By Natalie Harrison
NEW YORK, Dec 12 (IFR) - The battered US high-yield energy sector will face tough challenges until oil prices stabilize, although fears of a tidal wave of defaults seem to be overdone for now.
The collapse in US crude prices to below US$60 a barrel from above US$100 in the summer has spooked holders of US high-yield energy bonds. Spreads have ballooned to 771bp over Treasuries from just 375bp at the end of August, with some 160bp of that widening in the past 10 days, according to Bank of America Merrill Lynch data.
While those dramatic swings have fanned fears of a spike in defaults and potential contagion across the asset class, market participants remain calm.
"We do think that we'll see another leg down from here, but when you peel back the onion, we don't think defaults rates will be as bad as some people think," said Brian Gibbons, oil and gas analyst at CreditSights.
"Yes, there are about 20-25 names that could be in danger, but we think many of them should be able to muddle through over the next year." The biggest issuers among the top 10 weakest credits selected by CreditSights are Linn Energy, Halcon Resources, MEG Energy Corp and Forest Oil/Sabine. ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ For related graphic: http://link.reuters.com/vum63w ^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^
Those weaker credits account for about a quarter of the exploration and production companies in the BAML high-yield energy index, and many are trading above 1,000bp over Treasuries.
DISTRESSING TIMES
Part of the worry about defaults is that energy has become such a large part of the high-yield market at around 16%, driven by the US shale revolution and access to cheap financing.
CreditSights is forecasting energy defaults to double to about 8% next year - but that's not the bloodshed some fear even if it is higher than the near 6% rate in 2009 just after oil prices fell below US$40. Most analysts see the biggest risk of default coming in the US oilfield services sector rather than E&P.
"The real game being played now is to squeeze variable costs, and E&P companies will be leaning hard on suppliers," said Mark Howard, head of US credit strategy at BNP Paribas.
That's already starting to happen.
Goodrich Petroleum and Oasis Petroleum Inc said they expect to spend much less on exploration and production next year, while other large oil producers like ConocoPhillips and Apache Corp have set lower capital spending budgets for 2015.
Production cuts, analysts say, are unlikely to kick in until the first quarter. Asset sales will also be crucial for firms.