Back in May, we pointed out an interesting observation made by Goldman: unlike late 2015 and most of 2016, when equities demonstrated surprising resilience to the swoon in oil prices, in 2017 OPEC’s failure to stabilize oil prices finally hit energy equities disproportionately. As Goldman said in mid-May, discussing the latest crude oil sell-off, which has been “even more pronounced for longer-dated contracts reflecting increasing concerns over future balances in 2018 and beyond”… “in the HY market, the Energy sector has again outperformed its beta to crude over the past few weeks, a pattern that is reminiscent of previous oil sell-off episodes in the second half of 2016 and early 2017 (Exhibit 3).” Goldman also pointed out that the outperformance among energy high yield bonds “also contrasts with the sharp underperformance of Energy equities since the beginning of the year (Exhibit 4).”
And with many other traders and analysts also pointing out the rather odd decoupling between oil and junk bonds, Goldman proposed what it thought was the answer:
We think the much stronger resilience of Energy credits both vs. their own recent history and vs. their equities counterparts reflects three key factors.
- First, the interaction between the trajectories of the spot and long-dated oil prices has been more damaging for equities relative to credit. For equity investors, the sharp decline in long-dated prices suggests the outlook for future earnings may have turned more challenging, causing a downgrade of the sector’s valuation . For bond investors, the focus remains more on production costs and efficiency gains, both of which have dramatically improved over the past few quarters. Based on 2016 data, our Credit Research Team estimates the cost breakeven level for their E&P coverage universe at $56/bbl vs. $68/bbl in 2015, a sizeable decline that highlights the magnitude of the efficiency gains since the onset of the New Oil Order, especially for shale producers.
- Second, credit quality for HY Energy issuers has improved over the past few quarters. Defaults have slowed down materially while the share of CCC-rated Energy bonds declined to levels that are in-line with historical norms
- Finally, refinancing risk is quite low while funding markets remain accessible for Energy issuers.
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