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Leverage improvement is plateauing for IG Energy as a whole, given most balance sheet goals have been achieved, and incremental cash flow is primarily being directed to dividends and share repurchases.

IG Energy (CIEN) trades 10 bp behind the overall Corporate Index at +115, compared to 30-40 bp in 鈥渘ormal鈥� years (2017, 2018, 2019, 2021) and 65-80 bp in downturns (2015,2016,2020). We feel the macro environment, stronger credit metrics and capital allocation plans across the energy landscape reflect fair value at these tighter spreads. However, Midstream (CIGD) currently offers 20 bp of spread pickup to IG Energy, compared to 10-15 bp in the 鈥渘ormal鈥� years cited above and in-line with the 2020 spread differential to IG Energy.

We recently lowered our HY Energy recommendation to Market perform, as the sector trades ~65 bp tight to the HY Index and technical tailwinds from the wave of rising stars is largely behind us. The fundamental outlook for HY Energy remains positive, with balance sheet improvement a key focus for cash flow, but issuer selection will be key to outperformance going forward. The market is highly focused on M&A targets, and clearly, not all of the potential transactions will occur, leaving some names to underperform.

The IG Energy Index (CIEN) remains the third largest non-financials IG sector behind Healthcare & Utilities. After the index shrunk by $23 bn in 2021, $50 bn in 2022, rising stars drove growth of $39 bn in 2023 to ~$721 bn as we expected. In the IG index, ~$26 bn of energy rising star debt YTD and debt reduction among A-rated issuers led BBB debt to increase slightly to 59% of the IG Energy Index. Pipelines remain the largest IG subsector at 44% ($315 bn) of the index, followed by Integrateds at 31% ($226 bn), E&Ps at 16% ($113 bn), Refiners at 6% ($45 bn) and OFS at 3% ($22 bn)

While continued deleveraging and another wave of rising stars in 1H23 significantly shrank the overall HY index, the largest issuers have now made the move to IG. HY Energy index debt declined $8 bn to $149 bn, as rising stars were somewhat offset by Venture Global鈥檚 growth and Upstream M&A. Other than M&A, three remaining names under coverage remain on our rising stars list, but only total ~$9 bn of index debt. Pipelines are also the largest HY sub-sector, accounting for 41% ($61 bn) of the index, followed by E&Ps at 34% ($51 bn), OFS at 15% ($22 bn) and Refiners at 10% ($15 bn).

Oil Markets

Oil prices ended the year slightly lower than where they were at the beginning of the year after a bumpy ride that saw prices range from just below $70 when demand concerns were the market focus to $94 after the Israel/Hamas conflict sparked supply concerns. However, WTI prices averaged $78/bbl in 2023, in-line with our $80 target held for 2023, and compared to $95/bbl in 2022 and $68/bbl in 2021. Brent averaged $82/bbl in 2023, versus $99/bbl in 2022 and $68/bbl in 2021.

Current WTI and Brent strips point to 2024 prices of $73 and $77, respectively, below our WTI projection, which we are maintaining at $80 for 2024. The EIA recently cut its 2024 crude forecast by $8 to $78 WTI and $83 Brent, due to concerns about global demand growth. However, OPEC+ willingness and ability to support the market and SPR re-fills ~$70-$75 provide some downside price protection. Additionally, rate cuts and a weaker dollar should provide some demand support as well. Bakken production outperformance seems unlikely to occur again in 2024, with rigs counts in the basin down 25%.

OPEC+ has largely supported the market in recent years, with production cuts keeping 2 MMbpd off the market, but downside risk would come from greater disagreement on cuts while production in the Americas continues to grow. The most recent production cut agreement was delayed as a few countries were unhappy with their outcomes, though this was primarily related to Angola鈥檚 target being taken down by 350 Mbpd and not impactful for the market because Angola has been producing ~350 Mbpd below its former target for the last three years.

Another smaller source of price support comes from the Biden administration, which has slowly followed through on plans to begin re-filling the SPR when WTI prices reach the low $70s. The US intends to hold monthly tenders for SPR purchases monthly through at least May, so far only repurchasing 9 MMbbls at an average price of $75. This compares to the 180 MMbbls it sold to ease prices in 2022. Tenders are outstanding to purchase 3 MMbbls in each February and March.

We have seen a number of references to 鈥渟urprise鈥� growth from shale tipping the markets into oversupply, but these seem to focus on the EIA鈥檚 unrealistically low exit rate projection for 2023 that it published in late 2022. At that time the EIA projected only 200 Mbpd of US production growth, with a 2023 exit rate of 12.6 MMbpd, compared to Enverus鈥� projection of 13.1 MMbpd and sell-side estimates ranging from 12.9-13.1 MMbpd.