High Yield Bonds in View: Energy

Much has changed since the oil-market collapse in the early pandemic days of 2020, when prices actually turned negative. Franklin Templeton Fixed Income Research Analyst/Portfolio Manager Bryant Dieffenbacher looks back at industry developments since then, and outlines opportunities he sees in the high-yield energy bond market today.

What a difference a year makes! Our team last wrote about the high yield (HY) energy industry on March 9, 2020, following the collapse of talks among the oil-producing countries of the OPEC+ alliance (Organization of the Petroleum Exporting Countries, plus its allies Russia and other major oil producing countries). The accompanying graphic to that blog post of a thunderstorm—while certainly ominous—in hindsight may not have gone far enough to foreshadow the considerable storm the market was about to face. Just over a year ago on April 20, 2020, oil market volatility reached a crescendo when the West Texas Intermediate (WTI) crude oil benchmark price closed at a negative price of $37.63 per barrel. The outperformance of US HY energy in the year following that historic event has been dramatic: +44% total return for HY energy versus +15% for the HY ex-Energy and Metals & Mining Index.1

HY energy remains an important and topical industry for the US HY market, currently accounting for over 13% of the overall HY index. Despite a run of strong outperformance, energy still offers well in excess of 100 basis points2 of yield and spread pickup relative to the balance of the HY market. In this piece, we outline some notable events in US HY energy since the onset of the pandemic and outline how the industry has changed.

2020: The Year of the Energy Fallen Angel

After the March 2020 collapse in oil prices, credit ratings agencies moved quickly to reduce credit ratings or downgrade ratings outlooks for many issuers in the energy industry. Over the course of 2020, this pushed the credit ratings of several energy issuers down to HY from Investment Grade (IG)—so-called “Fallen Angels.” The exploration & production (E&P) subindustry was hit particularly hard, with a handful of large issuers downgraded to HY. Currently, 2020’s cohort of E&P Fallen Angels comprises just over 50% of the HY E&P subindustry.3