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Lower oil prices and debt combine to create a squeeze
http://www.houstonchronicle.com/business/energy/article/Lower-oil-prices-and-debt-combine-to-create-a-5939341.php#/0
December 6, 2014

Smaller companies are at the most risk if crude futures don’t stage a recovery

If oil prices stay below $75 for nine months to two years, oil analysts and credit experts say, many of the smaller independent oil companies pumping crude from U.S. shale plays will be at far greater risk of comingup short on cash to pay back billions of dollars of high-yield corporate debt they’ve used to drill expensive horizontal wells.

Because the energy sector makes up the biggest portion of the high-yield debt market, a surge of defaults could resemble earlier telecommunications and real estate busts that infected banks and hit other quarters of the U.S. economy, said Oleg Melentyev, head of U.S. credit strategy at Deutsche Bank in New York.

According to JPMorgan Chase & Co., if U.S. benchmark West Texas Intermediate crude remains around $75 a barrel through 2017, the default rates for the energy sector’s high-yield debt issuances - known as junk bonds because they carry higher risk for investors - could reach 8 percent if companies cut spending and sell assets, and 12 percent if they don’t.

Right now, the high-yield debt market is forecasting a 12-month default rate of 2.6 percent overall, but the energy sector’s projected default rate has risen to 5.4 percent - rising sharply after the Nov. 27 OPEC meeting, said Martin Fridson, chief investment officer at Lehmann Livian Fridson Advisors.

Energy now makes up 14 percent of the $1.3 trillion high-yield debt market, up from 4.3 percent in 2004, according to Barclays.

U.S. energy debt performed worse than all other industries by far in November with a 3.4 percent loss in total returns, according to the Bank of America Merrill Lynch High Yield Index.

But it will take at least a year for oil prices to have a dramatic effect on balance sheets, as about 7 in 10 U.S. oil companies have contracts in place locking in prices at around $90 a barrel through 2015, said Andrew Byrne, director of energy equity research at energy research firm IHS. Lenders typically require more such hedging as a company’s debt increases.

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