Top Hedge Fund News, Member Posts, Hedge Fund Daily Indices and more!

3yrs ago Hedge Fund hedgeweek Views: 317

4th May 2020 - 10:54am

What will the correction in oil mean for energy credits?

Submitted 04/05/2020 - 10:54am

Muzinich & Co’s Clint Comeux, portfolio manager, and Carl DeMuth, senior energy analyst, look at what the oil price correction can mean for energy credits…

The world is oversupplied with oil and the outlook for demand remains uncertain. Two developments are necessary to restore crude oil prices to levels that warrant economic reinvestment in energy exploration and development. First, demand needs to return to levels consistent with a globally functioning economy and secondly, production must be curtailed to levels that are consistent with the new norm of global demand.

“We believe that health concerns will persist long after lockdowns are lifted and the “new norm” for economic activity and travel may take two-three years to return to pre-COVID-19 levels.

“In the face of this outlook, we believe supply must contract. Supply side responses are happening and physical storage limitations may force well shut-ins. However, the announcements thus far have not been enough to balance markets. We believe the supply side response will take some time to reflect the bleak demand reality due to the fragmented nature of the supplier base, varied sovereign interests, and decisions by individual companies to operate for cash / liquidity needs.

“US Shale oil production, which has grown rapidly in recent years, could contract and contribute to balancing global supply/demand imbalances.  Low commodity prices and weak economic returns will likely reduce exploration and production investments. Contraction of the US Shale oil industry is expected to have negative implications for companies that lack scale, low-cost resources and financial flexibility to manage through the commodity cycle. Nonetheless, we expect US shale oil to remain a key supplier to global hydrocarbon demand given its sheer size, advantaged position on the cost curve, ability to flex up and down quickly to respond to demand and domicile in relatively stable sovereign.

“Globally, we expect to observe the following:

• Lower drilling investment will likely drive fundamental weakness for drilling companies (offshore and onshore) due to low capacity utilisation and price depreciation.

• High cost, highly leveraged companies will likely default. More than 25 per cent of the US sub-investment grade energy companies defaulted in 2015/16 cycle.

• Expect fallen angels. Ratings agencies will likely downgrade BBB/BBB- rated energy companies as they revise price forecasts lower.

• Survivors of this prolonged energy cycle will likely be low-cost, low-leveraged (mostly investment grade and higher rated BB) oil producers with financial flexibility to survive the cycle.

• Midstream companies (pipelines) and refineries should likely perform relatively well as these are volume driven rather than commodity price sensitive business models.

• Natural gas may experience counter cyclical upside as oil drilling activity declines (as much as 15-20 per cent of US natural gas is generated as by-product of oil production).

• State-owned oil and gas companies will likely benefit from sovereign support due to strategic nature of the enterprise.

“We learned several lessons from the energy commodity cycle in 2015/2016 that we believe can help guide how energy exposure may be managed through this correction:

• Sell high cost oil and gas producers with liquidity constraints – recovery rates in energy defaults were below historical norms for non-energy defaults.

• Avoid drilling services companies tied to exploration and production investment.

• Focus on low-cost producers, with strong liquidity profiles and dynamic management teams.

• Buy long-dated, high quality energy (including investment grade, fallen angels) in efforts to rebuild discount to par and participate in upside upon commodity normalisation.

“Hold midstream companies but expect volatility as these bonds may trade with energy sentiment, but fundamentals tend to be less volatile.”

Tags Comment Commodities & Resources Oil

Today's Hedge Fund Headlines:

Log In for More
Access Over 250K+ Industry Headlines, Posts and Updates
Not a member yet?

Join AlphaMaven

The Premier Alternative Investment
Research and Due Diligence Platform for Investors

Free Membership for Qualified Investors and Industry Participants
  • Easily Customize Content to Match Your Investment Preferences
  • Breaking News 24/7/365
  • Daily Newsletter & Indices
  • Alternative Investment Listings & LeaderBoards
  • Industry Research, Due Diligence, Videos, Webinars, Events, Press Releases, Market Commentary, Newsletters, Fact Sheets, Presentations, Investment Mandates, Video PitchBooks & More!
  • Company Directory
  • Contact Directory
  • Member Posts & Publications
  • Alpha University Video Series to Expand Investor Knowledge
  • AUM Accelerator Program (designed for investment managers)
  • Over 450K+ Industry Headlines, Posts and Updates
ALL ALPHAMAVEN CONTENT IS FOR INFORMATIONAL PURPOSES ONLY. CONTENT POSTED BY MEMBERS DOES NOT NECESSARILY REFLECT THE OPINION OR BELIEFS OF ALPHAMAVEN AND HAS NOT ALWAYS BEEN INDEPENDENTLY VERIFIED BY ALPHAMAVEN. PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS. THIS IS NOT A SOLICITATION FOR INVESTMENT. THE MATERIAL PROVIDED HEREIN IS FOR INFORMATIONAL PURPOSES ONLY. IT DOES NOT CONSTITUTE AN OFFER TO SELL OR A SOLICITATION OF AN OFFER TO BUY ANY INTERESTS OF ANY FUND OR ANY OTHER SECURITIES. ANY SUCH OFFERINGS CAN BE MADE ONLY IN ACCORDANCE WITH THE TERMS AND CONDITIONS SET FORTH IN THE INVESTMENT'S PRIVATE PLACEMENT MEMORANDUM. PRIOR TO INVESTING, INVESTORS ARE STRONGLY URGED TO REVIEW CAREFULLY THE PRIVATE PLACEMENT MEMORANDUM (INCLUDING THE RISK FACTORS DESCRIBED THEREIN), THE LIMITED PARTNERSHIP AGREEMENT AND THE SUBSCRIPTION DOCUMENTS, TO ASK SUCH QUESTIONS OF THE INVESTMENT MANAGER AS THEY DEEM APPROPRIATE, AND TO DISCUSS ANY PROSPECTIVE INVESTMENT IN THE FUND WITH THEIR LEGAL AND TAX ADVISERS IN ORDER TO MAKE AN INDEPENDENT DETERMINATION OF THE SUITABILITY AND CONSEQUENCES OF AN INVESTMENT.