US junk bonds face a day of reckoning when markets open on Monday, with the unfolding price war in oil set to knock energy companies buckling from the outbreak of coronavirus.
Saudi Arabia is set to raise oil production next month, in an apparent attempt to put pressure on Russia after Moscow refused to join other nations in curbing output to support the price of oil.
As well as squeezing Russia, the aggressive move is likely to threaten the US shale industry and imperil companies that are teetering on the brink of collapse.
“This was literally the last thing US high-yield energy producers needed,” said John McClain, a portfolio manager at Diamond Hill Capital Management, referring to the effects of the move from Riyadh on junk-rated companies. “There will be blood in the market on Monday.”
Energy companies are the biggest issuers of junk bonds, accounting for more than 11 per cent of the US high-yield market. Such issuers have credit ratings of BB or below, indicating that they are at higher risk of default than “investment-grade” issuers, rated BBB and above.
A Saudi-led price war could usher in the worst rout for junk-rated energy debt since the rise in US shale production and subsequent collapse in the oil price in late 2015.
The average US high-yield energy bond closed in “distressed” territory last week, defined as a cost of borrowing of 10 percentage points or more above Treasury yields. The spread was almost 11 percentage points on Friday, according to an index run by Ice Data Services.
The prices of bonds issued by heavily indebted oil and gas producers have dropped sharply in recent weeks.
Laredo Petroleum’s $600m bond maturing in 2025, for example, fell 10 cents to 58 cents on the dollar on Friday, while struggling Chesapeake Energy’s $2.2bn bond maturing in 2025 also tumbled about 10 cents to trade at 40 cents.
A recently issued $550m bond from Range Resources has slipped to 65 cents on the dollar, having been sold to investors at face value in early January.
A warm winter and falling global demand have also sent natural gas prices lower, compounding the fallout from the declining price of oil. Bond markets have been closed to new sales from low-rated energy companies in recent weeks, cutting off a vital source of additional financing.
“If this persists for any meaningful period of time you could see a wave of restructurings,” said Mr McClain.
Higher-rated companies may also suffer.
Just over 11 per cent of the investment-grade corporate bond market sits within the energy sector, with a host of companies rated BBB, the lowest rung. More pressure on cash flows caused by lower oil prices could result in downgrades, further weighing on junk debt.