Oil prices were the big story in the credit markets from the fall of 2014 through the fall of 2016 as the 40% decline in benchmark WTI helped drive a 400 basis point (bps) swing in credit spreads over that period. While painful, energy companies and credit markets quickly adjusted and by the end of 2016, sentiment had changed regarding the implications of $50/barrel oil. Rather than being an indication of a hard landing in China, or a rapid decline in global growth, the issue was confined to a one-year spike of default rates on a bunch of levered energy companies. By the time of the U.S. presidential election, oil prices in the $45 to $55/barrel range were viewed benignly with high yield spreads approaching their post-crisis tights, and capital market access had returned to all but the most distressed issuers. Even the most volatile part of the energy food chain, the oil field services companies, had managed to issue debt with most energy analysts discounting a bottom in rig counts in 2017.
Although capital expenditures and production are starting to accelerate among domestic producers, and OPEC discipline in adhering to previously agreed upon output has yet to be proven, the credit markets seem content with the “new normal.” With surviving companies able to quickly adjust their cost structures, low cost producers in attractive basins can drill profitability with oil in this new price range. As a result, oil seemed to be put on the back burner as the market rallied in the first two months of the year, and the correlation between oil prices and high yield spreads had dissipated.
However, a pull back in prices in early March also coincided with the first widening in credit spreads since last October. The risk off moment was relatively short lived as spreads resumed their grind tighter in the second half of the month. Still, it brought oil prices back into the discussion and reinforced the notion in my mind that a strong positive relationship continues to exist.Takeaway
Energy is still the largest component of the high yield market at over 15%, and is one of the largest sectors in the investment-grade corporate market, implying that sentiment in this sector still has an outsized effect on index performance. While $45/barrel is a stone’s throw from $50/barrel and doesn’t change a producer’s economics in a material way, breaching the former could lead to a repricing of risk in the market. This is why oil is the commodity I pay most attention to.
The material provided here is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management.
This material is for informational use only. The views expressed are those of the author, and do not necessarily reflect the views of Penn Mutual Asset Management. This material is not intended to be relied upon as a forecast, research or investment advice, and it is not a recommendation, offer or solicitation to buy or sell any securities or to adopt any investment strategy.
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