Both investment-grade and high-yield credit spreads in the energy sector continue to demonstrate significant correlation with oil prices.
6 month correlations between oil prices and corporate bonds
Despite the massive wave of defaults (c. 25%) in high-yield energy in 2016, the sector continues to account for c.16 % of total high-yield debt. Even within investment grade, the energy sector remains significant, at around 10% of total investment-grade debt. Risks still remain of ‘fallen angels’ (investment-grade companies downgraded to junk) coming into the high-yield index.
Median leverage (debt/EBITDA) levels within the high-yield energy sector are around 9 times. Both investment-grade and high-yield energy companies face significant maturities from 2018 onwards; the debt of these companies cannot be refinanced at anywhere near current rates, and earnings need to grow (which would require the oil price to reach more than $65 dollars per barrel) in order for them to do so. If one takes the view that oil prices remain bound between $45-$55, then the question becomes ‘when’ and not ‘if’ these companies will default.
High-yield energy spreads are highly correlated with the differential between the breakeven price (currently estimated at c.$43 per barrel) of shale oil and the 12-month forward price of oil. In the past, as the below chart demonstrates, when the forward price has dipped below the breakeven price, high-yield energy spreads have widened significantly, which has usually spilled over into the wider high-yield universe.
High-yield energy spreads versus the difference between the breakeven price of shale and the 12-month price of oil (US$ per barrel)
High-yield energy spreads have rallied significantly over the last year and now trade in line with, if not more tightly than, the index.
High-yield energy versus index spreads by rating
Our conclusion remains that this sector is highly overvalued, and that we should continue to avoid it. Nevertheless, we think the prospect remains for a much better entry point somewhere down the road.