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Oil Junk Bonds Cost Investors Billions
Just two weeks ago, we noted that chasing after high yield debt from beleaguered junior oil producers was likely not the best idea given the fact that geopolitical logrolling, surging supply, and shrinking storage capacity all point to further declines for crude. More specifically, we said the following in an update to a post in which we outlined what a tiny Colorado shale play has in common with a long-gone movie rental chain:
Update: And just to prove that people are indeed, idiots, moments ago this hits:
ENERGY XXI GULF COAST, INC. PRICES UPSIZED PRIVATE OFFERING OF $1.45 BILLION OF 11.000% SENIOR SECURED SECOND LIEN NOTES DUE 2020
As it turns out, we were right to be skeptical because, as Bloomberg reports, these very same notes have cost investors $7 billion in just 10 days:
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 $43.5, 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…
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.
The losses come at the expense of investors trying to call a bottom in crude prices and much as everyone who piled into oil ETFs while being simultaneously oblivious to the fact that the market was in the widest contango in four years subsequently suffered for their ignorance, so too will the yield-starved buyers of oil junk bonds take a beating for thinking that “buy the dip” is a viable investment strategy:
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 $44 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 1.1 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.”
Meanwhile, the same companies that are offering investors double-digit yields may ironically be shooting themselves in the foot (and, as we suggested last month, contributing to disinflation) because as the Bank For International Settlements notes, keeping current on debt payments often means maintaining elevated production...
A new element that can help shed light on this question is the high level of debt of the oil sector. The debt borne by the oil and gas sector has increased two and a half times over, from roughly $1 trillion in 2006 to around $2.5 trillion in 2014. As the price of oil is a proxy for the value of the underlying assets that underpin that debt, its recent decline may have caused significant financial strains and induced retrenchment by the sector as a whole. If the adjustment takes the form of increased current or future sales of oil, it may amplify the fall in the oil price. Similarly, if the need to service debt delays a pullback in production, a lower price may act more slowly to balance supply and demand.
...because keeping a leverage-driven bubble inflated means doubling and tripling down...
As regards financial constraints, the price decline occurred against the backdrop of much higher debt levels of oil producers. By analogy with the housing market, when the underlying assets of a leveraged sector fall in value, the strain imposed by the price decline induces retrenchment - for instance, by trying to sell more of the asset backing the debt.
… and this is exacerbated by investors’ willingness to take on risk if it means squeezing out a few basis points of yield versus “safer” debt which, depending on where you look, may actually produce loses thanks to NIRP…
The greater willingness of investors to lend against oil reserves and revenue has enabled oil firms to borrow large amounts in a period when debt levels have increased more broadly due to easy monetary policy. Since 2008, companies in the oil sector have borrowed both from banks and in bond markets. Issuance of debt securities by oil and other energy companies has far outpaced the substantial overall issuance by other sectors. Oil and gas companies' bonds outstanding increased from $455 billion in 2006 to $1.4 trillion in 2014, a growth rate of 15% per annum. Energy companies have also borrowed heavily from banks. Syndicated loans to the oil and gas sector in 2014 amounted to an estimated $1.6 trillion, an annual increase of 13% from $600 billion in 2006.
In the end, we get a high yield market awash in paper floated by US-listed juniors...
Overall, the stock of debt of energy firms has risen even faster than that of other sectors. Debt issued by oil and other energy firms accounts for about 15% of both investment grade and high-yield major US debt indices, up from less than 10% just five years earlier...
US oil companies have… borrowed heavily. They account for around 40% of both syndicated loans and debt securities outstanding. Much of this debt has been issued by smaller companies, in particular those engaged in shale oil exploration and production. Indeed, while the ratio of total debt to assets has been broadly unchanged for large US oil firms, it has on average almost doubled for other US producers - including smaller shale oil companies.
...which, as we noted six months ago, absolutely will not end well…
The combination of falling oil prices and higher leverage can lead to financial strains for oil-related firms. First, the price of oil underpins the value of assets that back these firms' debts. Lower prices will tend to reduce profitability, increase the risk of default and lead to higher financing costs. Indeed, spreads on energy high-yield bonds widened from a low of 330 basis points in June 2014 to over 800 basis points in February 2015, much more than the increase for total high-yield debt (Graph 3). Second, a lower price of oil reduces the cash flows associated with current production and increases the risk of liquidity shortfalls in which firms are unable to meet interest payments.
* * *
We would also note that all of the above serves to validate what we said in January, which is that as long as easy money policies are effectively subsidizing otherwise bankrupt shale companies, don't expect prices to rise anytime soon:
OPEC will not cut alone, or in other words, as long as shale companies are out there pumping, kept alive thanks to the Fed's ZIRP policy forcing investors to keep them well capitalized even though bankruptcy may be breathing down everyone's neck in short order, expect the Saudis to keep pumping at the same feverish pace…
Ironically, it may well end up as a showdown between the Fed and Saudi Arabia, the former doing everything in its power to keep otherwise insolvent companies well-capitalized, and on the other Saudi Arabia doing everything in its power to keep the cash flow drain as high as possible for High Yield debt-funded shale companies, and daring either the Fed, or rather junk bond investors who are scrambling for any source of yield, to back out.
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Whocouldanode?
Now that the debts are canceled US oil production cost is now the lowest in the world.
USA USA USA!
This can all be fixed with another Trillon in student loan debt. Who wants to go back to school for that masters in art?
Yellen has a secret plan to win the war in Vietnam.......
When does all the student loan debt get canceled? or is this another all animals are created equal but some animals are "more equal" than others... example?
It's not a let them eat cake moment. Yet. Just wait.
I'd argue that since only bankers and financiers have access to all the free money (ZIRP) they want, it has been a "let the majority eat cake" moment for quite some time. Remember however, half the population is in fact "below average".
It would have been a let them eat cake moment if not for EBT and other similar programs. Panem et circenses. But wait for the coming bond crisis that low oil prices is probably going to cause. When EBT stops, you're going to want to be far, far away from any Walmarts, and probably loaded for bear.
Yep-
I'm trading BBB Transocean 6.5's of '20 at a 10 basis.
This may not be the bottom.
Oil bondholders are fracked. They are stuck between shale rock and a hard place. Before the oil price downturn runs its course, thousands of investors will be hammered hard.
Looking back, in 1923, Shelby, Montana was an oil boomtown when it decided to promote a heavyweight prize fight between Jack Dempsey and Tommy Gibbons. The event turned into a financial bloodbath for Shelby, only 7,000 paying customers showed up. Four of the town's banks closed, they were backers of the fight. The people at Shelby did not know what they were getting into, dealing with sharpies. These Bakken Shale oil investors will also end up getting fleeced.
http://www.examiner.com/article/shelby-s-folly-recalls-dempsey-gibbons-f...
Peak paper oil ponzi bitchez!
ZIRP and oceans of cash equal bad investments in iffy paper and the ocean of cash just HAD to go somewhere.....
What is this risk you speak of?
Quicksilver Resources Files Bankruptcy as Gas Price Drops
http://www.bloomberg.com/news/articles/2015-03-17/quicksilver-resources-...
The Chapter 11 petition filed Tuesday listed $1.21 billion in assets and $2.35 billion in debts. It follows a February warning that the Fort Worth, Texas-based company wouldn’t pay interest on $298 million of bonds maturing in 2019. At the time, the company said it might not be able to restructure its debt or sell off assets.
Long Oaktree and Howard Marks then.
Just because you are bankrupt doesn't mean you are without assets.
Only Goldman and Draghi think that way.
IF the ability to restructure exists of course.
The USA has more than a "credit code" (although who can understand the legal arrangement on a simple credit card anymore) we also have a bankruptcy code.
Bailouts are illegal because they go against the very idea that through prosperity you can still prosper again.
Bailouts are for Kings and Queens...not economics.
The repayment demands of this "recovery" are in extremis indeed!
Oh, look! Another bubble to bail out!
Gotta run!
See ya!
Yet O&G related equities have rallied 2 of the last 3 days while WTI has crashed
lend my corporation no recourse money and i will build houses, drill for oil, (or any number of other things) until the damn cows come home.
Don't worry, the fed can monetize shale debt and add that to the long list of "assets" on its balance sheet. Uncle Sam can buy up cheap oil in preparation for WWIII which is effectively QE for oil. This can go on for quite some time, at least until the bombs start dropping.
In other news "
Feds to buy 5 million barrels of oil for emergency stockpile"what were you saying?
Article 14 of Federal Reserve Act says otherwise
but when staring at the abyss, anything possible, i suppose ... BUT it would mean that Congress goes along ... implicitly or explicitly
with Rs holding both Houses??
So, buy oil in preparation for war? That's easy for Rs, yes please, war it shall be.
Mandates and laws are for little people. I no more believe that Republicans or Democrats run this country than I believe that somebody making $200,000 a year runs the fed.
as the energy defaults and bankruptcies pile up ... capex will crater .... and market will be flooded with heavy machinery and such at rock bottom prices
CAT monthly sales reports?
got popcorn?
I hope I can get a CAT for 500$ !!
i think that some oil based dervatives have BLOWN up in the shadows - which is manifesting itself in part to the parabolic rise in the USD$.
the derivative chain be blowing up in the background........oil IS our black swan......
bullish
can't they just buyback stock to make this better like everyother company?
Eventually the wells drilled in the last two years will decline...shortly. Without drilling going on right now, how long before the oil surplus becomes an oil scarcity?
One year? Two years??
Gotta love US financial engineering....snake is now eating its own tail...derivatives in the oil sector now compell the markets to produce or have loan convenants pulled and the company dies....
banks are moving in on the storage issue to drive spot into the gutter so that they can create a deep contango and create yield returns by rolling over contracts while sitting on million of barrels floating on the oceans used for storage after land based storage is filled....
Spot price will be artificially surpressed the same as nat gas was 2-3 years ago for about a year or two....then for what is left will see gains...even if fracking can get new financing then because it wont be risk free at that point and the cost of financing will be much higher....
Sorry Obbi better come up with a better energy security policy.....
SCIENTISTS WARN THAT EVEN IF TIME STOPS, CRUDE PRICES WILL KEEP FALLING
Analysts desperate to find reasons for crude´s decline miss the obvious: there´s an oil glut.
Source: www.financialpaparazzi.com
This will have no impact on the banks.
Move along.....
What is all this bollox about Saudi, Russia, conspiracy theory's and all the fuck wit oil commentators and their fucking ridiculous charts and graphs and flogging dead horses to investors.
It is so simple
Is it easier to buy oil to day than it was yesterday or harder,.
Is it harder to sell oil today than it was yesterday.
Will it be easier to buy oil tomorrow than today
Or will it be harder to sell oil tomorrow than today.
It makes no difference what the price is. it is utterly irrelevant.
If it will be harder to sell tomorrow because not enough buyers or increased competition or gluts, then the price will fall as long as that prevails.
No matter what shit someone brews up as a story, no matter what valuations stuck there by wankers with nothing else to do, no matter manipulation and jawboning.
Who will sell me oil. Or who wants to buy oil.
And that's it, that's all you need to figure out.
At current flows of buyers to sellers I expect bottom about $19.60 end April early May, and rising to maybe $23 $23.50 by year end
^Truth - short Bakken pure plays.