Sunday, May 03, 2020 12:09
PM / by Fitch Ratings/ Header Image Credit: The Guardian
Low oil prices, caused by coronavirus-driven demand destruction and excess supply, and historic volatility due to storage concerns could accelerate US energy sector defaults, says Fitch Ratings. OPEC+ has agreed to a production cut and the US government is contemplating providing aid to the struggling sector but uncertainty regarding the pace of demand recovery for oil remains.
We anticipate energy high-yield bond and institutional leveraged loan default rates at 17% and 18% this year, nearing the peaks of 19.7% and 25.4% set in January 2017 and January 2018, respectively. This equates to potential default volume of $33 billion for bonds and $10 billion for loans, nearly five times the average sector total from 2007 - 2019. Over the TTM, $24 billion of high-yield bonds and leveraged loans have defaulted, with Chapter 11 filings accounting for 57%, distressed debt exchanges/restructurings 27% and missed payments 16%.
Fitch cut its oil price assumptions in early April due to the effect of the coronavirus pandemic on the global economy and oil demand and the resulting very large oversupply. Our West Texas Intermediate (WTI) base case assumption is $32 per barrel (bbl) in 2020 and $42/bbl in 2021, while our stress case is $27/bbl and $32/bbl, respectively.
WTI fell from $18.31/bbl to well below zero for the first time in history on April 20 but almost fully recovered, closing last week at $17.00/bbl. The decline was due to the supply-demand imbalance resulting in storage issues that caused traders to pay buyers to take their May supply. Some OPEC+ nations are accelerating production cuts due to the collapse in pricing, but we do not view the 10 million of planned reduction as sufficient to correct the market imbalance, given the substantial reduction in demand.
Prolonged weakness in industry fundamentals combined with highly levered capital structures will not be sustainable for many US energy companies. Effects are widespread across upstream, downstream refining, oilfield services, and midstream transportation, storage, and wholesale. Oil field services company Diamond Offshore Drilling filed for bankruptcy on Sunday. The company plans to use the proceedings to restructure and strengthen its balance sheet and achieve a more sustainable debt profile.
The US government is considering a number of alternatives to help struggling oil companies, including a lending program, taking equity stakes in exchange for some loans and/or easing credit rating requirements of the existing Federal Reserve bond-buying program. However, absent bipartisan support for a bailout of the oil industry, defaults could continue before a program is passed in Congress, given the sheer number of energy companies in distress. Even if a program materializes some companies may not be eligible to participate.
The TTM high-yield bond energy default rate is 10.4%, compared with 4.2% for all issuers, following the bankruptcy of Diamond Offshore Drilling and E&P issuer Whiting Petroleum. Several names on our 'Top Bonds of Concern' list could be imminent defaults including Ultra Resources, Vine Oil and Gas, Jonah Energy, Chesapeake Energy, California Resources, Denbury Resources, Unit, Bruin E&P Partners and Chaparral Energy. Fitch's 'Top Bonds of Concern' volume climbed to $44.1 billion in April from $35.7 billion in March, with energy comprising 60% of the volume.
The TTM leveraged loan default rate for energy is 5.5%, compared with 2.6% for all issuers. However, sizable expected defaults from Seadrill Partners, California Resources and Chesapeake Energy, would push the rate closer to our 18% year-end forecast. Several energy companies were added to Fitch's Loans of Concern lists in April including, Fieldwood Energy, Stetson Midstream and Petroleum GEO Services. Within the energy sector, the Top Loans of Concern represent 20% of all outstandings.