Short Sellers Use Bond Market To Bet Against BP And Anadarko

29th Jun 2010 20:29

By Katy Burne Of DOW JONES NEWSWIRES NEW YORK (Dow Jones)--Fast-money investors such as hedge funds seeking to bet on further troubles for BP PLC (BP.LN, BP) and Anadarko Petroleum Corp. (APC) have been selling the companies' bonds short rather than using more traditional approaches of buying credit default swaps on their debt or selling their stocks short. The shorting accelerated in early June after Moody's Investors Service lowered BP's credit rating to Aa2 and before another cut to A2 on June 18, said Will Duff Gordon, senior researcher at data provider Data Explorers in London. Standard & Poor's lowered its rating on BP to AA-minus from AA on June 4 and to A on June 17. Investors looking to short corporate bonds borrow them from another investor for a fee, sell the bonds and hope that they fall in value before buying the bonds back and returning them to the lender. In doing so, they hope to make an adequate return on their investment in excess of their borrowing costs. Short sellers have used the bond market to bet against distressed enterprises, particularly in the gambling sector, but it is uncommon to short bonds of oil and gas companies. One theory offered for why firms may be using bonds instead of CDS or equities is that they feel it might be easier to profit via the bond market. "My personal view is that it is a debt-downgrade play," said Duff Gordon. According to Moody's, the implied rating for BP is B2, based on the cost of insuring its debt against default; for Andarko, it is B3. Both are well below their current levels and deeply into what is called speculative-grade investments. The jump in short selling was quick and sharp. On June 2, for example, investors had sold short 2.5% of BP's 4.75% bond due 2019; three trading days later, on June 7, fully 22.5% of the $1 billion issue value had been sold short. The figure is now around 24%. Shorting of Anadarko's 8.7% bond due 2019 is around 20% of its $600 million issue. Anadarko is a partner in the leaking oil well in the Gulf of Mexico that BP operates. "Based on its financial statistics, BP is still investment grade, even though one could make the argument it may not be," said Thaddeus Strobach, a credit strategist at the Royal Bank of Scotland. The risk premium, or spread, on BP's 2019 bonds is 463 basis points, or 4.63 percentage points, over a comparable Treasury security, a measure of the extra return investors demand to own the riskier oil-company debt. That premium is similar to the spread on oil and gas companies rated BB--six notches below BP. "The 2019 bonds are one of the more liquidly traded BP bonds on the market, and therefore is more available to borrow and sell short," said Otis Casey, credit analyst at Markit. Meanwhile, the cost of a credit default swap to protect against BP missing payments on its debt is quoted at 575 basis points, or 5.75 percent of the amount insured--$575,000 each year to cover $10 million of bonds for five years. That is more than for any other oil or gas company whose CDS are actively traded. The situation is similar for Anadarko. Its 8.7% notes due 2019 trade at 665 basis points over Treasurys, similar to B-rated oil and gas companies; its five-year CDS is quoted around 711 basis points. "The market is pricing in significant downgrade risk to BB levels at BP, and B levels at Anadarko," Brian Gibbons, senior oil and gas analyst at research firm CreditSights, told Dow Jones Newswires. S&P cut Anadarko's credit rating to BBB-minus, the lowest rung on the investment-grade ladder, on June 8; Moody's lowered it to Ba1, which is below investment grade, from Baa3 on June 18. "No one knows the ultimate cost to Anadarko," said Strobach. "There is a strong school of thought they will pay for some cleanup, even though they are not legally obligated to do so, in order to generate goodwill." -By Katy Burne, Dow Jones Newswires; 212-416-3084; [email protected] (END) Dow Jones Newswires June 29, 2010 15:29 ET (19:29 GMT)