Global Energy Sector Quarterly: Refreshing Relative Value Post M&A Parade; EIA Sees Commodity Prices Sustained at Levels Similar to Last Year

Relevant Items:
EnLink Midstream - ENLC
Equitrans Midstream - ETRN
New Fortress Energy - NFE
DT Midstream - DTM
Genesis Energy - GEL
Crestwood Midstream - CMLP
Hess Midstream - HESM
High-Yield Gasoline Distributors
High-Yield Propane Distributors
Civitas Resources - CIVI
High-Yield Natural Gas Exploration & Production
High-Yield Oil Exploration & Production - 1
High-Yield Oil Exploration & Production - 2
   

• Rig counts have generally been stable over the fourth quarter of 2023 given sustained weakness in the back half of the year amid rising tensions in the Middle East.
   
• The EIA is currently forecasting oil and natural gas prices in 2024 to look similar to 2023.
   
• We provide an updated view on relative value given the current environment - we continue to favor picking up spread in E&P and within midstream, and we see better value among the more defensive credits.

The oil futures curve has continued to shift down over the last 12 months despite the ongoing unrest in the Middle East. Data shows Saudi Arabia, one of the key members of OPEC+, has continued to pare down production to levels not seen for a few years given prices are not at or above desired levels. Current spot prices appear to have bottomed for now with a recent rise toward the $80 per barrel mark for West Texas Intermediate.

Natural gas prices had recently found some support, particularly to start this year, with colder weather in mid-January. However, the Biden administration’s announcement that it would be pausing approvals for new LNG export facilities may have led to some of the recent pullback in pricing, along with sustained warmer weather. The steeper curves have persisted with the market continuing to anticipate higher prices in the outer years of the curve.
 
Rig counts have continued to bottom out from levels seen last fall, with very minimal shifts in natural gas and oil rigs.
   
The EIA in its short-term energy outlook recently published its 2024 expectations for WTI crude oil to range from the mid-$70 per barrel to low $80 per barrel. Further, its forecast calls for natural gas at Henry Hub to remain under $3 per MMBtu but for prices to average above 2023 levels this year.

We note that the EIA forecast appears to largely ignore geopolitical tensions, and in the event of an escalation, prices are likely to rise in response. However, some market participants are concerned that Saudi Arabia, in response to some perception of waning influence of OPEC+ on market prices, may eventually elect to significantly increase production to drive down prices and, in turn, hurt U.S. producers.
 
Assuming the EIA scenario holds for the time being, companies with a petroleum liquids focus will clearly continue to perform well under this scenario with many now able to continue to focus on equity returns versus the prior heavy focus on deleveraging. For those focused on natural gas, the forecast prevailing natural gas price is inadequate to drive significant free cash flow, which positions this cohort less favorably within exploration and production.

It is this theme that is likely to continue to drive consolidation. Oil and natural gas producers are both emphasizing scale, as this is intended to lead to a better cost of capital in a reality of higher rates. Many companies in high yield discuss investment-grade credit ratings as a definitive goal, and in order to achieve this, consolidation is a factor management teams can control to affect credit improvement in the short term.
 
In our coverage initiation on natural gas producers, we highlighted the bull case being discussed by management teams, which focuses on continued growth in exports. While the EIA agrees that exports will largely enable demand growth of 2 Bcf per day this year, it also acknowledges that storage levels after last winter are at medium-term highs, which positions supply well enough that even in a heavier demand year, given some return to normal weather, storage depletion is not enough to influence prices. We also note the recent shift in rhetoric from the Biden administration has led to some pressure on natural gas prices but note this policy shift does not affect projects that have already been permitted.
 
We view the EIA assumptions as generally a reasonable framework to consider relative value. As noted in our two coverage initiations on oil-focused exploration and production, in this environment we would favor picking up spread. We highlight Callon Petroleum, which at the time of our coverage initiation was indicated at a mid-300 spread and is now trading at investment-grade levels following the announcement that it would be acquired by APA Corp.

At the time, we had noted that Vital Energy was similarly perceived by the market as a “show me” story, and we continue to expect that spreads should eventually reflect the greater scale following a number of acquisitions made by the company in the last year. In our second oil-focused exploration and production company initiation piece, we highlighted Baytex Energy as an example where indicated spread levels do not reflect the current focus on deleveraging and change in composition of its underlying production profile. To summarize, we continue to prefer picking up spread in the current environment while commodity prices remain supportive of credit.

Shifting the focus to midstream, indicated spread levels have come in substantially since our coverage launch over the course of 2023. This is the case even for the companies with higher uncertainties in business profile such as New Fortress Energy or Genesis Energy where indicated spread levels have come in as much as 300 bps from the wides of 2023. We view current indicated spread levels for both of these companies as more accurately reflecting the risks relative to peers. However, we did question whether investors were being adequately compensated in our primary analysis of NGL Energy Partners.

At this time, we view the higher-quality names with the potential for a crossover to investment grade as well as the more “carry”-oriented companies, with limited ratings improvement prospects, as offering better relative value versus lower-quality midstream given this positive shift in sentiment, especially as we head into earnings season when 2024 outlooks will be discussed.
   
Overall exploration & production companies continue to deleverage where deemed necessary but otherwise have directed free cash flow to shareholders. Leverage targets within the cohort range from under 1x to 1.5x. In the cases where leverage has risen due to M&A, the companies have a clear plan in place to reduce leverage back to target levels in the next 12 months.

Our observation in the first few weeks of 2024 is that the third-quarter earnings season appears to have set the stage for some of the M&A of the new year to be consummated. In the case of Chesapeake Energy, where there was some recognition that scale was one of the missing pieces for an imminent acceleration to investment-grade credit ratings, and especially following its asset sale program earlier on in 2023, consolidating footprints in its core basins made plenty of sense.

In the case of Callon Petroleum, which reported earnings results on Nov. 2, the company continued to demonstrate success in deleveraging, but there was little momentum on the ratings front with its senior notes remaining single B, despite all the progress on the balance sheet. We note management highlighted on its call regarding its sale to APA Corp., that shareholders will benefit from an improved cost of capital. Meanwhile, Talos commented on its third-quarter earnings call that “more scale and diversity” would likely lead to a “shareholder return model that’s sustainable.” Clearly, scale is what was achieved in the recently announced transaction, and while the transaction had a fairly meaningful cash component, it quickly addressed slightly more than half of the bridge loan with the issuance of $351 million of equity.

Within midstream and adjacent sectors, the themes persistent in the third quarter had been consistent for much of 2023. Gasoline margins for Sunoco have been elevated outside of its guidance range for a number of quarters, and that enabled it to raise guidance heading into the end of the year. Parkland, which is more diversified than Sunoco, saw similar trends as of the third quarter. For Sunoco, following its early January concurrent asset purchase and sale agreements, it is clear that deleveraging remains a priority, along with increasing its exposure to stable midstream income.

Broader midstream was less sensitive to shifts in commodity prices and for the most part was on track to meet goals outlined earlier in the year. EnLink continued to forge below its leverage target in its quest for its second investment-grade credit rating and recently announced an updated leverage target of 3.5x, which should be supportive of further positive ratings momentum.

Meanwhile, propane distributor Ferrellgas Partners continued to manage through headwinds of warmer winter weather, while Superior Plus and Suburban Propane generally managed well despite weather conditions. In addition, after UGI’s (not covered) most recent quarterly report, uncertainty remained regarding its ongoing strategic review of AmeriGas. Further uncertainty resulted after the abrupt departure of its CEO in mid-December, although UGI shares appeared to have reacted favorably to the management change following the announcement.
 
E&P
 
We have created a report in Credit Cloud of all exploration and production fixed-income securities available in our database. The report can be sorted by price performance in the fourth quarter and in this section of our report, we highlight the top and bottom price performers for the period.

The top price performers during the fourth quarter included Callon Petroleum, Comstock Resources, Chesapeake Energy and Crescent Energy’s new issue. We attribute at least some of the positive momentum to the continued M&A wave with the bonds of the companies mentioned rising significantly following Occidental’s announcement in mid-December 2023 that it would acquire Crownrock. Coincidentally, both Chesapeake and Callon were each involved in consolidation announcements in the first quarter of 2024.

The top declining securities included companies such as Frontera Energy, Rockcliff Energy, Energean and Hilcorp Energy, along with long end bonds across investment grade and high yield, reflecting the impact of broader rate moves. The small decline in Rockcliff Energy’s securities may be attributed to the market’s reaction to its announcement that it would be acquired by an affiliate of Tokyo Gas. Energean having assets offshore in Israel undoubtedly was under pressure due to the ongoing conflict. Lastly, we attribute some weakness in Hilcorp to incremental supply related to its new issue in November 2023.

Midstream
 
We have created a report in Credit Cloud of all midstream fixed-income securities available in our database. The report can be sorted by price performance in the fourth quarter, and in this section of our report, we highlight the top and bottom price performers for the period.

The top price performers of the subsector included Global Partners, Harvest Midstream, Genesis Energy and EnLink Midstream. We attribute some of Genesis Energy’s performance to its refinancing transaction in December in which it issued new bonds and tendered for its existing 6.5% notes due in 2025 in a largely leverage neutral transaction.

The top declining securities included companies such as Gibson Energy, DT Midstream and New Fortress Energy. New Fortress Energy 6.75% due 2025 spreads reached levels of 600+ during the quarter and ended the year around a 300 spread, which we perceive as the market taking a more constructive view of the credit. We attribute the underperformance of the bonds in the data to a temporary price anomaly occurring in early September 2023.
   
New Fortress Energy had its senior secured notes affirmed at B1, and Moody’s adjusted its outlook to stable from negative. This rating action was in response to the company’s proposed senior secured term loan facility, which it rated Ba3. Moody’s noted that it expects projected EBITDA and operating cash flow will be derived under its new contract to supply LNG to two new emergency power plants in Puerto Rico that will operate under a two-year supply contract backed by FEMA. The company has made significant strides in building out its LNG infrastructure, which will support the delivery of LNG to this facility. Moody’s believes that leverage peaked at 6x in the third quarter of 2023 and will start to decline. As highlighted after its November 2023 earnings call, the company sees as much as $1.2 billion of free cash to be used for deleveraging purposes in 2024 as its ultimate goal is reaching investment-grade credit ratings over the next 12 to 24 months.

Hess Midstream had its BB+ ratings placed on CreditWatch positive by S&P following the announcement that Hess Corp. would be acquired by Chevron. S&P noted that the final rating will depend on how strategic Hess Midstream is to Chevron at the close of the transaction.

Weatherford International was upgraded by both Moody’s and S&P during the fourth quarter, resulting from debt reduction and continued earnings growth. Moody’s rates its secured notes Ba2 and its unsecured notes B2, while S&P raised its secured debt rating to BB from BB- and its unsecured debt rating to B+ from B. Oilfield service industry fundamentals continued to improve over the course of 2023, and the company has seen revenue growth and margin expansion as it has grown into its new capital structure. Moody’s and S&P both left their respective outlooks at positive, reflecting the view that further upgrades are possible in the future. As we noted in our third-quarter earnings report, the company does not necessarily have a target for leverage, but reducing its cost of debt and quantum of debt remained a priority.

Permian Resources’ issuer credit rating at S&P was upgraded to BB- from B+, reflecting the effects of its acquisition of Earthstone Energy, but the issuer credit rating of its unsecured debt was left at BB-. S&P’s outlook was left at positive, which reflects an expected increase in the company’s production and reserves, subject to its execution after the close. With leverage down to 0.9x, Permian Resources noted on its third-quarter call that it is targeting investment-grade credit ratings over the next 12 to 24 months.

Vital Energy had its B rating affirmed by S&P last November and removed from CreditWatch negative. The removal from CreditWatch negative reflects its improved liquidity resulting from the refinancing of its 9.5% senior unsecured notes maturing January 2025. It further notes that recent debt and equity issuances help support its liquidity along with funding a series of acquisitions made by the company earlier in the year. It left its outlook at positive, reflecting the expectation that credit measures will improve to substantiate positive ratings action. As discussed in our third-quarter earnings call report, the company targets net leverage of 1x by the end of 2024 and placed hedges to support deleveraging over the course of this year.
 
Within our coverage universe, companies have been addressing coming debt maturities and in some cases have done so in conjunction with new acquisition financing. We note that EnLink Midstream and Equitrans Midstream each have maturities in the 2024 and 2025 time frame, which we anticipate will be refinanced in the coming months. In addition, given indicated levels for each of Range Resources, SM Energy and Southwestern Energy, we would anticipate accommodative primary markets for a refinancing transaction.

As identified by Reorg last week, NGL Energy Partners was working with banks to refinance its capital structure and tapped the primary markets to refinance a number of coming debt maturities including its notes due in 2025. New Fortress Energy for much of 2023 was indicated well wide of midstream- and LNG-focused peers. The company contemplates total debt under $3 billion by the end of this year, which could mean that it opportunistically addresses its 2025 maturity, particularly as it approaches the date at which it would become current debt.

Lastly, Transocean has a couple of maturing debt securities in 2025, with the total amount due sitting at about $650 million. At the company’s recent capital markets day, it discussed its broader plans, which involve reducing debt to $4 billion to $4.5 billion and leverage at midcycle to 3x over time, seeing this as a realistic level for the business going forward.

Transocean has been active in the capital markets over the years, opportunistically addressing certain aspects of its debt stack while funding new rigs such as the Deepwater Aquila project. Assuming market stability and a continued favorable day rate environment, we would anticipate Transocean to be opportunistic as these debt maturities approach. Its cash flow illustration in its investor materials, which provides a rough capital allocation forecast through the end of 2026, discusses debt reduction as a core priority, with $2.6 billion of debt assumed being paid down and not refinanced.
   
Primary Analysis

Civitas Resources funded its acquisition of Vencer Energy in the primary market with $1 billion of senior unsecured notes. Initial price talk was in the low-9% range to start, and it priced at 8.625%. We saw fair value closer to its BB peers, which at that time were in the low-7% range. Please see our primary analysis HERE

Venture Global LNG initially came to the primary market in mid-October with $4 billion of new bonds to refinance its VG Commodities term loan. It then subsequently reopened its October debt offering, pricing $1 billion of additional debt in two existing tranches. The 9.5% 2029 notes priced to yield 9.238%, and the 9.875% 2032 notes priced to yield 9.683%, reflecting strong market reception. Please see our primary analyses HERE and HERE.

Helix Energy Solutions priced a $300 million debut senior unsecured notes offering to refinance its existing convertible debt. The 9.75% notes priced with a small OID to yield 9.875%. Please see our primary analysis HERE.

Talos Energy upsized and priced a two-tranche second-priority senior secured notes offering of $1.25 billion. Proceeds were earmarked to fund its acquisition of QuarterNorth Energy and the redemption of its 12% and 11.75% existing notes. Please see our primary analysis HERE.

NGL Energy Partners priced $2.1 billion of senior secured notes to refinance its capital structure. The senior secured notes priced in two tranches: the five-year priced at 8.125%, and the eight-year priced at 8.375%. We raised some concerns that free cash would now likely be directed to its preferred securities, paying down arrears and eventually the Class D securities, which carry an investor put option. Please see our primary analysis HERE.
 
APA Corp. announced an all stock acquisition of Callon Petroleum. On its conference call, APA Corp. provided incremental color regarding how it plans to treat its debt after the acquisition. Please see our note HERE.

Chesapeake Energy announced it is acquiring Southwestern Energy in an all-stock transaction. Importantly, the acquisition accelerates both companies’ investment-grade credit rating aspirations. Please see our note HERE.

Sunoco LP announced its all-stock acquisition of NuStar Logistics. While leverage will be elevated because of higher debt on the NuStar balance sheet, the company guided that it would return to its 4x target in the next 12 to 18 months. Please see our note HERE.

Energy Chapter 11 Filings

Only one energy-related company filed for chapter 11 with more than $10 million of liabilities in the fourth quarter of 2023.

El Dorado Gas and Oil Inc.: The Gulfport, Miss.-based E&P company, filed for chapter 11 protection on Dec. 22, 2023, in the Bankruptcy Court for the Southern District of Mississippi. The debtors reported $500 million to $1 billion in assets and $50 million to $100 million in liabilities. According to the company’s website, the company provides well refurbishment and recompletion services as well as other natural gas supply services. The debtors said it intends to file a liquidating plan, which it states would provide payment in full of its $50 million term loan from First Service Bank as well as all unsecured creditors.

In-Court Coverage

In the Cox Operating cases, the parties closed the sale of assets to W&T Offshore for $72 million subsequent to year-end. The approximately $72 million sale price pursuant to a revised purchase and sale agreement was below the original $88.5 million PSA, which failed to close.

In October, prior to the initial PSA falling through, counsel for W&T said that the parties “can’t get there” and said he believed the parties were in this “predicament” because of the DIP lenders, as the DIP lenders have “nothing to lose.”

With a material portion of the debtors assets now sold, the debtors continue to contend with its DIP agent, which has terminated access to cash collateral.