Given the apparent bottoming out of the decline in oil prices, improving credit conditions in the oil and gas sector, and the favorable financing conditions across markets currently, many distressed oil and gas companies appear to be a high-return bet.
However, risks do exist, and adding more debt to these firms’ existing loads may prove costly if interest rates rise, if the larger U.S. or European economy dips into recession, or if oil prices once again decline, S&P Global Fixed Income Research warned in a report this week.
The drop in oil prices that began in the second half of 2014 was particularly hard felt among U.S.-based shale oil producers, as this relatively expensive extraction method proved unsustainable amid an approximate 80% drop in oil prices.
“The speculative-grade default rate has risen in recent years primarily due to disproportionate stress in the energy and natural resources sector, where oil and gas companies have been struggling with falling revenue due to lower oil prices,” said Diane Vazza, head of S&P Global Fixed Income Research.
Moreover, many recent defaulters in the oil and gas sector have gained extra funding sources via private equity companies taking out ownership.
In terms of recovery prospects, bond prices for defaulting U.S.-based firms with private equity ownership do show some interesting distinctions among sectors. In the energy and natural resources sector, the average bond prices leading up to default were generally lower than those in other industries. But these same firms’ average bond prices were generally higher a month after default.
Generally, favorable recent bond prices for the oil and gas segment are in line with or slightly better than historical recovery rates.
The full report can be found here ($). — Rachelle Kakouris
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