Risk

Moody’s Sees Doubling in Energy Firm Defaults

The fall in oil prices is expected to fuel an increase in the oil and gas default rate from 2.7% to 7.4% by March 2016.
Matthew HellerMay 21, 2015
Moody’s Sees Doubling in Energy Firm Defaults

The default rate for oil and gas companies with lower credit ratings could double in the next year as the effects of the sharp drop in oil prices hit home, Moody’s Investors Services predicts in a new report.

As of May 1, oil and gas companies already accounted for 14.8% of all the companies covered by Moody’s with credit ratings of B3 or lower, up from 8% the prior year. Moody’s estimates in the new report that the one-year portfolio-average baseline default rate for those energy companies rated B2 or lower will increase from 2.7% to 7.4% by March 2016. (A B2 rating is five notches below Ba1, the credit ratings firm’s baseline speculative-grade rating. )

“With a gradual recovery in energy prices, the weaker oil and gas issuers are at a much greater risk of default,” Moody’s Senior Vice President David Keisman said in a news release. “The companies on the lower end of spec-grade ratings are the ones that should be most worried.”

Moody’s is expecting oil prices will rebound to $70 to $75 per barrel after 2016, compared with a current range of $59 to $65 per barrel. But it admitted that any recovery could be limited by, among other things, a significant lifting of sanctions on Iran or a further decline in China’s growth.

Independent exploration and production companies should have the most trouble in the coming year, Moody’s wrote, since “In times of weak commodity prices, these companies have a higher reliance on borrowings under their credit facilities and external financing sources.”

“The current environment for U.S. oil and gas companies has evolved from a story of an entire industry sector at risk to a more nuanced story of risk migrating to the weakest,” Moody’s said.

The silver lining, according to the report, is that senior secured bank lenders have generally been made whole in U.S. E&P bankruptcies. The normal practice of capitalizing speculative-grade E&P issuers using senior secured bank debt alongside unsecured debt “has historically translated into good recovery rates (or low loss-given-default rates) for the secured bank debt in the liability structure of those that defaulted,” Moody’s said.