Future Energy - Energia Przyszłości - The oil market mess

New year has started, so as new future. At the start of 2014, few expected a third straight year of double –digit gains for S&P 500 and sharply lower long-term Treasury yields.As for oil prices, the collapse from above 100$ a barrel to their lowest levels in five years was unforeseen. The drop in crude oil illustrates the complacency that has existed across the markets for several years.

Much of this encouraged investors to downplay risk and rich for returns. Sharply lower energy prices serve as a warning that eventually even the most ebullient markets turn, or experience what is known as a “Minsky moment”.

Hyman Minsky, an economist, highlighted how at some point financial engineering and leveraged bets based on the idea that asset prices would continue ascending usually reached a peak and then unraveled. A classic boom and bust cycle may well be what we are seeing with energy and junk bonds. A long boom in US oil and gas drilling and exploration found plenty of funding from a junk bond market comprising yield- hungry investors, who downplayed the risk of a significant shock hitting their holdings. Such sanguine thinking has been stripped bare with oil prices sliding below 70$ barrel and seen by some observers as heading towards 40$.

For the US junk bond market , the long-ignored topic of adequate risk premium for owning debt has been roused from slumber. Banks that expected loans oil and gas developers are also sweating, while real estate and other businesses dependent on the US energy boom could also have problems.So far in 2014 the energy component of the US junk market shows a total return of minus 5,3 per cent, while the broad Bank of America Merill Lynch US High Yield Index has gained 3,1 per cent. While the average junk bond yields 6,1 per cent , energy issues have fallen dramatically in price and they sport yields of between 8 and 9 centSuch an outcome illustrates why some managers in the bond market have been cautious about chasing junk names, or what has been called the “dash for trash”. Within the broad junk market energy accounts for some 16 per cent, which is a fourfold increase over the past decade. Not surprisingly, the severe underperformance of the energy sector has weighed on returns for the asset class.

It may soon presage a wave of restructurings and defaults, the type of outcome long downplayed by credit investors and bankers as not arriving until 2017 due in part to the Federal Reserve’s aggressive monetary policy actions since 2009 r.  Nearly a third of speculative grade debt issuance by energy companies trades so poorly it qualifies as being classed as distressed, indicating a high likelihood of being restructured. Martin Fridson, chief investment officer at Lehmann Livian Fidson Advisors, makes the point that while energy junk bonds represent a sixth of the overall market half of the expected defaults in the coming 12 months. Much depends on whether oil prices stabilize and possibly even rebound. A case may be made that deeply distressed energy debt offers an opportunity for the bravest of investors, as was the case in early 2009 r. More likely, energy sector debt and stock prices will remain under pressure, particularly should prices head further south. Investment managers are in little mood for having a large exposure to the sector ahead of their yearly performance being reviewed by clients in January. Across Wall Street, the woes afflicting energy are largely seen as being contained, and that appears he case now. Time will tell whether broader market complacency stands on the cusp of a Minsky moment.


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