Investors are demanding less compensation for taking on the risk of lending to gold-listed energy companies as commodity prices rise and industry executives shun the drill-at-all-costs mentality that sparked a crisis there Eight years.
The additional borrowing costs investors need to hold the debt of poorly rated energy companies relative to U.S. government bonds fell from more than 4 percentage points in March to 3.65 percentage points this week, according to an Ice Data Services index that tracks US debt trading activity. Marlet.
The drop pulled the “spread” on junk-rated energy bonds below that of the broader high-yield market – something that hasn’t happened on a sustained basis since the crisis in the US energy industry that began in 2014.
A supply glut caused by increased production from U.S. shale drillers and weaker demand caused by slowing Chinese economic growth caused oil prices to crash between mid-2014 and early 2016. Falling oil prices triggered a wave of defaults among exploration and production companies, many of which financed their drilling by borrowing from the junk bond market.
“Business behavior has changed,” said Ken Monaghan, high yield portfolio manager at Amundi US. “Energy companies are paying off debt instead of following the ‘drill baby drill’ mantra.”
Fiscal discipline combined with rising oil prices led to a rapid market rally, with energy bonds trading at spreads around 12 percentage points higher than the rest of the market, on average, at the worst of the month. the pandemic-induced sell-off in March 2020. The additional spread above the broader market had also peaked at around 11 percentage points during the 2016 energy crisis.
Monaghan also said he expects some energy companies to move from high yield to investment grade soon, with companies like Occidental Petroleum that slipped down the rating scale during the pandemic expected to move up.
JPMorgan expects $68 billion of North American energy sector debt to drop from junk to investment grade through 2023, leaving the industry as the biggest contributor to the ‘rising stars’ list of Wall Street banking.
These companies are currently helping to improve the overall quality of debt in the junk bond market, as they share more attributes with high-level borrowers than those more common on the lower side of the rating scale.