The biggest plunge in oil prices since 2008 is prompting bond traders to treat $27 billion of investment-grade energy debt as junk amid concern those companies will have to cut spending to conserve cash.
Investors are demanding more yield premium to own the debt of high-grade companies including Transocean Ltd., Noble Corp. and Continental Resources Inc. than the average for bonds with the highest junk rating, according to data compiled by Bloomberg. Oil has slumped 8.7 percent this year to $48.65 a barrel through yesterday, adding to the more than 50 percent decline since its June 20 peak.
The collapse in the price of petroleum spurred by a global supply glut has seen investors dump energy-company bonds as returns shriveled in 2014. The amount of the sector’s debt outstanding hasn’t migrated much across ratings, reflecting the more static and backward-looking nature of rating-company metrics, according to a Jan. 7 UBS AG report.
“The ratings firms try to rate through the cycle and are slower to move than the market,” Spencer Cutter, a Bloomberg Intelligence analyst, said in a telephone interview. “Markets do overreact but unlike the 2008 price drop, which was a result of an economic shock, this is a result of excess supply and that’s not going away.”
Perceived Junk
The average spread on bonds with a Bloomberg composite rating of BB+, is 361 basis points over government bonds, index data show. The yield premiums for Transocean, Continental Resources, Noble, Weatherford International Plc and Superior Energy Services Inc. exceed that level. A basis point is 0.01 percentage point.
Transocean, the worst performer in the Standard & Poor’s 500 index last year, has the most debt of the five companies on the precipice of junk, with $9.1 billion of obligations. Moody’s Investors Service and Standard & Poor’s placed the offshore driller’s debt on review for downgrade this week.
Continental Resources, which has $5.8 billion of borrowings, has seen the yield premium on its bonds increase to 391 basis points. The company was lifted to investment grade in August 2013 by S&P. Its stock, which had climbed to an all-time high of $80.64 in August 2014, has since tumbled 58 percent to $33.58 as of yesterday in New York trading.
A sustained slump in oil prices may see these companies joining other high-yield energy firms in having to cut spending to cope with the market downturn, according to a Jan. 6 report from debt researcher CreditSights Inc.
“As such, balance sheet protection and liquidity preservation will be critical,” analysts led by Brian Gibbons wrote in the report. Companies will be “forced to make drastic capital spending reductions in order to limit leverage creep and substantially reduce or eliminate free cash flow shortfalls.”