At least 50% of all energy bonds are likely to default if the price of oil remains around $40 a barrel, according to Jeffrey Sherman, a portfolio analyst and global macro strategist at DoubleLine Capital. That said, Sherman said bondholders could expect to see all of 20 cents on the dollar.
Sherman voiced deep skepticism about the way Wall Street was keeping many energy businesses afloat and deemed it unsustainable. Investment banks have been selling equity and diluting existing shareholders to allow energy companies to keep paying interest on their debt. Sherman didn't say it, but in some cases Wall Street firms have raised equity for oil companies to pay back securities firms' loans.
Were true, smart equity investors to purchase oil interests in today's oversupplied market, the first thing they would do is cap the well and wait for oil prices to recover. Instead, they raise money, keep pumping oil, further depressing prices and bringing the ultimate day of reckoning that much closer.
"It's like [a gambler] going back to the bookie" and borrowing another $1,000 in the hope that the gambler's luck turns around, Sherman said.
The upshot, according to Sherman, is that many depressed energy bonds could all default at nearly the same time and flood the market with assets, depressing the recovery value. Whereas the financial crisis in 2008 and 2009 was caused by a liquidity crisis, the problems in the energy market revolve around solvency.
Sherman was speaking about commodities investing in Orlando at the Investment Management Consultants Association's annual conference. "I like gold, even though I expect deflation," he told attendees at a packed audience.
Why? "There is $7 trillion out in sovereign debt out there selling at negative yields," he said. Recently, DoubleLine was pitched sovereign European debt selling at a yield of negative 0.10%, and the salesman argued it would soon go to negative 0.20%.
The argument didn't cut the mustard with Sherman. "Ms. Yellen has said she doesn't want to do any more QE," he said.