ESG concerns are rapidly raising the cost of borrowing for oil companies as interest in hydro-carbon investment wanes and fund mandates become ever more restrictive, according to Aegon Asset Management’s (AAM) Eleanor Price.
Eleanor Price, Senior Credit Analyst at AAM, says that while many oil companies are in better health from a credit perspective than they have been in recent years, having seen their balance sheets bolstered by strengthening oil prices in 2021, they are finding it increasingly difficult to raise financing as the pool of willing investors shrinks and banks bow to pressure to decarbonise their lending operations.
"Tullow Oil issued a bumper $1.8bn deal in April that was well received by the market due to its double-digit coupon and the concurrent simplification of its capital structure," she says. "But last month's deal from Delek-owned Ithaca has been a 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."
Ms Price says that with most new client mandates requiring an increasingly stringent ESG focus, it is unsurprising that investors are shying away from such an environmentally unfriendly sector. However, she believes it is significant that this shift is happening so quickly at a time when oil companies offer solid credit fundamentals and attractive coupons.
"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," she says. "This is not just a High Yield phenomenon - the pool of available lending banks is also shrinking as institutions come under increasing pressure to decarbonise their lending operations."
Ms Price points out that, paradoxically, many oil companies are actively responding to energy transition trends by shifting their operations to managing mid and end of life assets. But while the oil majors seek to diversify away from production assets, she argues this is not 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,” she says. “If this trend of investor aversion continues, you have to ask - how will some of these bonds eventually be refinanced? For the HY investor it is an increasing consideration as we try to price in this added dimension of risk.”