Paris/London: Bargain hunters may have to think twice before scooping up shares of beaten-down oil services companies, as a slump in crude prices raises questions about their ability to pay back debt.
The damage from the drop in crude, down by nearly half in six months, is pummelling the bonds of energy companies and sending shock waves through the high-yield credit market as investors reassess the firms’ balance sheets.
Spreads on the bonds of energy companies have widened by 148 basis points to 841 basis points over US. Treasuries in the last two weeks, according to Bank of America Merrill Lynch data.
That has led to a number of deals being pulled — and effectively shut the primary market for a time — as contagion fears rippled across the markets, according to IFR.
With depressed oil prices, the default rate on high yield bonds in the US energy sector — about a fifth of the entire US high yield market — could rise to 10 per cent, according to UBS analysts.
“People are just starting to dump these bonds given the trajectory of oil prices,” Saxo Bank Chief Investment Officer Steen Jakobsen said. “When the flight out of the sector accelerates it’s going to be ugly.” In JPMorgan’s ‘worst-case scenario’ where oil would remain around $65 for the next three years, the cumulative default rates in the energy sector could rise to as high as 25 to 40 per cent.
“We’re reaching a point where there’s a risk of seeing corporate and sovereign defaults in energy-producing countries, which could revive global systemic risks,” said Christophe Donay, head of strategy at Pictet, which has $441 billion in assets under management and custody.
The MSCI World energy sector index has tumbled 30 per cent since June, wiping out about $1 trillion in the market value of oil and gas shares, roughly the size of the combined annual GDP of Saudi Arabia and Qatar, according to Thomson Reuters Datastream data.
Corporate bonds in oil-producing Russia — where the rouble has tumbled against the dollar — have been particularly hard hit, with JPMorgan’s CEMBI benchmark Russian corporate debt index showing yield spreads have more than doubled this year to above 1,000 basis points.
Dividends scrapped
The energy sector’s first line of defence against falling cash flows has been to scrap dividend payments, drawing the ire of investors used to rich payouts.
Offshore oil driller Seadrill, seismic data firm CGG and marine services and engineering group Fugro
have already scrapped payouts. Seismic survey specialist PGS warned on Friday it was likely to do so.
More drastic measures, such as capital increases, may be required.
Goldman Sachs analysts, downgrading their rating on Seadrill to “sell”, wrote on Friday that the firm would be in breach of its debt covenant in 2016 if Brent hovers in the $70 a barrel region, warning that this could trigger an equity issue.
Goldman also flagged ‘balance sheet risks’ at PGS and CGG.
“Some companies with a significant level of debt will have to think whether they can continue to keep paying dividends, or even more drastically, if they will be able to repay their debt,” said Edouard Vecchioli, co-manager of hedge fund Parus Finance, which has short selling positions on a number of energy stocks.
