Following its 30% increase to start the year, WTI has range traded in a $5 band around $60 since mid-March. Demand is normalizing and is expected to attain pre-pandemic levels by early 2022. At its April meeting, OPEC agreed to modestly increase production in May. Natural gas continues to find support at $2.50.
Despite higher prices, U.S. crude supply remains constrained. 2021 public company guidance indicates continued adherence to capital discipline, and those few producers that sought to materially raise production and/or capex were punished by investors and analysts alike. The majors have cut spending on oil and gas and, instead, are forging ahead with investments in energy transition. The current commodity price environment has prompted several producers to pay dividends, and announcements of those dividends have been well-received.
Traditional energy equities have significantly outperformed both the broader market and transitional energy equities, returning nearly 30% year-to-date versus 10% for the S&P 500 and -17% for the S&P Global Clean Energy Index. As a result, the sector has increased its weighting within the index to 3%, though still lingers well below its 2014 peak of 10%. Market performance notwithstanding, recent equity issuance has been light, with only three follow-on offerings for oil and gas producers pricing thus far in 2021. Vine Energy’s March IPO may portend the reopening of the energy IPO market.
Energy credit spreads continue to grind tighter and, with the Credit Suisse High Yield Energy Index offering a yield of 5.8% as of April 26th, are again approaching lows last realized in 2014. In a complete reversal from last year, ratings agencies have upgraded 14 energy issuers while downgrading only two. High yield issuers have capitalized on the accommodative markets: Issuance in the first quarter reached its highest level since 2014. Thus far in 2021, the sector represents a quarter of all new issuance activity, and of that figure, oil and gas producers represent nearly 50%.
In contrast, banks continue to retreat, creating more senior secured investment opportunities in the form of discounted reserve-based loans—both single names and larger portfolios—and new senior secured originations. Access to senior secured credit is generally rationed for all but the largest and best debt issuers that offer significant bank product cross-sell and ancillary revenue opportunities. The banks that remain are tightening lending standards, by way of increased interest rates and reductions in both advance rates and value ascribed to anything other than proved developed producing reserves.
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Dispersion is substantially greater in high yield energy than in the broader index, potentially providing more opportunity for deep research and individual bond selection.
Year-to-date, S&P has only upgraded energy issuers—a significant change following a multi-year downgrade cycle and reflective of a significant, industry-wide de-levering.
With capital discipline firmly entrenched, companies will apply free cash flow toward debt reduction this year. This will result in meaningfully improved leverage metrics for most issuers; less than two-times leverage is increasingly common.
Traditional energy equities have significantly outperformed both the broader market and renewables year-to-date.
Capital discipline continues to keep production growth in check. U.S. crude output has stabilized around 11 million barrels per day.