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Euro, US high-yield markets diverge as energy default risk takes hold

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Oil cartel OPEC’s decision to freeze production at current levels has caused the European and US high-yield markets to diverge due to the high energy concentration in the latter.

Some US high-yield indices contain as much 18% concentration in oil extraction and production, which has seen value drop and yields spread as sector-based default risk increases.

Barclays’ US corporate high-yield and global high-yield indices contain a 15% and 10% exposure, respectively.

The BofA Merrill Lynch US High Yield Master II Index had a 14% exposure towards the energy sector, according to AXA Investment Managers.

Oil prices have been steadily falling in the latter half of the year, falling from $94 (€75) per barrel on 28 September to $68 on 28 November, the day of OPEC’s last meeting.

Since the announcement, prices bottomed out at $64 on 30 November before reaching $67 today.

This has severely impacted the cash-flow generation plans of exploration and production companies in the US, which had taken on debt burdens throughout the year.

Energy companies issued a significant amount of bonds this year, according to fund managers, in order to refinance existing debt and increase capital expenditure.

Barclays said year-to-date high-yield energy bond issuance totalled $57bn across 107 transactions.

Kames Capital high-yield global fund manager Claire McGuckin said the decision by independent US energy companies to ramp up issuance meant they were investing in excess of current cash flows given the falling oil price.

“It is the bonds from these companies that have suffered the heaviest in the recent market turbulence, and a quick rebound is unlikely given the viability of projects/expected cash flows,” she said.

“A material adjustment for the increased risk has already been priced in by the market.”

Peter Aspbury, lead portfolio manager for European high-yield at JP Morgan Asset Management, said there was a visible impact on performance of the European and US markets over the last few weeks, with the former faring much better.

European high-yield markets, unlike US, contained less exposure to energy estimated to be around 1%.

The growing spread between the two markets would almost entirely be down to US energy exposure, Aspbury said.

“Just as high-yield was starting to perform well again after a few months of weakness, the OPEC decision caused spreads to widen again,” he said.

“Given that most of the widening occurred in one sector, it overshadows what is otherwise a pretty healthy market.

“It certainly serves to remind credit investors of the risks associated with an industry where there is so much exposure to a single commodity’s price.”

Research from Barclays showed that, at current price levels, around a dozen companies would produce negative cash flows, affecting credit ratings and increasing default risk.

Other companies would have adequate liquidity to last until the end of 2015 but be unable to sustain low prices much longer.

However, Aspbury said there was a risk markets were over-discounting the added default risk given the potential fall in revenues for the US companies.

“The key question for oil prices is not how low but how low for how long,” he said.

“If prices do fall further and remain so beyond 2015, then it will start to cause some pain.

“A higher default risk does not translate into higher default rates straightaway. That will depend on the degree and duration of the oil price decline.”

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