The ability of some shale operators
Confirming that weak oil prices are problematic for the junk bond market are the aforementioned sector ETFs’ allocations. HYG allocates 14.7% of its weight to oil and gas issuers, making that the ETF’s largest sector weight. Approximately 120 of the high-yield bonds held by JNK are issued by companies engaged in the exploration, production or transportation of coal, natural gas or oil. [Oil Slicks Affect Junk Bond ETFs]
“Energy companies now account for 15 percent of U.S. high-yield bonds, up from 9.7 percent at the end of 2007,” reports Lisa Abramowicz for Bloomberg, citing Bank of America Merrill Lynch data.
With oil prices tumbling, production costs at various shale formations high and the ability of some shale operators to generate cash dubious, some fund managers see a day of reckoning coming for high-yield exploration and production issuers.
“Much of the U.S. E&P industry is unsustainable,” said Peritus Asset Management Chief Investment Officer Tim Gramatovich in an interview with ETF Trends. “It’s (shale exploration) is like getting blood from a turnip. These are horrible reservoirs with viscous decline curves, meaning wells deplete by 90% in two years. There’s a lot of E&P high-yield paper floating around and many of these issuers will fail.”
California-based Peritu is the sub-advisor for the AdvisorShares Peritus High Yield ETF (NYSEArca: HYLD). Pertius, which manages over $1 billion in client assets, including about $663 million at the actively managed HYLD, does not own debt issued by domestic shale producers.
“These companies are highly leveraged with no free cash flow,” notes Gramatovich. “I can’t give you a loan for that type of business. A lot of these companies weren’t sustainable at higher oil prices. The real problems haven’t started yet because a lot of these companies are hedged a year out, but there is huge default risk coming, whether oil prices come back or not.”