Junk-rated US energy bonds rallied by the most in four years on Monday following measures to prop up credit markets by the Federal Reserve, as well as an agreement between oil-producing nations to drastically cut production.
The average additional yield above Treasuries on low-rated energy bonds fell 1.16 percentage points on Monday to 16.21 per cent, marking the second-biggest daily drop on record for data going back to 2000, according to Ice Data Services. Movements on Tuesday were also positive in early trading.
However, the index remained deep in “distressed” territory on Monday — defined as a spread above Treasuries of more than 10 percentage points. Many debt-laden energy companies continue to battle for survival as weak demand for commodities in the wake of the coronavirus outbreak, and an unusually warm US winter, weigh on oil prices.
“It is difficult to distil how much of the move was due to the Opec announcement versus the Fed,” said Fraser Lundie, head of credit at Federated Hermes in London. “Energy bonds have been trading at a historically cheap price. It’s no surprise that they have outperformed the market when there is a broad injection of positive news.”
Opec and its allies, including Russia, agreed on Sunday to the biggest ever cuts in oil output, slashing 9.7m barrels per day of production and ending a price war between Moscow and Riyadh that had helped send the price of Brent crude more than 65 per cent lower for the year at its nadir in March.
The decision to cut production has delivered little fresh support to the oil market, but prices did spring higher in the run-up to the Opec+ meeting. In addition, it came days after the Fed announced that it would support the high-yield bond market by purchasing exchange traded funds invested in the asset class. The moves by the Fed, coupled with a rebound in oil prices has bolstered access to credit markets for higher-quality groups such as ExxonMobil and Valero, which on Tuesday was seeking to raise new capital.
While the prices of bonds issued by lower-rated companies rebounded on Monday — debt from Seven Generations Energy rose by 20 cents on the dollar to 91 cents — junk-rated oil and gas producers have still had trouble securing new funding. Christian Hoffmann, a portfolio manager with Thornburg in Santa Fe, New Mexico, said investors were still “very negative” on highly leveraged energy companies. He added that some of the price gains reflected short-covering by hedge funds.
Almost $124bn of the $174bn Ice index still trades with a distressed spread above Treasuries.
Energy companies have been at the forefront of this year’s wave of corporate defaults and investors said they expected many restructurings in the oil patch in the months ahead. Six oil and gas groups have defaulted this year, a tally matched only by the retail sector, according to S&P Global Ratings.
“There are a lot of headwinds still,” said John Gregory, head of leveraged finance capital markets at Wells Fargo in Charlotte, North Carolina. “Unless a company has very low leverage and operates in a high-quality location, it will still likely run into problems.”