WTI has doubled since March to settle at $40. OPEC production is currently at lows last realized in 1991, while U.S. crude production has declined by over two million barrels per day. Global crude demand is slowly recovering from second quarter troughs; however, it appears that the pandemic may permanently reduce demand by three million barrels per day, or 3-5% of total demand, absent a return to pre-COVID-19 levels of commuting and business travel. Additionally, as COVID-19 cases spiked this summer – typically peak demand season – U.S. gasoline consumption declined for the first time since lockdowns began in March.

Production cuts by OPEC+ will begin to taper in August, eventually totaling one to two million barrels per day. U.S. rig count remains near all-time lows, though frac spread count has begun to slowly tick up, suggesting completion activity has resumed in certain basins.

Regulatory risk increased materially, as a U.S. District Court ordered the shutdown of the Dakota Access Pipeline. An administrative stay was granted, and the pipeline will continue to operate pending appeal. Separately, the abandonment of the Atlantic Coast Pipeline project was announced after ongoing permitting delays significantly increased the project’s cost. New large-scale energy infrastructure now reliably faces permitting and litigation challenges that are additive to the capital shortage hurdles that have developed over the last few years.

Energy credit spreads have narrowed from March peaks, now offering a 12-13% yield. Nonetheless, spreads remain 300 and 500 basis points wide, respectively, of pre-pandemic levels and the broader high yield market.

Pressure on banks is mounting from all sides, and efforts to exit individual and portfolios of first lien loans are underway. As a recent example, a U.S. regional bank announced the sale of its energy loan portfolio at a deeply discounted price to par. Banks are keen to clean up balance sheets in advance of year-end stress tests, so selling will continue and likely accelerate.

Additionally, energy equity market sentiment is dismal, with valuations challenging 25-year lows: The S&P 500 and the XOP Index are down 1% and over 45% year-to-date, respectively.

In energy land, there are the capital haves and the capital have nots, the latter being far more numerous. Most companies and formerly active issuers are unable to access reasonably priced debt capital, as the company size needed to access the market with a new issue is larger than ever. Recent activity validates this, with WPX and Endeavor Energy pricing $1.1 billion in new bonds in late June, but smaller, less well-rated oil producers nowhere to be seen. Not surprisingly, the volume of bankruptcy filings has escalated, as the number of oil and gas producers filing during the second quarter increased significantly. With recent announcements from California Resources and Denbury Resources, 2020 filings are likely to surpass levels experienced during the 2015-2016 downturn.

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Energy credit spreads continue to narrow from March peaks, though remain substantially wide of the broader market and elevated when compared to pre-COVID trading levels – a bond picking opportunity.

U.S. crude producers collectively wrote down $48 billion worth of assets in Q1 2020, the largest quarterly adjustment in the last five years and an indication of the distress to come.

Indicative of the switch from growth to value strategies, rig count is at the lowest level since data began being collected in 1940. Despite the recent rally in WTI, current pricing does not support new drilling activity in the U.S.

After the devastating Saudi-Russian price war in early March, OPEC has undertaken historic production cuts to help rebalance the market, and crude production is at 30-year lows.

As crude prices tumbled during Q2, the number of new bankruptcy filings spiked to the highest level since Q2 2016. 2020 filings are now poised to exceed a record 2016.

Angelo Gordon’s Capital Markets Perspectives

AG Capital Markets Perspectives (“CMP”) provides our portfolio managers’ views on the credit, real estate, and private equity markets. To access this quarter’s CMP and past quarterly reports, please complete the form below.

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