Coronavirus Sickens an Ailing Energy Bond Market
(Bloomberg Opinion) -- The most obvious symptom of coronavirus’ spread in the energy sector is the slumping oil price. The less obvious, but equally serious, signs can be found in the financing market for oil and gas producers.
Exxon Mobil Corp., that haven of havens in oil, just saw its dividend yield spike above 6% for the first time since the merger that formed the modern company more than 20 years ago. If you want true stability among Big Oil in stormy seas these days, you have to go to Saudi Arabian Oil Co., or Saudi Aramco, which yields a mere 4.2% (prospectively). Then again, the remarkably subdued price moves and turnover in Aramco’s stock amid the turmoil rather underscores how its IPO was quarantined already from the wider world long before that behavior caught on elsewhere.
Exxon’s fall from grace is roughly inversely correlated with its counter-cyclical investment binge; the sort of thing that worked better with investors when they (a) trusted oil majors to spend money wisely and (b) trusted oil demand to never stop going up. It will be interesting to see if the messaging on strategy has shifted at all when Exxon faces analysts in 10 days’ time.
The really vulnerable crowd, however, is those oil and gas producers who had compromised their immunity with excessive leverage, exposure to natural gas or both. As I wrote here in November, E&P stocks with higher debt have performed notably worse than less encumbered peers since last spring. Coronavirus’ impact on commodity prices and sentiment in general has exacerbated that. Since the start of the year, low leverage stocks in my sample are down about 16%; not great, but better than the very-high leverage index, which has fallen more than 40%.
The really eye-catching action is in the bond market. The rush to safety in Treasuries has widened an already gaping risk premium on high-yield bonds for energy issuers. The option-adjusted spread for the ICE BofA U.S. High Yield Energy Index ended Friday at 772 basis points. That’s up from 650 points at the start of 2020. But another way to look at it is that the gap between the energy index’s spread and the spread for the broader CCC-rated bond index — the junkiest end — has narrowed sharply. Indeed, this spread-of-the-spreads is now narrower than at any time since early 2016, the very depths of the oil crash:
Besides the echoes of that earlier panic in today’s market, the structure of the sector plays a part. In terms of face value, almost a fifth of the energy high-yield index — which is the biggest sector of the overall index — is rated triple-C or less. That segment of the market is highly concentrated in relatively few issuers, with the top five accounting for roughly half the market value, according to CreditSights. That, er, upper echelon is dominated by the truly suffering oilfield services sector, with issuers such as Transocean Inc. and struggling gas-weighted producer Chesapeake Energy Corp., whose stock hasn’t traded above a buck since early November.
Meanwhile, single-B issues account for roughly another 40% of the index. While this segment is less concentrated, the biggest issuers consist of oilfield services again, gas-heavy producers and midstream names such as Genesis Energy LP, which, as an aside, slashed its dividend in late 2017 to save cash but now sports a higher yield than before that (see this for some history).
This is a target-rich environment for a curve ball like coronavirus. While oil dominates, keep an eye on natural gas, which had been hit hard by the mild winter already. Benchmark prices are below $2 in the late February, and they are only that high because of the escape valve of liquefied exports. Now coronavirus is leading some buyers to refuse cargoes. If that spreads, then the effect will move quickly back up the chain to crash prices further in a U.S. market where the flaming flares of west Texas illuminate the glut in depressingly literal terms.
There was some relief in energy circles last week, and not just because virus-related fears had subsided. Several Permian-focused E&P companies, such as Diamondback Energy Inc. and Pioneer Natural Resources Corp. reiterated plans for bigger payouts, signaling they were sticking with newfound strategies of drilling less and rewarding shareholders with more cash. Monday serves as a reminder that the hole, dug over the course of years, is deep. A broad shift in the sector’s mindset, while welcome, has come late and under duress. And the duress is intensifying.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.
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