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Appalachian drillers' bond prices crumbling as credit markets grow wary

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Appalachian drillers' bond prices crumbling as credit markets grow wary

Already suffering from declining stock prices, Appalachia's shale gas drillers are now watching their bond prices fall sharply. The drop may signal a credit-worthiness crisis that worries Wall Street analysts and could impact the ability of some drillers to borrow against their bank-determined lines of credit or refinance their debt.

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While bond refinancing does not become an issue for most Marcellus and Utica drillers until 2022 or 2023, market signals indicate that the high-paying bonds of shale gas producers can be had for double-digit markdowns. The discounts reflect rising uncertainty about the financial future of the debt-laden sector, especially given forecasts that natural gas prices will remain low over the coming three years. But revolving lines of credit from the banks — used to finance routine day-to-operations — are redetermined every year, presenting opportunities for banks to make their credit concerns known.

"This sell-off in the debt market mirrors conversations in the equity market that suggest structurally reducing absolute debt (as opposed to growing into leverage metrics) should be a top priority, especially for operators who have core inventory that depletes over the next 6-8 years," analysts at energy investment bank Tudor Pickering Holt & Co. said Aug 21.

Essentially, the bond market seems to be telling producers to do the same thing that the equities market recommends: Reduce costs and generate free cash flow. But while the stock market would have operators redirect that cash to shareholders, the bond market would have the sector pay down debt to increase credit confidence.

"We're not worried yet, but we are wary," Guggenheim Securities LLC oil and gas analyst Subash Chandra told his clients Aug. 23. "The high yield markets have been largely closed to upstream issuers. We are watchful of 2020, 2021, and even 2022 maturities as refinancing is more likely than retirement for most issuers."

Chesapeake Energy Corp.'s $850 million bond, due in 2024 and paying a healthy 7% annual coupon, illustrates the confidence gap surrounding the shale gas sector that Chesapeake is trying to exit. That bond was selling at a 24% discount to face value, 75.72 cents on the dollar, Aug. 22, for a nearly 14% yield at a time when the Fed funds rate is 2.25%. The discount is needed to get wary borrowers to bet on Chesapeake's ability to pay off the bond in some fashion by 2024. S&P Global Ratings rates Chesapeake's credit as B+ with a stable outlook.

The driller with the most immediate need for bond refinancing is investment grade-rated EQT Corp., with $1 billion worth of low-paying bonds coming due in the fall of 2020. Normally, investment grade bonds sell at a premium to their par, or face, value, because of their perceived safety. EQT's average price for the two $500 million bonds was 99.62 cents on the dollar for bonds paying 2.5% and 3.1%, for an average 3% yield.

While direct comparisons between EQT — the nation's largest gas producer — and the other investment-grade rated gas company in Appalachia — vertically integrated National Fuel Gas Co. — are inexact, National Fuel's $500 million bond paying 4.9% and due in 2021 was selling for a more confident 4% premium on Aug. 22 at 103.99 cents on the dollar.

The decline in bond prices for the shale gas sector began after first quarter earnings were reported out and accelerated after second quarter earnings reports were issued amidst a flood of "free" gas from Permian Basin oil wells capped the natural gas prices realized by producers.

"We believe many operators are now at the end of their rope as balance sheets on both the private and public sides are exhibiting distress," Tudor Pickering Holt told clients Aug. 22.

Tudor Pickering Holt has also told clients it would not predict which driller will run into credit difficulties first "but suspect[s] names with low cash on hand and muted [free cash flow] forecasts will need to take proactive steps to mitigate risk."

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This S&P Global Market Intelligence news article may contain information about credit ratings issued by S&P Global Ratings. Descriptions in this news article were not prepared by S&P Global Ratings.