Oil and gas companies’ credit quality is improving as oil prices increase.
Significant oil and gas supply aided by the shale revolution, followed by plummeting oil and gas demand due to the the COVID-19 crisis, brought oil prices and companies to their knees until recently.
Top Five Oil Producing Countries/Regions, 1980-2020
U.S. Energy Information Administration; data as of April 2021.
Last quarter had the highest exploration and production company bankruptcy filings since the first quarter of 2016.
2015-2021 CUMULATIVE NORTH AMERICAN E&P BANKRUPTCY FILINGS
HAYNES AND BOONE OIL PATCH BANKRUPTCY MONITOR
As the economy has been reopening, good news for the beleaguered energy sector may be here so long as the pandemic does not worsen. Oil prices, a key indicator for the financial health of oil and gas companies, are presently at about $71, a level not seen since April 2019.
Global Oil and Gas Key Forecasts
Fitch Solutions, Q3 2021
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Today’s oil price level is a 255% increase from April 2020 when COVID-19 caused oil and gas demand to plummet. For the second half of this year, the U.S. Energy Information Administration is forecasting an average of $72 for Brent crude oil.
Brent and WTI Crude Oil Forecast
U.S. Energy Information Administration
The Fitch U.S. Leveraged Loan Default Insight released today by Fitch Ratings, shows that the energy sector’s trailing twelve-month default rate now stands at 9.1%., in comparison to 11.8% in June. This is the first time that the default rate is below double digits since April 2020 and at a far lower level than its 20.3% default probability peak in March of this year.
U.S. Leveraged Loan Default Rates
Fitch U.S. Leveraged Loan Default Insight
Eric Rosenthal, Senior Director of Leveraged Finance at Fitch Ratings, is not expecting “many bankruptcies coming in the next few months. Only 2% of our Top Market Concern Loans relates to energy. Glass Mountain Pipeline is probably the most imminent bankruptcy.” He also told me that his colleagues and he expect an energy leverage loan “to end the year at just 5%.” This would be a significant improvement from the current 9% default probability rate.
Rosenthal is forecasting a 2% default probability in energy high yield bonds. “Energy makes up only 10% of our Top Market Concern Bonds list, down from 57% as of one year ago. There has been only $3.2 billion of YTD high yield energy defaults compared with $14.4 billion for the same period in 2020.”
U.S. Industry Default Rates
Fitch U.S. Leveraged Loan Default Index, Refinitiv LPC, Bloomberg.
The rise in oil prices has also eased credit concerns for high yield North American oil and gas producers. According to Bill Holland of S&P Global Ratings, “U.S. speculative-grade issuance in the oil and gas sector remains robust in 2021, with close to $18 billion of U.S. primary issuance through June 30, as financing conditions remain extremely benign, even for lower-rated issuers. So far in 2021, speculative-grade issuance in the oil and gas sector is the highest since 2015.”
Speculative oil and gas bonds distressed ratio has declined
S&P Global Ratings, June 30, 2021.
It will be important to observe how new COVID-19 mutations impact the economy, which would inevitably impact oil and gas demand. According to recent Fitch Ratings analysis, “Oil demand has been improving this year and is likely to continue to grow in 2H21 if vaccination rollouts are successful and pandemic-related restrictions are eased. New breakouts, particularly of new Covid-19 variants, remain the main risk for the sustained recovery in demand.”
Moreover, there are concerns that some banks have reduced their lending to the fossil fuel sector because of poor returns in previous years, and now, possibly because of stakeholder pressure due to concerns about climate change. Since the Paris Agreement banks have financed oil and gas companies a total of about $4 trillion. One third of the globally systemically important banks (G-SIBs) have increased their lending to oil and gas companies. It is too early to tell if at some point lending from banks will decrease significantly. And even if it did, it is likely that non-banks, such as private equity and venture capital, would step in to finance fossil fuel companies. For the time being, I anticipate that these companies’ credit quality will continue to improve.
Top Banks Financing Fossil Fuels, 2016-2020
Rainforest Action Network
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