Oil Prices and the High Yield Market
Oil prices continued on a downward trajectory following last Thursday’s OPEC meeting where member countries decided to maintain current production quotas. On Monday, the price of West Texas Intermediate (WTI) crude oil was down 31% year to date, 16% over the last 30 days, and 12% over the last five days, with the current contract trading under $68 a barrel.
We expect the market to remain oversupplied for a more extended period of time and for prices to remain soft. A pick-up in economic growth from China, the U.S., and/or Europe could help to change this equation, as would a geopolitical event which materially curtails production from a major oil producer. Any future OPEC cuts to production quotas would obviously alleviate the current supply imbalance; however the group is not scheduled to meet again until June 2015.
Energy Industry Impact – We expect major cuts to growth capital expenditures across the industry with regard to 2015 budgets. U.S. high yield oil producers will look to live within their operating cash flow and preserve liquidity. Expensive “green field” exploration and development projects will likely be put on hold, such as the Canadian oil sands, Arctic exploration, and U.S shale plays. Most of these types of projects require a view of $75 to $80 oil prices over their life to generate acceptable rates of return. For projects already pumping oil, the marginal breakeven cost for an acceptable low-digit internal rate of return (IRR) ranges between $50 and $60 per barrel for U.S. shale plays.
Impact on High Yield Market – The energy sector is the largest part of the high yield market at roughly 15% (and about 5% of the loan market). Venezuela, Russia, and Colombia will feel the largest negative impact in the sovereign large-cap issuer space. Smaller issuers like Iraq and African oil producers will also be impacted. Oil importers across Asia including China, Indonesia, and South Korea, as well as Turkey and Chile, will benefit. For Brazil and Mexico, the impact is mixed as they are both net importers of crude oil. Despite being significant producers, they have higher refining requirements than internal production can meet. Generally speaking, lower oil prices is good for most of the world, not only for reducing production costs for many industries, but providing a boost to consumer spending due to lower retail gasoline and heating costs. This could provide an overall boost to global economic activity and ultimately lead to a pickup in the demand for oil.
We continue to assess our energy holdings and will take appropriate actions to preserve value and/or take advantage of opportunities we identify.