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Investors are warming to energy again as bonds trade like stocks

For the first time in months, energy bond and stock investors are both feeling good.

Correlation between energy debt and equity hit a year-to-date high in November, yet another sign that investors' confidence is returning to the sector. Energy junk bonds have increased 7.7 per cent since their low point on June 22, when they took a dive as oil prices tumbled into the $40 range, according to the Bloomberg Barclays high-yield energy index. Equities are following suit: In the same period, the S&P 500 Energy Index has jumped more than 10 per cent after falling almost 13 per cent in the first half of the year.

The energy sector has turned a corner as drillers are beginning to show signs that they're kicking the old habit of relying on debt to fund expansion. Banks seem pleased with the companies, as many have maintained or extended lines of credit in recent weeks. The sector includes every facet of energy production and dissemination, from explorers to pipeline owners to refiners.

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"Energy companies have taken a much more conservative stance on spending and talking a bit more about returns-focused investing," said David Deckelbaum, an analyst at KeyBanc Capital Markets Inc. That "would obviously play into the hands of high-yield investors that aren't looking for additional balance-sheet stress."

The turnaround involves more than just improving commodity prices, though that certainly has helped. With oil at $57 a barrel, most high-yield energy companies are generating enough cash to stay current on their obligations, which is a bondholder's primary concern, said Bloomberg Intelligence analyst Spencer Cutter.

The rosier outlook also helps boost companies' refinancing prospects, an important consideration for investors in an industry that has more than $48-billion of bonds coming due in 2018 and 2019.

"We're at this inflection point where if prices hold here, not every company is going to be in the clear, but it's certainly going to help the cash flow position out a lot," Mr. Cutter said.

Equities have taken a similar roller-coaster path this year. Chesapeake Energy Corp., for instance, has gained 11 per cent since hitting its 2017 low on Oct. 26, after falling almost 50 per cent before that.

As the junk-bond market recovers from an early November sell-off, yields on high-yield energy bonds are falling. Speculative-grade energy notes yield an average of 6.3 per cent, according to Bloomberg Barclays index data, down from 6.7 per cent in mid-November.

'Extremely Attractive'

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As yields fall, energy companies are finding success in the new-issue market. Continental Resources Inc. became the latest entrant to the market with a $1-billion offering Monday. It joins other issuers including Endeavor Energy Resources, NuStar Energy LP and Centennial Resource Development Inc. that have brought deals in recent weeks.

Drillers are also taking advantage of the upturn to refinance at "extremely attractive rates," Mr. Deckelbaum said. In one recent transaction, Concho Resources Inc. used some of the proceeds from an offering of 3.75 per cent and 4.875 percent bonds to buy back notes that carried 5.5-per-cent coupons.

In the last few months, the market "started to see more and more people tap the high-yield markets, and coming out with a pretty positive outcome," Mr. Deckelbaum said.

Energy companies have sold more than $50-billion of high-yield bonds this year, making them the second most-active junk issuers, trailing only consumer-related companies, according to data compiled by Bloomberg.

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