Thursday, 18 July 2019

Over a barrel

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  • A worker prepares pipes to service an oil well on oil fields operated by a subsidiary of the KazMunayGas Exploration Production JSC in Kyzylorda region, southern Kazakhstan.

Asian energy credits have suffered less than those in other emerging markets, but some are still finding it tough to cope with a continuing slump in oil and commodities prices.

The sustained drop in energy prices has had less of an impact on Asia than on other regions, but it has put some corners of the bond market under intense pressure.

Some commodities producers have been shut out of the market, while large declines in some bond prices have created opportunities for bold investors.

On January 22, Moody’s put a dozen oil-and-gas companies in Asia Pacific on review for possible downgrades, as part of a global action on the sector after it revised its estimate for the average price per barrel of Brent and WTI crude to US$33 for 2016 – a US$10 reduction from its last forecast.

“Increased production vastly exceeds growth in oil consumption, even with consumption growth by major consumers such as the US, China and India,” wrote Moody’s. “Production now exceeds demand by about two million barrels per day, adding to already high global oil stocks.” It noted that Iran would add around 500,000bpd to the market in 2016, which, together with increased production in other countries, would offset or exceed expected declines in US oil output by the same amount.

In Australia, Moody’s put on review for a possible downgrade Woodside Petroleum; in China, China Oilfield Services, Hilong Holdings and CITIC Resources Holdings; in India, Oil and Natural Gas Corp, ONGC Videsh and Oil India; in South-East Asia, Petronas, PTT, PTT Exploration and Production, Pertamina and Energi Mega Persada.

Standard & Poor’s took action the following week, downgrading China’s Sinopec and CNOOC after cutting its oil-price assumption to US$40 per barrel in 2016. “We don’t believe China’s national oil companies will be able to stabilise their cashflow adequacy amid the current price environment, despite their efforts to cut capital expenditure and costs,” wrote Lawrence Lu, a credit analyst at S&P.

Fitch, meanwhile, said that most national oil companies in Asia would face a deterioration of credit metrics in 2016, leaving them little headroom under their ratings criteria to weaken further, but underlined state links would support their ratings. “In contrast, non-state-linked upstream companies face higher risk to their ratings this year,” Fitch wrote.

The reports added to a sell-off in some Asian energy credits. The outstanding 2020s of Sinopec and CNOOC are more than 30bp wider in Z-spread terms since the start of the year, and the Petronas 2020s have widened almost 20bp.

“I’m surprised the market reaction was so strong,” said one credit trader. “It didn’t tell people anything they didn’t already know.”

Oil credits are dragging others down, too. Around 26% of the US$1.4trn emerging market credit space is linked directly to oil and gas, according to Barclays research.

“Oil-and-gas-related credits have underperformed non-oil EM credits by 250bp since August 2014 and now command an average spread premium of 30bp (AA) to 900bp (B) across the rating buckets,” wrote Barclays at the end of January. “Likely due to index and relative value effects, the correlation of non-oil EM credits to oil is still substantial and, indeed, higher than for many other asset classes, such as developed market credit.”

State support

Asia has escaped the worst effects of the oil price collapse, since most countries in the region are net oil importers and have actually benefited from cheap fuel as a result. Malaysia, a net exporter, is suffering, but domestic political concerns related to allegations of corruption and the misuse of funds at state investment vehicle 1MDB have far outweighed the impact of any external factors.

The region’s state-owned oil companies have had little trouble securing capital. Malaysia’s Petronas accessed the debt market in March 2015, when 1MDB rumours swirled and oil prices stayed low. It was able to raise US$5bn last year in its first bond offering for six years, suggesting that its rarity value overcame the negative background factors, but, in order to secure tight pricing and re-establish its curve, it had to compromise on size from a rumoured US$6bn-$7bn target.

China’s state-owned oil giants, too, managed to print huge deals last year, even as investors fretted over waning demand for oil. Sinopec raised US$4.8bn in dollars and €1.5bn in euros, CNOOC US$3.8bn and Kunlun Energy US$1bn over a three-week period.

Chinese and Malaysian oil names, though, benefit from their state ownership, and the companies’ strategic significance to the state means that short-term fluctuations in energy prices have little impact on their credit quality, since they will almost certainly benefit from state support in tough conditions.

Offshore Chinese oil bonds also benefited from onshore investors looking to move into US dollar-denominated Chinese assets to improve returns as the renminbi weakened.

That led to Chinese oil credits trading far tighter this year, in relative terms, than they have done historically. International investors had tended to apply a “China discount”, meaning that the Chinese oil majors traded wider than lower-rated US peers. By January, however, that trend had reversed as investors realised that Chinese oil majors’ significance to the state meant that they had a far lower risk of defaulting than privately owned US energy producers. CNOOC and Sinopec have moved inside the curve of US-based ConocoPhillips, trading 50bp inside maturities of 2020 and longer.

That repricing should serve the Chinese oil giants well when they make their next visits to the offshore credit market in the second quarter.

Distressed opportunities

Conditions have been trickier in the lower-rated parts of the Asian credit market.

Defaults are almost unknown in the Singapore dollar market, but the city state’s status as a hub for the offshore oil-and-gas services sector has meant that many bond issuers there are affected indirectly as energy explorers cut back on investments in new rigs and marine services.

Issuers like Swiber Holdings, Marco Polo Marine, Pacific Radiance and Nam Cheong have sought bondholders’ permission to ease covenants on their outstanding bonds, giving them more headroom on their debt levels as profits slow down. Swiber’s perpetual bonds dipped as low as the 70s in the first half of last year, as investors worried whether it had the funds to meet a call in September, but it made the redemption in full without any problems, and also bought back some other bonds in the secondary market to try to restore confidence.

Investors looking to pick up a bargain while commodity prices remain low, however, are turning to other sectors.

“In Asia, there have been opportunities in the coal sector selectively,” said Alexis de Mones, portfolio manager at emerging markets investor Ashmore Group. “That’s been the case in Indonesia. It’s not really an oil-and-gas play in Asia yet, as far as we are concerned.”

Several Indonesian coal producers have struggled to service their debts in recent years, with Bumi Resources and Berau Coal both currently working through restructurings after defaulting on offshore dollar notes.

Mongolia, too, has been a favourite play for investors hoping to profit from its exposure to commodities, which has prompted large swings in bonds from the country. Mongolian Mining Corp’s March 2017s were quoted at 16/17 in mid-February, while the sovereign’s 2018s were at 86.4/87.4, having traded as high as 97 last May. In a reversal of the situation in much of Asia, Mongolia’s commodities producers gain very little benefit from state backing, given the sovereign’s high debt burden and heavy reliance on the mining sector for much of its GDP.

Falling commodities prices have also made Singapore-listed trader Noble Group particularly vulnerable to an attack from a short-seller who criticised its accounting practices. Its 2020 US dollar notes lurched from par last July to 40 bid in late January, after Moody’s and S&P downgraded it to speculative grade. The bonds had jumped up to 53 by the end of that month, after it bought back some of its offshore paper in the secondary market, and agreed to sell its agribusiness division as part of efforts to cut gearing. Its CDS remained extremely high, and reached more than 3,500bp in early February as Noble negotiated a new loan facility.

Lower-rated private sector corporate credits are expected to remain under pressure as long as energy prices remain low, with China taking part of the blame for reducing its consumption as its economic production slows. The People’s Bank of China’s repeated rate cuts and devaluation of the renminbi could help spur the economy and drive oil consumption, but that will be a long process and some credits may struggle to stay above water while they wait for a recovery.

Some analysts, though, foresee a reduction in production to match demand, though crude seems unlikely to revisit the highs of US$100 per barrel it hit 18 months ago.

“I would expect the flow of oil to decline over time, eventually pulling supply back in line with sluggish demand,” wrote David Lafferty, chief market strategist at Natixis Global Asset Management. “Therefore, we think the price should rebound closer to $45 to $65 a barrel at this new equilibrium. But it may take another six to 18 months to get there.”

High-grade Asian energy credits have shown resilience, with the help of this year’s limited supply of investment grade paper in the primary market, but privately owned issuers further down the credit curve may find the wait for higher oil prices rather uncomfortable.

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