after some of them sought court protection from creditors. Ultra Petroleum Corp.’s 2024 bonds led the group with a 623 percent gain, according to data from Bloomberg Intelligence, bringing the increase since February to more than 1,400 percent.
The recovery in oil prices from record lows means the assets that bondholders will inherit in a bankruptcy may be far more valuable than expected earlier in the year, when E&P debt from names like Ultra and Chaparral Energy Inc. sold for pennies on the dollar. Investors are betting that a small rise in crude prices could spur a much bigger increase for the underlying assets, said Spencer Cutter, a BI analyst who specializes in high-yield energy debt.
“If the worst-case scenario isn’t going to play out, maybe there’s some value in the debt,” Cutter said.
Ultra’s $850 million of 6.125 percent notes due in 2024 defaulted after the company filed for bankruptcy in late April, citing its $3.9 billion debt load. They’ve jumped from 4.75 cents on the dollar on Feb. 22 to more than 70 cents.
Chaparral’s $300 million of 9.875 percent notes due 2020, which defaulted after the company declared bankruptcy in May, have gained 1,392 percent from their February low of 4 cents on the dollar. They traded at 59.69 cents on July 7. Some of Energy XXI Gulf Coast Inc.’s bonds gained 150 percent during the second quarter, according to BI data.
Not all bankrupt E&P companies did so well. Unsecured bonds issued by Energy XXI and Midstates Petroleum Co. made up six of the sector’s 10 worst performers in the sector in the second quarter, with some falling more than 80 percent.
“We’ve seen very high bankruptcy in the energy space,” said Margie Patel, a high-yield portfolio manager at Wells Capital Management, which oversees $349 billion. “I think you’ll continue to see high default rates and low recovery rates in that sector.”
Too Little, Too Late
Even if crude’s rebound had come sooner this year, it wouldn’t have been enough to save the bankrupt E&Ps, which were under heavy pressure after banks cut their credit lines, according to Cutter and Patel. Patel said the rate of negative cash flow is simply too high, and Cutter estimated the E&Ps needed oil to get back to $70 by last January to avoid bankruptcy.
“The bulk of new issuance from the energy sector came during those five years ending 2014 when energy was $100 a barrel,” Patel said. “They simply have way too much debt for energy prices anywhere near the current levels.”
Many of the biggest returns have come from holding companies, whose debt is generally subordinate to that of the operating companies. They’re last in line to get paid in a bankruptcy, so they’re often what investors dump first when they’re concerned about the company’s credit, Cutter said. While this leaves more potential for exponential returns if there’s a rebound, there’s still plenty of room for disappointment, he said.
“When you’re talking about playing in the distressed world, there may be a few diamonds in there or something of value worth salvaging, but a lot of it is still wreckage,” he said.
(An earlier version of this story was corrected to delete a misquotation of Margie Patel and the amount Wells Capital manages.)