The Teflon Energy SectorPosted on July 20, 2020
By: Caesar Silvestro
Over the past two weeks, there has been a great deal of news that would seem to negatively impact the prospects for traditional oil and gas companies that largely comprise the High Yield Energy sector. However, High Yield Energy credit spreads were little changed. Is the +300 basis point of credit premium in comparison to the aggregate market really compensating investors for the risk?
Biden’s Green Plan
Former Vice President Joe Biden unveiled a promise to spend $2 trillion over four years to reduce emissions. In his plan, he would expand subsidies for solar and wind power and give the auto industry subsidies to develop electric vehicles. In addition, Biden promised to curtail oil and gas development on-federal lands and water.
A US District Court ruled that Energy Transfer LP’s Dakota Access pipeline will have to shut by August 5th. If the ruling survives appeals, it would be the first time a major pipeline in service was ordered shut because of environmental concerns.
The US Supreme Court refused to let construction start on TC Energy Corp.’s Keystone XL oil-sands pipeline, rejecting a bid by The Trump administration to jump start the $8 billion project.
Dominion Energy and Duke Energy announced the cancellation of the Atlantic Coast Pipeline due to ongoing delays and increasing cost uncertainty which threaten the economic viability of the project.
OPEC Turns Up the Spickets
OPEC + announced its plan to gradually open the taps in August, adding at least 1 million barrels a day of supply to the market. OPEC + members believe the supply increase is warranted given an anticipated rebound in demand as the world recovers from the COVID crisis. However, the move also indicates that the consortium is willing to add supply when oil is only trading at $40 barrel, spelling trouble for US oil producers that have a high cost of production.
Chaparral Energy, Noble Drilling, and Denbury Resources defaulted on debt payments last week.
It appears traditional oil and gas companies could be facing a further reduction in demand from renewables and EVs. Environmental litigation could curtail new pipelines and increase the cost of existing pipelines, adding additional pain to MLP operators that are already working in a challenged environment. Margin pressure will likely continue for US E&P companies from OPEC producers that appear to be more than willing to supply oil at $40 a barrel.
So far, the High Yield Energy sector seems to have shrugged off the news. Are these negative factors already baked into the +300 basis points of credit spread premium over the aggregate market? Is the Federal Reserve’s support of the credit markets causing investors to turn one eye blind to risks as they reach for yield in a low interest rate environment? Time will tell.
Caesar Silvestro has nearly 20 years of buy-side and sell-side research experience in the High Yield and Distressed markets. He was an Executive Director at BBVA Securities focused on the Energy Sector and an Executive Director at MF Global overseeing the Distressed/High Yield research effort. He holds a MBA in Finance from NYU Stern School of Business and is a graduate of Franklin and Marshall College.
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