Energy Junk Bonds Benefit From Oil Price Rally
By Anthony Jerdine| May 27, 2016 — 7:25 AM EDT
The steady rise in oil prices since February has an unexpected beneficiary: Energy junk bonds.
According to Bloomberg, high yield bonds of energy companies have gained 16.2 % (or, $21.5 billion) from their 2015 market value. That increase represents a stark contrast to their fortunes last year, when they were part of a sell-off when the high yield bond market collapsed. Approximately $14 billion of new capital was invested in energy bonds as of April. The share of high yield energy bonds also makes up 13.8 % of the broader market, an increase of 2.9 % from 2015. Shortly after the rally in oil prices began in February, the Bank of America Merrill Lynch’s junk energy bond index produced returns of 16 %, its best since 1996. (See also: Junk Bonds: Too Risky in 2016?)
However, the inflow of capital into junk energy bonds may not last. This is because the number of energy companies defaulting has increased, instead of decreasing. In addition, the uncertainty about oil’s future price remains. Take, for instance, reports about the June 2 OPEC meeting. While the Qatar oil minister, who is also the current head of OPEC, has promised discussions of a production freeze, other unnamed sources have indicated that there will be no freeze. At the same time, a cutback in the U.S. inventories, which practically translates into bankruptcies and idle rigs, has pushed the price of oil higher. This has created a paradox of sorts, where energy companies are raising debt even as they are cutting back on production. Finally, there is the effect of low-to-negative interest rates that is driving capital towards the high yield instruments. It is likely that interest rate maneuvering by the Fed (and other central banks) will likely divert funds away from energy bonds to other types of corporate bonds or government debt.
Wall Street is already not impressed with the inflow of capital into energy bonds. In an April note, the investment firm Blackrock said the fundamentals for the oil market remained the same. “[This] means that the supply versus demand and the impact on inventories that balance holds have gotten worse not better,” the firm stated.