Defaults are still occurring in US energy despite higher oil prices, said Fitch Ratings, pointing specifically at exploration and production companies.
In August 2016, the distress rate peaked with a 32.1% default rate for E&P companies. In January 2017 the default rate hit 19.7% for energy overall. While removed from those days, “lingering dislocations from shale and the lagged cleanup of capital structures is resulting in continued distressed debt exchanges (DDE) and Chapter 22 filings for speculative-grade E&P firms,” Fitch said.
Fitch raised its West Texas Intermediate and Brent oil price assumptions for 2018 to $65/bbl and $70/bbl, respectively, from $55/bbl and $57.50/bbl, last week, in response to improving supply-demand balances, robust demand growth, and heightened geopolitical tensions, including the renewal of US oil sanctions on Iran. Higher oil prices, the firm said, “are expected to provide significant relief for high-yield E&P companies, as higher realized prices improve cash flow and support liquidity, and generally ease refinancing conditions.”
According to Fitch, the E&P high-yield bond trailing 12 months (TTM) default rate at the end of May stood at 5.8% vs. 2.7% for the total US high-yield market. The May TTM institutional leveraged loan energy default rate was 19.4%, however, due mainly to Fieldwood Energy LLC, which comprised 40% of energy loan defaults over the past year, Fitch said, vs. 2.5% for the total market. Fieldwood was the largest energy loan default on record.
Many of the TTM defaults reflect the lagged impact of lower oil prices and the lingering effect shale dislocations had on company business models. This includes bankruptcies, or DDEs, by refiner Philadelphia Energy Solutions, Proserv Global, and Denbury Resources Inc. Philadelphia Energy’s Chapter 11 bankruptcy filing earlier this year was driven in part by the collapse in discounts for Bakken shale crude oil differentials. Proserv’s DDE reflected the negative effect of the redirection of capital out of the offshore and into US shale markets. Denbury’s DDE resulted from its limited ability to reduce its cost structure in the downcycle vs. shale peers.
Additionally, 45% of 157 issuers that completed DDEs since 2008 experienced a subsequent default, due partially to the lagged cleanup of capital structures, Fitch said. Close to one third of such cases were E&P firms, Rex Energy Corp., Denbury Resources, EXCO Resources Inc., SAExploration Holdings Inc., Legacy Resources Co. LP included.
Fitch forecasts few additional defaults this year, with the high-yield bond energy sector default rate declining to 2% for the year, in line with that of the total high-yield universe, and the leveraged loan energy sector default rate falling to 11%. Debt of energy companies on Fitch’s US Top Bonds of Concern list total $7.1 billion, or 28%, of the bonds flagged and include E&P companies EP Everest, Jupiter Resources Inc., Jones Energy Inc., and Northern Oil & Gas Inc. Energy companies represent 27%, or $7.8 billion, of Fitch’s US Tier 2 Bonds of Concern, Fitch said.
Longer term, Fitch said, improving shale economics provides a more stable outlook for the E&P business. “We believe US shale oil production will remain a major supply-growth driver over time. However, transport constraints, due to pipeline bottlenecks and worker shortages, may limit drillers’ near-term ability to ramp up production,” Fitch said.