US shale defaults to ‘creep up’: JPMorgan

Rig hands thread together drilling pipe at a hydraulic fracturing site owned by EQT Corp. located atop the Marcellus shale rock formation in Washington Township, Pennsylvania.
Ty Wright | Bloomberg | Getty Images

April's running tally for U.S.-based energy defaults has reached $14 billion so far, according to Fitch ratings.

This week, oil and gas exploration firm Energy XXI and coal giant Peabody Energy both filed for bankruptcy while Linn Energy missed a debt payment.

And today, Houston-based Goodrich Petroleum has announced it has filed for voluntary restructuring under Chapter 11, as the firm looks to cut around $400 million debt from its balance sheet.

The U.S. shale revolution of the last few years has been typically backed by small and mid-sized firms who borrowed heavily to finance operations.

"The biggest cost for U.S. shale oil is digging wells. In order to keep in business firms will have to return to the debt market to raise cash.

"This is where the problem lies, if you lent to them at $100 per barrel a few years ago you will think twice about lending to them at sub $50," said Alex Dryden, analyst at J.P. Morgan Asset Management Friday.

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Dryden believes this fact alone should see U.S. shale oil producers drop out the market and excess supply begin to tail off.

"We are already seeing U.S. firms step out of the market with [overall] US crude production down below 9 million barrels per day, down significantly from 9.7 million in April 2015", he said.

And within the shale sector, the U.S. Energy Information Administration forecasts oil output from major U.S. regions will fall to 4.84 million barrels a day in May, marking a steep fall from April.

"The takeaway for investors is that you could see defaults in the U.S. high yield energy sector creep up over the course of the year, which means investors need to be cautious when investing in the U.S. high yield energy sector," said Dryden.

Beyond Energy?

Fitch notes that energy bond prices remain depressed, with more than half of B- or lower rated firms bid below 50 cents.

Investment management firm, Morningstar, believes the struggle in U.S. shale energy is the primary reason for volatility in high yield debt.

"The current conniptions affecting the high yield market are being driven primarily by the exposure of the asset class to U.S. energy companies and, in particular, those involved in the production of shale products," it said in a note Tuesday.

Morningstar says while price falls affecting the energy company bonds may be fully justified, the negative sentiment created has swiftly extended to other parts of the market.

"Evidence for this is provided by the average credit spread for U.S. auto manufacturers, which has risen more than 300 basis points since the beginning of 2015," the note reads.