Monday, February 15, 2016

The energy complex

A few weeks ago I said that it was possible that oil had finally found its floor, well the market made a fool out of me, from $30 it fell all the way down to $26 (its back around $29 now).  But it remains that the oil and gas sector are having a difficult time -- really it's bad!

The US non-conventionals have been using the debt high yield market to finance their operations, it was for a long time much cheaper than the equity markets, in fact 2012/14 saw massive issuance in the high yield market -- somewhere between 20% and 30% of all HY instruments are related to the energy sector.

Rumours a few weeks ago emerged that the Feds were encouraging banks to play nice with the borrowers -- as they say that was then, this is now, and now is looking distressed.  M&A bankers buddies have told me that the restructuring of the E&P sector was was long though to go via sale of business has moved to debt reorg.  The equity has been wiped out, and  good chunk of the debt too (watch out pension funds).

There is no doubt that in the 26/30 range most producers are underwater for their fixed costs, but now it appears that even their variable costs are no longer covered, because the WTI is light and sweet and the stuff out of non-conventional is not light and sweet, there are issues with storage and the price for the non-con production is apparently closer to $15 (someone told me near $12...) that around $30.  That's because there is such a glut of crude in the system, pricing is difficult.

So lenders (who played the game) and FI book that "spiked their yield" with some good old fashion HY debt instruments are finding their books in trouble.  On top of everything, these HY instruments were covenant lite, so that there was no way for lenders to take action until interest payments are delinquent.

So debt write down are about to start (maybe already started), and borrowers are looking at Chapter 11 or maybe even chapter 7 liquidation... the road is going to be difficult.  Now not to add to all these problems but now even China is starting to get unconventional with its bad debt.  Rumours of Chinese NPL entering the US distressed market have emerged in the past few weeks...


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