The largest industry subsector among US junk-rated companies is energy. Over the weekend, Saudi Arabia pledged to ramp up oil output to punish Russia for not agreeing to supply cuts. The US WTI benchmark dropped almost a third to $30 per barrel on Monday morning, before staging a smaller rebound. It is down by almost a half so far this year. A wave of brutal distress is once again gripping weak credits.
This latest body blow will lead to more sector bankruptcies in the US where the numbers had already ticked up in 2019. Fresh capital, and debt in particular, kept flocking to cash-guzzling companies, many of them shale oil producers, after the price implosion of 2015 and 2016. Wall Street must finally, after this latest bust cycle, come to grips with the US energy sector’s fundamental inability to carry mountains of loans and bonds.
There will be no shortage of capital standing ready to recapitalise the energy sector. Preqin estimates that there is more than $800bn of assets in so-called private credit alone. Alternative managers such as Blackstone can quickly make direct loans into companies outside the traditional leveraged finance markets.
The timing of rescue financings is crucial. Moody’s estimated that recoveries among energy defaults in 2016 averaged a near 50 cents on the dollar compared with the sparse 21 cents for 2015 defaults. As commodity prices rose between 2016 and 2018, capital gushed back into the sector which drove up production and asset prices — but not so much profits. The default surge in 2019 included three so-called “Chapter 22s” — companies going through Chapter 11 reorganisations for the second time.
Plenty of blood has already been spilled in 2020. CreditSights counts six companies, including Chesapeake Energy and Whiting Petroleum, whose debt had fallen more than 20 per cent this year through last week. The temptation to bolster these companies with fresh borrowings is understandable in a world of zero interest rates.
Equity is a more expensive funding choice for businesses that pass basic viability tests. But, given energy’s sharp vulnerabilities to geopolitics and other exogenous shocks, it is a wiser one. Five years on from the first reckoning of the shale era, it is time to learn its lessons.
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