The dawn of the new decade has brought a reprieve for debt-laden companies in the energy sector: Investors are throwing money their way again, for now.
Having been largely shut out of capital markets in 2019, low-rated energy firms, some on the brink of default, are racing to secure financing. They are finding willing lenders.
Indeed, the first two weeks of the year have brought as many energy junk bond sales as in the last half of 2019, according to data from Dealogic, a data analytics firm.
In addition, total return in the oil and gas sector is broadly outperforming the wider high-yield debt market after getting walloped last year.
This new wave of deals may keep distressed companies alive for now, but it could ultimately prolong and worsen the pain.
The fundamental story in the sector has not changed—companies are highly leveraged, the oil market is amply supplied and prices are not seen rising all that much despite the recent bump from the heightened tensions between the U.S. and Iran.
"We'll see how long this window lasts, but I think everybody is trying to take advantage," said Sreedhar Kona, senior analyst at Moody's Investors Service.
Of the $14.9 billion in high-yield deals to price in 2020 so far, $9.45 billion—roughly two-thirds—came from energy companies, according to Refinitiv's Eikon.
The spark appears to have come from one of the weakest credits in the sector. In early December, Chesapeake Energy Corp., battling to stave off bankruptcy, secured a $1.5 billion loan after repeated failed attempts.
Since then, the ICE/BofAML U.S. junk-rated energy index , which tracks the value of U.S. high-yield energy bonds, has risen nearly 7%, more than double the total return of the wider non-investment grade market. Energy credit spreads—a measure of the compensation demanded by investors for the added risk of holding those bonds rather than safer U.S. Treasuries—have narrowed by the most since 2016, when the sector was recovering from a collapse in oil prices.
"In December we were starting to see one or two companies show that access to the market is possible, although it may need to come with strings like secured financing as opposed to unsecured or covenants that were more stringent than in the past," said Sonali Pier, portfolio manager at PIMCO.
January's rush to market was also aided by a brief rise in oil prices on the escalation of Middle East tensions after the Trump administration killed a top Iranian military official. Brent crude futures rose above $70 a barrel but have since given back all those gains and then some.
The newly revived markets will be a lifeline in particular for companies on the hook for some of the $55 billion of energy debt maturing in the next three years, according to JPMorgan. Most of January's junk energy issuance has been for refinancing purposes, including a $750 million deal from midstream servicer Genesis Energy LP and a $550 million deal for natural gas producer Range Resources Corp.
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Demand has also been robust enough to support a $750 million offering from offshore driller Transocean Ltd. rated by Moody's at Caa1, the lowest category of junk.
The market may provide a chance for companies like oil transport firm Hornbeck Offshore Services Inc. to refinance some of the $674 million it has maturing in the coming two years, $224 million of which comes due on April 1. Hornbeck has been trying to complete a deal for the past two years, according to Kona.
"If companies with maturities inside three years can access the market, that really does change the liquidity profile, which is what's in question today," said PIMCO'S Pier.
The oil and gas industry depends on access to capital markets to finance its growth. With urgent needs to refinance and service existing debt, firms may not also be able to raise the cash needed to invest in new projects.
Even if they do, expectations for sustained higher oil prices in 2020, and therefore cash flow in the sector, are low. A Reuters poll in late December forecast U.S. crude prices averaging $60 a barrel or more only in 2023. They were at $58.20 on Jan. 14.
The more stringent terms companies have had to accept to get deals done may come back to bite.
For example, Western Midstream Partners LP, rated junk by Moody's and one notch above junk by S&P, secured competitive pricing for its $3.5 billion offering only by adding a provision that gives investors an additional 25 basis points on their coupon for every ratings downgrade. It is a risky bet: while the company's outlook may be developing, the sector's is not.
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