Q&A: Rising Energy Prices and the High Yield Bond Market | Lord Abbett
Image alt tag

Error!

There was a problem contacting the server. Please try after sometime.

Sorry, we are unable to process your request.

Error!

We're sorry, but the Insights and Intelligence Tool is temporarily unavailable

If this problem persists, or if you need immediate assistance, please contact Customer Service at 1-888-522-2388.

Error!

We're sorry, but the Literature Center checkout function is temporarily unavailable.

If this problem persists, or if you need immediate assistance, please contact Customer Service at 1-888-522-2388.

Tracked Funds

You have 0 funds on your mutual fund watch list.

Begin by selecting funds to create a personalized watch list.

(as of 12/05/2015)

Pending Orders

You have 0 items in your cart.

Subscribe and order forms, fact sheets, presentations, and other documents that can help advisers grow their business.

Reset Your Password

Financial Professionals*

Your password must be a minimum of characters.

Confirmation Message

Your LordAbbett.com password was successully updated. This page will be refreshed after 3 seconds.

OK

 

Fixed-Income Insights

With crude oil prices rising, we recently spoke with Lord Abbett credit analyst Andrew Bernstein about the implications for the high yield bond market.

Read time: 4 minutes

There’s nothing like a spike in oil and gas prices to focus investor attention on the energy patch—especially the high yield issuers that participate in the sector. But while volatility abounds, there’s more to the high yield energy sector than simply higher prices. In this Q&A, Lord Abbett research analyst Andrew Bernstein provides his in-depth views on the high yield energy sector in the current environment, and reveals why he believes there are potential opportunities ahead.

Q: What’s behind the current period of energy volatility?

Andrew Bernstein: Historically, the energy sector has been more volatile in terms of credit spreads and the prices of the underlying oil and natural gas commodities. In the previous episode of volatility following the global financial crisis (GFC) of 2008, the need for energy across industries declined considerably. Similar demand destruction was caused by the COVID-19 lockdown in March 2020. However, shortly following this period, OPEC’s (Organization of Petroleum Exporting Countries) attempt to address the decline in market prices did not result in a uniform approach to supply. Consequently, large OPEC producers flooded the market with crude oil. The combined impact of COVID-related demand destruction and excess supply pushed prices to historic lows.

In response, U.S. producers substantially reduced capital expenditures and curtailed domestic production. Subsequent agreement by OPEC to bring global inventories back to normalized levels enabled U.S. producers to gradually increase production to a certain degree, as global supply slowly adjusted upward. Currently, as global supply slowly returns to normalized levels, demand is increasing faster than supply. Prices are reflecting this supply squeeze.

Q: Have energy companies adapted to the disruption?

Bernstein: In previous periods of price correction, energy companies would cut capital expenditures and slow down production, only to aggressively grow production, increase capital expenditures, and draw down credit facilities when prices increased‒a practice that often resulted in negative free cash flow. Now, U.S. producers, which have been the fastest growing region in the past decade, in response to OPEC seeking market share, are looking to grow production more efficiently. Whereas in the past, aggressive drilling, increased debt levels, and negative free cash flow were ubiquitous with higher energy prices, companies now are adapting operations to efficiently produce supply, while maintaining consistent and stable free cash flow to return to shareholders.

Investors have largely contributed to this change in business plans among U.S. energy companies through engagement and reluctance to underwrite debt offerings. We view the transformation of operating models to lower growth and efficient use of capital, combined with sustained higher energy prices, as being fundamentally positive for the sector over the next few years.

Q: How has the natural gas situation in Europe affected the energy sector?

Bernstein: Prior to the pandemic, natural gas was in oversupply in the United States, as associated gas was produced by oil fields. One example is the Permian Basin in Texas and New Mexico. At the onset of the pandemic, domestic production of oil and, consequently, gas declined, eventually helping support natural gas prices in the U.S. We viewed this as a positive for U.S. natural gas producers’ fundamentals.

Outside of the U.S., an unusually cold winter this year elevated LNG (liquified natural gas) demand in Europe and Asia, with much of the supply imported from already reduced inventories in the U.S. Current demand-pull into Europe and Asia is being compounded by the European Union’s (EU) pending approval of a Russian natural gas pipeline, while at the same time, Russian production is being reduced, exacerbating upward pricing pressure.

Q: What do these global price pressures imply for high yield energy issues? What is your outlook on the group?

Bernstein: The overall effect of higher energy prices globally, coupled with the fundamentally positive change in operations among U.S. energy companies focusing on consistent, positive free cash flow and lower leverage, has caused a meaningful compression of spreads within high yield energy, especially high yield exploration & production (E&P) companies (see Figure 1.)

 

Figure 1. High Yield Energy Spreads Could Remain Tight Versus the Broad Market
Spreads on high yield bonds, December 31, 2005‒September 30, 2021

Source: ICE Data Indices, LLC. Data as of 09/30/2021. High Yield Bond Spread is the percentage difference in current yields of various classes of high-yield bonds (often junk bonds) compared against investment-grade corporate bonds, Treasury bonds or another benchmark bond measure. Spreads are often expressed as a difference in percentage points or basis points (which equal one one-hundredth of a percentage point). Past performance is not a reliable indicator or guarantee of future results. It is important to note that the high-yield market may not perform in a similar manner under similar conditions in the future. The historical data shown in the chart above are for illustrative purposes only and do not represent any specific portfolio managed by Lord Abbett or any particular investment. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.

 

Looking back historically (prior to 2013), high yield E&P companies have generally traded relatively tight to the high yield bond market. More recently, since 2013, wider spreads were warranted, given previous business models that used elevated leverage and high capital expenditures to aggressively increase production in an environment of moderate-to-low oil and natural gas prices.

In the current environment, with improved operating models and business plans along with relatively healthy oil and gas pricing, we believe the E&P sector could once again consistently trade tight to the overall high yield bond market, which supports our positive view of the sector.

Q: What are the risks going forward?

Bernstein: What we all need to be cognizant of when thinking about the near-term risks to the energy sector is ESG (environment, social, and governance) and the environmental footprint that carbon producers, like oil and gas companies, have on the planet. Lord Abbett actively and continuously engages with energy companies to gauge their plans to reduce emissions and align their operations to address ESG risk factors. Meaningful engagement has been crucial, and energy producers are fully aware of how important ESG issues are to investors. So that's something that we're certainly very cognizant of and paying significant attention to. Ultimately, our goal is to create long-term, sustainable investments in companies that are solid operators within the ESG paradigm.

 

Unless otherwise noted, all discussions are based on U.S. markets and U.S. monetary and fiscal policies.

Asset allocation or diversification does not guarantee a profit or protect against loss in declining markets.

No investing strategy can overcome all market volatility or guarantee future results.

The value of investments and any income from them is not guaranteed and may fall as well as rise, and an investor may not get back the amount originally invested. Investment decisions should always be made based on an investor’s specific financial needs, objectives, goals, time horizon, and risk tolerance.

Market forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

Equity Investing Risks

The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. While growth stocks are subject to the daily ups and downs of the stock market, their long-term potential as well as their volatility can be substantial. Value investing involves the risk that the market may not recognize that securities are undervalued, and they may not appreciate as anticipated. Smaller companies tend to be more volatile and less liquid than larger companies. Small cap companies may also have more limited product lines, markets, or financial resources and typically experience a higher risk of failure than large cap companies.

Fixed-Income Investing Risks

The value of investments in fixed-income securities will change as interest rates fluctuate and in response to market movements. Generally, when interest rates rise, the prices of debt securities fall, and when interest rates fall, prices generally rise. High yield securities, sometimes called junk bonds, carry increased risks of price volatility, illiquidity, and the possibility of default in the timely payment of interest and principal. Bonds may also be subject to other types of risk, such as call, credit, liquidity, and general market risks. Longer-term debt securities are usually more sensitive to interest-rate changes; the longer the maturity of a security, the greater the effect a change in interest rates is likely to have on its price.

The credit quality of fixed-income securities in a portfolio is assigned by a nationally recognized statistical rating organization (NRSRO), such as Standard & Poor’s, Moody’s, or Fitch, as an indication of an issuer’s creditworthiness Ratings range from ‘AAA’ (highest) to ‘D’ (lowest). Bonds rated ‘BBB’ or above are considered investment grade. Credit ratings ‘BB’ and below are lower-rated securities (junk bonds). High-yielding, non-investment-grade bonds (junk bonds) involve higher risks than investment-grade bonds. Adverse conditions may affect the issuer’s ability to pay interest and principal on these securities.

This material may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize, or that actual returns or results will not be materially different from those described here.

The views and opinions expressed are as of the date of publication, and do not necessarily represent the views of the firm as a whole. Any such views are subject to change at any time based upon market or other conditions and Lord Abbett disclaims any responsibility to update such views. Lord Abbett cannot be responsible for any direct or incidental loss incurred by applying any of the information offered.

This material is provided for general and educational purposes only. It is not intended as an offer or solicitation for the purchase or sale of any financial instrument, or any Lord Abbett product or strategy. References to specific asset classes and financial markets are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations or investment advice.

Please consult your investment professional for additional information concerning your specific situation.

Glossary Definitions

Environmental, social, and governance (ESG) criteria are a set of standards for a company’s operations that socially-conscious investors use to screen potential investments.

Free cash flow is the amount by which a business's operating cash flow exceeds its working capital needs and expenditures on fixed assets. 

The ICE BofA U.S. High Yield Constrained Index tracks the performance of U.S. dollar-denominated, below-investment-grade, corporate debt publicly issued in the U.S. domestic market. Qualifying securities must have a below-investment-grade rating (based on an average of Moody’s, S&P, and Fitch), at least 18 months to final maturity at the time of issuance, at least one-year remaining term to final maturity as of the rebalancing date, a fixed-coupon schedule, and a minimum amount outstanding of $250 million.

The ICE BofA U.S. High Yield Energy Index is a subset of the ICE BofA U.S. High Yield Index and tracks the performance of the U.S. dollar-denominated, below-investment-grade, corporate debt publicly issued by energy companies in the U.S. domestic market.

ICE BofA Index Information:

Source: ICE Data Indices, LLC (“ICE”), used with permission. ICE PERMITS USE OF THE ICE BofA INDICES AND RELATED DATA ON AN "AS IS" BASIS, MAKES NO WARRANTIES REGARDING SAME, DOES NOT GUARANTEE THE SUITABILITY, QUALITY, ACCURACY, TIMELINESS, AND/OR COMPLETENESS OF THE ICE BofA INDICES OR ANY DATA INCLUDED IN, RELATED TO, OR DERIVED THEREFROM, ASSUMES NO LIABILITY IN CONNECTION WITH THE USE OF THE FOREGOING, AND DOES NOT SPONSOR, ENDORSE, OR RECOMMEND LORD, ABBETT & CO. LLC., OR ANY OF ITS PRODUCTS OR SERVICES.

This material is the copyright © 2021 of Lord, Abbett & Co. LLC. All Rights Reserved. 

Important Information for U.S. Investors

Lord Abbett mutual funds are distributed by Lord Abbett Distributor LLC.

FOR MORE INFORMATION ON ANY LORD ABBETT FUNDS, CONTACT YOUR INVESTMENT PROFESSIONAL OR LORD ABBETT DISTRIBUTOR LLC AT 888-522-2388, OR VISIT US AT LORDABBETT.COM FOR A PROSPECTUS, WHICH CONTAINS IMPORTANT INFORMATION ABOUT A FUND'S INVESTMENT GOALS, SALES CHARGES, EXPENSES, AND RISKS THAT AN INVESTOR SHOULD CONSIDER AND READ CAREFULLY BEFORE INVESTING.

The information provided is not directed at any investor or category of investors and is provided solely as general information about Lord Abbett’s products and services and to otherwise provide general investment education. None of the information provided should be regarded as a suggestion to engage in or refrain from any investment-related course of action as neither Lord Abbett nor its affiliates are undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity. If you are an individual retirement investor, contact your financial advisor or other fiduciary about whether any given investment idea, strategy, product or service may be appropriate for your circumstances.

Important Information for non-U.S. Investors

Note to Switzerland Investors: This is an advertising document.

Note to European Investors: This communication is issued in the United Kingdom and distributed throughout Europe by Lord Abbett UK Ltd., a Private Limited Company registered in England and Wales under company number 10804287 with its registered office at Tallis House, 2 Tallis Street, Temple, London, United Kingdom, EC4Y 0AB. Lord Abbett UK Ltd (FRN 783356) is an Appointed Representative of Duff & Phelps Securities Ltd. (FRN 466588) which is authorised and regulated by the Financial Conduct Authority.

FIXED-INCOME INSIGHTS PDF

 

    Q&A: Rising Energy Prices and the High Yield Bond Market

FEATURED CONTRIBUTOR

Related Funds
 

High Yield Fund

 

image

Please confirm your literature shipping address

Please review the address information below and make any necessary changes.

All literature orders will be shipped to the address that you enter below. This information can be edited at any time.

Current Literature Shipping Address

* Required field