Give Your Portfolio a Jolt With Energy Bonds

Many investors are intrigued by relatively high yields available in the corporate bond market. But given the economic backdrop, the fundamental picture with most investment-grade companies is deteriorating.

The energy sector may be an exception. Bond yields for pipeline and exploration companies are enticing, and despite falling energy prices, there is reason to believe the fundamentals of these credits will improve over the next 12 to 18 months. Any improvement in the economy over that time will be icing on the cake.

We know energy prices have been falling. Crude oil is down 66% from its high, natural gas is down 73%. Obviously this isn't great news for energy stocks, but it might not be all bad for bond holders.

High energy prices encourage firms to expand production, spend more on exploration, lay more pipelines, etc. Now with energy prices falling, firms are pulling back dramatically on capex spending. This is likely to result in better credit metrics for many energy-related companies. Cash flow will be available for debt service rather than more risky expansion projects. So while it is a stretch to say that falling oil and natural gas prices are good for the energy sector bonds, it isn't all bad. According to individual company estimations, the top 10 investment-grade energy bond issuers anticipate capex spending to decline by an average of 23% in 2009.

Second, energy companies have shown they have good access to the debt markets. Twenty-three different investment-grade energy companies have issued new bonds since Dec. 1, totaling more than $37 billion. And the market isn't just open to the highest-rated firms -- of the 23 new issues, 18 were rated Baa/BBB. This is extremely important, as it reduces fears that firms will be unable to fund upcoming bond maturities.

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At the time of publication, Cavanaugh Capital Management had positions in Anadarko and Energy Transfer, although positions may change at any time.

Tom Graff is a managing director of Cavanaugh Capital Management, a registered investment adviser in Baltimore Maryland. The opinions expressed here are Graff's own and in no way are the statements of Cavanaugh Capital Management, and may or may not reflect the strategies being pursued for clients of Cavanaugh Capital Management. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Graff appreciates your feedback; click here to send him an email.