The recent plunge in oil prices spells rising subordination risk for bondholders in the energy sector, says Moody’s Investors Service in a new report.
The rating agency says that, as oil prices fall, and energy companies’ credit positions become more precarious, the risks for their bondholders increases.
“Oil companies require a high level of ongoing investment in exploration and development to maintain their asset base, much of which has been funded with debt,” says Alexander Dill, vice president and head of covenant research at Moody’s. “Amid falling oil and gas prices, their financing is most likely to take the form of second-lien debt secured by collateral of diminished value and that ranks senior to liens held by their bondholders.”
The flexible structure of many oil and gas bonds adds to their liens subordination risk, Moody’s says. This is most common in the midstream and propane subsectors, where it affects 86.7% and 85.7% of bonds, respectively, it reports; and, it’s least often a feature in the oilfield services and refining and marketing subsectors.
Moody’s assesses covenant quality on a five-point scale, in which 1.0 denotes the strongest investor protections and 5.0 represents the weakest. It says that the midstream and propane subsectors have average scores for liens subordination of 4.80 and 4.88, respectively.
“The midstream and propane subsectors offer the poorest protection against liens subordination,” Dill notes.