Increasing ESG concerns raise the cost of oil sector financing

Increasing ESG concerns raise the cost of oil sector financing

In a year in which there has been a significant strengthening in oil prices, we have seen two oil production companies come to the European High Yield (HY) bond market. Tullow issued a bumper $1.8bn deal in April, well received by the market due to its double-digit coupon and the concurrent simplification of its capital structure. Last month’s deal from Delek-owned Ithaca has been a somewhat different story. The deal priced at the wides of its marketed price talk and is still trading slightly below issue level, despite a juicy 9% coupon, well-invested low-cost asset base and significant cash generation. Yes, there are differences between these issuers in terms of geographic focus and asset base and Ithaca offered a lower coupon, but the differing market reception of these issues also signals waning interest in hydro-carbon investment and the limited funds willing and able to invest therein.

 

Most new client mandates require an increasingly stringent ESG focus and its hardly surprising that investors are shying away from what is without doubt, one of the most environmentally un-friendly of sectors. The rub is that from a purely fundamental basis, many of these companies are in a much better state credit-wise than they have been in recent years, despite their spiralling cost of capital. In a market hungry for yield, it’s a brave investor who would completely eschew all hydro-carbon investment, but for the issuers it must feel like an ongoing game of musical chairs as their available investor bases continue to shrink. Pre-pandemic, I asked one company what is the biggest risk they are facing was and they immediately cited investor aversion to the sector. This is not just a HY phenomenon - the pool of available lending banks is also shrinking as institutions come under increasing pressure to decarbonise their lending operations.

 

Paradoxically, these oil companies still need to exist and are actively responding to energy transition trends by shifting their operations to managing mid and end of life assets. While the oil majors seek to diversify away from production assets, this isn’t a luxury as easily available to smaller HY companies. Despite the world’s ongoing need for significant supplies of oil for several decades, the sector is left scratching its head about how to finance its operations. If this trend of investor aversion continues, it begs the question - how will some of these bonds eventually be refinanced?

 

For the HY investor it’s an increasing consideration as we try to price in this added dimension of risk. Nevertheless the institutional investment community is probably a better assessor of these risks than other less scrutinised investors.

Eleanor Price

Investment Manager, Fixed Income

Eleanor Price is an investment manager in the Fixed Income team with responsibility for high yield bonds.

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