Given weak demand but restrained supply from both OPEC and U.S. producers, crude prices have been stalled near $40 since May, exhibiting stability seldom found over the last five years. Natural gas prices have increased meaningfully given supply abatements from gas associated with declining oil production. A La Niña—a phenomenon that typically produces colder than average temperatures across the northern U.S.—has formed in advance of heating season and is giving support to a bullish case for natural gas.

The energy credit environment is one of extreme distress, complete dislocation, and an unprecedented absence of capital. The industry remains in a prolonged workout and restructuring mode, one in which bankruptcy filings are accelerating and a presumed exit may not always result in a recapitalized going concern. Long portended and much needed, widespread industry consolidation has only just begun.

All but the largest companies fight for liquidity and survival amid valid investor questions regarding a variety of concerns about the industry, including whether it is sub-scale, will ever recover, is misaligned in terms of both compensation and governance, can adapt, is over-levered, and will ever truly embrace prudence in capital budgeting.

A major capital withdrawal is underway. Energy is now the smallest sector in the S&P 500, representing just 2% of the index. The XLE Index, which tracks the broader energy sector, has declined 50% year-to-date. Equity valuations remain near 25-year lows.

Despite a material tightening in spreads since March, the Credit Suisse High Yield Energy Index remains 375 basis points wide of the broader high yield market at a 9.3% yield. Recent issuance has been limited, with market access firmly shut to all but the largest issuers.

Bank lenders expect cuts in many fall-redetermined borrowing bases—potentially more severe than in the spring. Amid rising loan loss provisions as well as Office of the Comptroller of the Currency-criticized assets, bank exits are accelerating.

In this seemingly dire time for the industry—during which the typical, cheap capital has fled and is perhaps never to return—we believe there are opportunities to increase yields and reduce advance rates both through purchases of bonds and reserve-based loans as well as increasingly in new well-structured first lien loans and real property conveyances.

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Bankruptcy filings by oil and gas producers remain elevated.

Though oil and gas producers have begun to rein in spending, the group outspent cash flow by approximately $50 billion from 2015-2019.

While demand remains depressed due to COVID-19, consumption of jet fuel by U.S. commercial passenger flights is slowly recovering.

La Niña years typically generate colder weather in the northern U.S. and result in higher-than-average heating degree days.

A recent survey of energy lenders and borrowers suggests that borrowing bases will continue to shrink during fall redeterminations.

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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