Energy Exploration & Production Sector Facing Tough Challenges

Western Asset Says "Unsustainable" Oil Prices Threaten E&P Issuers

Jul 16, 2015, 09:00 ET from Western Asset Management

PASADENA, Calif., July 16, 2015 /PRNewswire/ -- In a recently published market briefing on global oil and high-yield energy, Western Asset Management posits that while no significant moves can be forecast, oil prices are "unsustainable" at current levels. This will likely spur change in the form of pullbacks and consolidations, particularly in the exploration and production (E&P) sector.

"Not much works in E&P domestically or internationally at these prices," wrote the paper's author, Western Asset research analyst J. Gibson Cooper.

"Despite the tough near-term macro backdrop, we continue to believe low crude oil prices will drive the necessary reduction in global industry activity that results in a tighter supply/demand imbalance in the long run, a process we believe will take several years."

"The outer part of the oil futures curve refuses to move beyond the psychologically important $70/barrel level," he wrote. "Despite all the noise, the industry is unsustainable at current prices, which means capital will continue to be withdrawn globally until low prices cure low prices."

The Western Asset white paper, "Oil and High-Yield Energy Brief," can be accessed via the Western Asset website. 

To Mr. Cooper, "the market was exceedingly worried about the U.S. storage situation in the face of continued ramp up in U.S. production and the seasonal trough in refining demand. The storage risk never materialized, and since then, the data points have been generally constructive for tighter future supply/demand (slowing growth in key supply basins, better demand both in the U.S. and throughout the world, high global refining margins and renewed supply disruptions in several countries). Coupled with the sustained lower U.S. rig count and lower expected upstream capital spending globally, the oil futures curve had been gradually moving up on better fundamentals until Greece and China, and its follow-on risks grabbed the headlines."

"The threat of an additional 700,000 oil barrels per day (bpd) from Iran, if sanctions related to the country's nuclear ambitions were to lift, seems a manageable near-term headwind and there is a fair amount of skepticism that Saudi Arabia can sustain over 11 million bpd over time."

The Western Asset team's analysis also shows that:

  • Renewed macro risks around China, Greece and Iran, and resulting heavy high-yield sector outflows over the last two months, have caused energy bond spreads to weaken back to year-to-date wide spread levels versus the broad high-yield index.
  • The July 6 futures curve has retreated back toward March lows as the worry has moved from supply to demand.
  • For high-yield E&Ps, several themes are expected to move to the forefront over the back half of the year — M&A, acquisitions/divestitures and continued liability management. Low commodity prices and declining hedge gains will work to sharpen and shape management teams' decision-making processes on corporate survival.

In Western Asset's analysis, high-yield E&P issuers face serious, even existential challenges.

"They are hedging to ensure 2016 survival, not to ramp capital expenditures," Mr. Cooper wrote. "Some companies have portions of their inventory continuum that can (using a loose definition) 'make money' but, broadly speaking, the industry is unsustainable at current prices."

"Capital extraction out of the industry will accelerate quickly in the coming quarters."

About J. Gibson Cooper CFA

Mr. J. Gibson Cooper is a Research Analyst at Western Asset and has been at the Firm since 1998. He was Assistant Portfolio Manager at Franklin Templeton Advisors and Senior Account Manager at Aetna Capital Management prior to joining the Western Asset team.

Mr. Cooper is a graduate of the University of California, Berkeley and has an MBA from the UCLA Anderson School of Management. He is a CFA charter holder.

About Western Asset Management

Western Asset Management is one of the world's leading fixed-income managers with $455 billion in assets under management as of March 31, 2015. The firm is a wholly owned, independently operated subsidiary of Legg Mason, Inc. (NYSE: LM) From offices in Pasadena, Hong Kong, London, Melbourne, New York, Sao Paulo, Singapore, Tokyo and Dubai, the company provides investment services for a wide variety of global clients, across an equally wide variety of mandates. To learn more, please visit

About Legg Mason

Legg Mason is a global asset management firm with $699 billion in assets under management as of June 30, 2015. The Company provides active asset management in many major investment centers throughout the world. Legg Mason is headquartered in Baltimore, Maryland, and its common stock is listed on the New York Stock Exchange (symbol: LM).

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