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(Bloomberg) -- Transocean Ltd. is poised to be the first in a wave of energy-related issuers downgraded to junk status, making the speculative-grade market even more vulnerable to the fate of oil as concern mounts that crude will resume its slide.
The world’s largest offshore driller, which has about $9 billion of borrowings, may be stripped of its investment-grade ratings soon after it reports earnings Feb. 25, according to a report last week from Barclays Plc. As much as $20 billion of energy-related debt may be cut to junk within 18 months, expanding what is already the largest part of the high-yield, high-risk market by 11 percent, analysts led by Brad Rogoff and Eric Gross wrote in the report.
The downgrades would increase the market’s link to the direction of oil at a time when Citigroup Inc. predicts prices may drop by more than 50 percent. The biggest plunge in crude since 2008 has battered the outlook for drillers and oilfield service firms, making the $200 billion of outstanding high-yield energy bonds last year’s worst-performing industry, according to Bank of America Merrill Lynch indexes.
“It’s definitely something everyone has to be focused on,” said Tim Anderson, chief fixed-income officer at RiverFront Investment Group LLC, which oversees $5 billion in assets. “Oil prices is something people are most concerned about. No one really knows where the bottom is, and that uncertainty is spooking the market.”
Crude oil, which has tumbled below $50 from more than $107 in June, may be set for a longer fall. Prices may slump as low as $20 a barrel and remain there “for a while,” as U.S. supplies are joined by record output from Russia and Brazil, Ed Morse, Citigroup’s head of commodities research, wrote in a Feb. 9 report.
Morse’s outlook for a weaker oil market was echoed by Goldman Sachs Group Inc. and Vitol Group, the world’s biggest independent oil trader, signaling prices may fall in reports this month. That may spell more pain for high-yield investors.
“We’ve seen recently the extent to which energy can influence the high-yield market,” Barclays’ Gross said in a telephone interview. “Even the ex-energy part of the market underperformed as a result of outflows because investors associate high yield with oil exposure.”
Weatherford International PLC, Nabors Industries Ltd. and Canadian Oil Sands Ltd. are among the other investment-grade energy companies at risk of a downgrade to junk by mid-2016, according to Barclays.
Transocean’s proposal this month to slash its dividend and a management shake-up may not offset the damage from oil prices. Last month, Moody’s Investors Service placed its rating on review for a downgrade, while Standard & Poor’s put it on watch with negative implications. Moody’s Baa3 rating for Transocean and S&P’s BBB- both represent the lowest level of investment grade.
Pam Easton, a spokeswoman for Transocean, declined to comment.
In a Feb. 15 statement, Transocean said it aims to cut its annual payout to stockholders by 80 percent. The Vernier, Switzerland-based company also announced that day that its chief executive officer, Steven Newman, will step down.
The cost of credit swaps used to protect Transocean debt against default within five years has soared to 714 basis points, a level associated with junk-rated companies, from less than 200 in September, according to data compiled by Bloomberg. Contracts covering Transocean were the most actively traded among all credit swaps tied to corporate debt in the week through Feb. 13, Depository Trust & Clearing Corp. data show.
Junk bonds are high-yield, high-risk securities rated below Baa3 by Moody’s and lower than BBB- at S&P.
Just because the debt is downgraded to junk doesn’t mean it will perform poorly, according to Chris Kettenmann, chief energy strategist at Macro Risk Advisors.
“It will come down to the quality of the rock, the quality of the assets,” he said in a telephone interview. “If you’re willing to deploy money into the high-yield energy market, the implicit idea is that there will be a recovery in oil prices.”
Energy-bond bets caught prominent investors including Bill Gross wrong-footed in 2014. Gross’s $1.46 billion Janus Global Unconstrained Bond Fund trailed its benchmark in the fourth quarter primarily because it had plowed about five percent of net assets into debt issued by U.S., Russian and Brazilian energy companies, according to a quarterly overview published on the Denver-based firm’s website.
“Whatever your view on the outlook for energy, the potential addition of more names in that sector could make oil an even more significant factor in high yield,” Barclays’ Gross said in the interview.
--With assistance from Elliott Stam in New York.
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