The Default Probabilities Of Struggling Energy Stocks

It’s no secret that the energy sector has been hit hard by the collapse in oil prices since mid-2014. Despite a recent bounce-back in oil prices, shares of the United States Oil Fund ETF USO remain more than 46 percent lower than they were priced this time last year.

Survival of the fittest
During any market downturn such as the one that the energy sector is currently experiencing, poorly-run, inefficient and poorly-hedged companies are usually the first casualties. While the Energy Select Sector SPDR XLE has fallen more than 15 percent in the past year, many stocks in the energy sector are down 80 percent or more during that time because the market believes there is a good chance they will not survive the downturn.

Default probabilities
Kamakura Corp uses their Kamakura Risk Information Services (KRIS) model to estimate the default probabilities of different companies. According to founder Donald van Deventer, the latest version of the model has been built based on 2.2 million observations and more than 2,700 defaults from 1990 to 2014.

Energy names at risk?
With Goldman Sachs recently predicting that WTI oil prices will remain at $50 per barrel in 2020, many energy investors are worried about the survival of their companies. For some names, the threat of default is more imminent than others.

Most properly-run and properly-hedged big names in energy have very low near-term default probabilities. For example, according to van Deventer, the one-year default probabilities of ExxonMobil Corp XOM, Chevron Corp CVX and Occidental Petroleum Corp OXY are each less than one tenth of one percent.

However, other names in the sector are much more at-risk in the short term. Here’s a list of nine energy companies that Kamakura has determined have one-year default probabilities of greater than 10 percent:

Miller Energy Resources Inc MILL-default probability 22.92 percent
Swift Energy Co SWFT-default probability 18.84 percent
Warren Resources Inc WRES-default probability 18.16 percent
Resolute Energy Corp REN-default probability 17.55 percent
SandRidge Energy Inc SD-default probability 17.30 percent
Hercules Offshore Inc HERO-default probability 13.09 percent
Exco Resources Inc XCO-default probability 12.28 percent
Arch Coal Inc ACI-default probability 10.31 percent
PetroQuest Energy Inc PQ-default probability 10.16 percent