High Yield Market Faces Jitters From Low Oil Prices

Friday, December 18, 2015

In the latest edition of the Numbers Report, we'll take a look at some of the most interesting figures put out this week in the energy sector. Each week we'll dig into some data and provide a bit of explanation on what drives the numbers.

Let's take a look.

1. Low oil prices sparking sell off in junk bonds

- Barclays high-yield corporate index is down 6 percent, but the energy portion is down 22 percent.
- Moody's says about one-quarter of the junk defaults this year come from energy.
- A fund controlled by Third Avenue Capital Management, a junk bond mutual fund, will shut its doors after suffering steep losses. The move sparked a larger sell off in high-yield debt this week.
- Investment funds are having trouble finding willing buyers for their junk bond assets, which are rapidly losing value.
- Few are concerned that the defaults could lead to financial contagion, but the Fed's rate increase added extra pressure on the high-yield market. Moody's sees the default rate rising in 2016.

2. Different crude benchmarks fetch different prices

- Everyone watches the headline figures for WTI and Brent, but most oil companies sell oil at other benchmarks that are often discounted from the more popular benchmarks. This happens because of differences in quality, costs of transportation, and regional supply/demand circumstances.
- Mexico's oil dipped to an 11-year low this week at $28 per barrel.
- Western Canada Select, a marker for Canadian heavy oil, is in the low $20s, which verges on making even existing fields unprofitable to operate. Bitumen tar sands are down to around $13 per barrel. By some estimates, tar sands producers are losing $3 on every barrel produced right now.
- "More than one-third of the global oil production is not economical at these prices," Ehsan Ul-Haq, senior consultant at KBC Advanced Technologies Plc, told Bloomberg.

3. Baltic dry index falls to new lows

- The Baltic dry index continues to fall after a brief rally in November, touching its lowest level since the 1980s.
- The index is a measure of freight activity, and often used as a proxy for global economic conditions. The sharp decline is a worrying sign of China's slowing economy.
- China produces half of the world's steel, but is set to see the largest drop in production in more than 20 years. That means fewer imports of coal, iron ore, and other commodities.
- That, in turn, spells bad news for commodity markets, where prices for materials other than oil have also plunged.
- The Fed's rate hike will put more deflationary pressure on the commodity sector.

4. Coal prices have collapsed

- Coking coal, used for steelmaking, has seen prices collapse. Although there are a variety of contributing factors, one of the main reasons is slowing demand in China (see #3 above).
- Coking coal prices have fallen to $89 per ton in the fourth quarter of 2015, down from a peak of $330/ton in 2011.
- China is set to import around 45 million tons of coking coal in 2015, down by a quarter from a year ago.
- The depressed market is leading to more bankruptcies in the coal industry, and many more are likely coming down the pike. But as SNL Financial notes, "zombie mines" continue to produce even when their owners go bankrupt. As a result, the glut in supply is not easing.
- The U.S. coal industry is in particularly bad shape. Currencies matter greatly, and the strengthening dollar is putting the U.S. coal industry at an uncompetitive position relative to Australia.

5. Congressional budget deal boosts renewable energy

- Congress agreed (vote pending) to lift the ban on crude oil exports, in exchange for an extension of the Investment Tax Credit for solar, among other measures. The ITC was set to expire at the end of 2016 for solar, and had already expired for wind in 2014.
- The extension will add an additional 20 gigawatts of solar power on top of previous estimates for the next five years, according to Bloomberg New Energy Finance. Greentech Media pegs the additional solar capacity from the ITC at 25 gigawatts. For wind, the credit will add an extra 19 gigawatts of capacity.
- The tax credits are expected to cost $25 billion over five years, and will drive $38 billion in investment into solar and $35 billion into wind power. Costs of wind and solar will decline, which could further stimulate investment.
- SolarCity saw its share price surge by 34 percent on December 16 when the news broke that Congressional leaders agreed to the tax credits.

6. Currency collapse for oil producers

- The Canadian dollar dropped to its lowest level in 11 years this week. Canada's currency is down 17 percent so far in 2015.
- Oil-producing countries around the world are seeing their currencies fall significantly because of low oil prices.
- Year to date: Mexico's peso -13%; Brazil's real -30%; Russia's ruble -10%; Colombia's peso -40%.
- Countries with pegged currencies are under pressure with depleting foreign exchange. Saudi Arabia, Venezuela, Nigeria, China, are all finding it difficult to hold their pegs. Devaluation is an option, but one that countries with pegged currencies hope to avoid.
- The Fed's rate hike will add extra pressure as all currencies face depreciating pressure relative to the dollar.

7. U.S. oil production not quite declining

- The U.S. is only now starting to see some production declines from the oil patch, but is still up for the year. The U.S. produced 9.4 million barrels per day (mb/d) in September, down from a peak of 9.6 mb/d in April.
- But large gains from the Permian Basin and the Gulf of Mexico have blunted losses from elsewhere, especially Alaska and the Eagle Ford.
- Still, legacy production (depletion from older wells) is overwhelming new sources. IEA sees a loss of 95,000 barrels per day in November, plus a loss of 115,000 barrels per day in December.
- Put another way, production from new wells across the U.S. only added 235,000 barrels per day in gross production in December, which is only about two-thirds of the estimated legacy production. Those losses will continue to pile up, accelerating the decline of U.S. oil.
- The balance should flip to profoundly negative in 2016, with losses from nearly every major shale region. Very few places are profitable with oil prices at $40 or lower. The only region expected to see gains is in the Gulf of Mexico where offshore projects, planned years ago, start to come online.

That's it for this week's Numbers Report. Thanks for reading, and we'll see you next week.