Amid Oil Price Plunge, High Yield Bond Energy Issuers Go On Offense

Halcon Resources last week slashed in half its already reduced preliminary 2015 budget that it announced back in November. The company is the latest in a string of speculative-grade credits in the space to make such a move, cutting dividends, suspending drilling, and/or mothballing rigs in the face of the first big bear market in the world's key commodity since 2008.

In the latest announcement, Halcon revised lower its drilling and completions budget for 2015 to $375-425 million, expecting to produce an average of 40,000-45,000 barrels of oil equivalent per day in 2015. This is half of the already reduced $750-800 million budget outlined in Halcon's preliminary 2015 outlook released in November. At that time, the company stated that it would shut down five oil rigs, operating a total of six rigs this year.

Halcon said it was hedged through 2015 and into 2016, but that the precipitous drop in crude prices “calls for conservatism.” Halcon 9.75% notes due 2020 hit a high last June in a 110/111 context before tumbling in the fall, reaching 74 in early December after OPEC refused to cut supply. After sinking further to 71 earlier this week, the notes were quoted as high as 77 on Thursday afternoon following the latest cuts.

Meanwhile, Linn Energy took it a step further, announcing earlier this month an alliance with GSO Capital Partners in addition to cuts to its budget and distributions. GSO agreed to commit up to $500 million with a five-year availability to fund drilling programs on locations provided by Linn, which will allow Linn to develop assets without increasing capital intensity, the company said.

GSO will fund 100% of the costs associated with new wells drilled under the agreement and is expected to receive an 85% working interest in these wells until it achieves a 15% internal rate of return on annual groups of wells, according to a company statement. Linn is expected to receive a 15% carried working interest during the period. Upon reaching the internal rate of return target, GSO’s interest will be reduced to 5%, while Linn’s will increase to 95%, the company said.

Linn also slashed its oil and natural-gas capital expenditures by 53% for 2015, to $730 million, from roughly $1.55 billion in 2014, and reduced its dividend to $1.25 per unit, from $2.90 per unit or share previously. Linn Energy 8.625% notes due 2020 gained a couple of points since the announcement, with quotes this week at 89.5/90.25. The issue hit a low in mid-December at 85.5, after trading in the 108.5 area during the summer.

Expectations are that every high-yield E&P credit will have to make budget cuts. "A lot of the [E&P] credits haven't announced their 2015 budgets yet, but you would expect that they all at least announce a capex budget cut," according to one sector analyst. 

Kapil Singh, portfolio manager at DoubleLine Capital said: “There are some companies that are well-hedged, but even they may have cuts as the fall re-determination happens. The spring re-determination won’t be as harsh. There’s a little bit of cushion for the first half of the year, but come June or July you’ll see even more differentiation between credits.”

Other offensive moves already out publicly include American Eagle Energy suspending drilling and monetizing its hedge positions, and Concho Resources reducing spending. Concho on Monday updated investors with a reduced 2015 capital program "as a result of the sharp decline in commodity prices," according to a company statement. The company revised its 2015 capital program to $2 billion, down from $3 billion, the result of the sharp decline in commodity prices.

At this level of activity, Concho said it expects to generate 16-20% year-over-year production growth in 2015. Concho 5.5% notes due 2023 had traded as high as a 108 context in the summer ahead of the oil spill, sinking to 95 by mid-December. They have since bounced back to 100, according to trade data on Thursday. 

American Eagle Energy last week said it monetized all of its crude-oil hedge positions for December 2014 through December 2015, generating proceeds of $13 million which will be used to improve its liquidity position. The hedges represented roughly 414,000 barrels of oil at an average price of $89.59 per barrel. American Eagle has $175 million of 11% secured notes due 2019, which priced in August at 99.059, and no outstanding debt on its senior secured revolver. The secured notes, which are callable in August 2016, last traded at 43 in late December, down from 90 in October, according to trade data.

Others also took the dividend-slashing route. BreitBurn Energy Partners on Jan. 2 announced it would reduce its cash distribution to shareholders to $1 on an annualized basis, from $2.08 previously, in order to improve its financial flexibility. The company also reduced its 2015 capital budget to roughly $200 million. Meanwhile, EXCO Resources in December suspended its cash dividend to provide additional funds to reinvest in the company.

BreitBurn 7.875% notes due 2022 have recorded a 31% drop since the summer, with quotes this week at 74.25/74.625, versus a 108 context in June. EXCO 7.5% notes due 2018, which traded at a summer high of 103.5, are now quoted at 73/74, trade data show.

The moves coincide with concerns that the credit markets may be closed to most E&P credits for the foreseeable future. While energy sector issuance accounted for roughly 20% of supply last year, forecasts are much lower for 2015. Many energy deals that do hit the regular-way high-yield market could come as secured, particularly second-lien, instead of previously unsecured, and/or in the form of rescue financings for better companies, bankers have said.

Earlier, Resolute Energy turned to the loan market, securing a $150 million second-lien term loan through 

Highbridge Principal Strategies. The terms allow the company to borrow up to an additional $200 million in second-lien loans within 60 days following the closing. Proceeds were used to repay bank debt but the move sank the company's unsecured bonds. Yesterday, Moody's downgraded the company's unsecured debt to Caa2, from Caa1, due to the additional term loan.

For now, market participants are preparing for more pain. Bank of America strategists said in a research note this week that energy yields could widen another 100 bps over the next several months. “With further Energy weakness, the rest of the market may have a hard time decoupling, and could realize an additional leg lower,” said Michael Contopoulos, high-yield credit strategist, in the report. Citigroup equity analysts also this week downgraded a number of E&P companies. “This is a cyclical industry and the near-term outlook has turned quite dire,” they wrote.

According to Marty Fridson, chief investment officer of wealth-management firm Lehmann Livian Fridson Advisors, the energy industry's industry-specific distress ratio is now 29.8%. At that high level, which is a recession-like number, the historically based multiplier is just 20%, Fridson said in a piece published last week on LCD.

This suggests that the market expects a 6% default rate for energy companies over the next 12 months. According to Fridson, for the non-energy portion of the market, the market currently expects a default rate of 2.5% (8.1% x 31.25%) over the next 12 months

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