This Is How Far Oil Prices Have To Fall To Trigger Junk Bond Chaos

A persistent theme in these pages is the extent to which the mammoth spread compression (i.e. rally) we’ve seen in HY over the past 13 months isn’t justified by crude prices or by the fundamentals underpinning the oil market.

To see this, simply have a look at the following chart we’ve highlighted before:

(Click on image to enlarge)


Put simply: the last time cash and synthetic spreads were as tight as they were prior to oil’s plunge earlier this month, oil was hovering around $90/bbl.

Not only are we nowhere close to $90/bbl, but not even the most optimistic of forecasts sees us getting there anytime soon.

Now the counterargument is that US operators have learned their lesson and are now more efficient  – you know, lower breakevens and all. Which is fine. If the US energy complex is now leaner and meaner and thus prepared to truly compete, then great. Good for those companies. But it sure doesn’t inspire much confidence in that narrative when the first thing these companies do once oil rises above ~$50 is go out and tap equity markets for nearly $7 billion in capital – which is exactly what happened in January.

In any event, in light of everything said above, consider the following from UBS who is out with a great note detailing the level at which, to put it colloquially, sh*t hits the fan for US energy and in turn, for HY as a whole.


At what oil price level should the sensitivity of US high yield energy spreads escalate? We believe the low $40s is the key threshold. Why? Cash flow is king, and we find a stronger relation between HY energy spreads and the differential between breakeven oil prices for US shale and 12mo WTI (Figure 8). According to our colleagues the average breakeven oil price has fallen from $65 in early 2014 to $56 in early 2015 and $43 by mid-20166. In recent years, when 12mo forward oil prices have fallen below breakeven levels, HY energy spreads have surged – suggesting distressed concerns quickly get priced into market spreads.

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Kurt Benson 3 years ago Member's comment

I've become increasingly impressed by your work, The Heisenberg Report.

The Heisenberg Report 3 years ago Author's comment

me too

Ayelet Wolf 3 years ago Member's comment

Lol, a great writer and a great sense of humor too! Thanks for sharing your thoughts with us!