Authors

Last week, US oil major Chevron announced plans to buy its smaller peer Anadarko.

The high-yield energy sector underperformed in the final quarter of last year as oil prices sold off. Amid this volatility, how can credit investors find stable outperformers?

Almost two years ago, we argued that the market for European hybrids – instruments that blend features of debt and equity – was attractive for both issuers and investors. Today, we revisit the case for hybrids and ask: in the growing global hybrid market, where is the relative value?Hybrids have developed a track record with both issuers and investors in recent years: investors are attracted by the yield pick-up they offer, while they are a relatively cost-effective funding instrument for issuers.

Engagement is an integral part of the investment approach adopted by Hermes Credit. By engaging with issuers, we can encourage them to adopt better environmental, social and governance (ESG) practices, and thereby, deliver a better financial return and a public good. Here we explain how we addressed our ESG concerns by engaging with oil producer Pemex.

As energy companies focus more on balance-sheet strength and less on maximising growth, the sector is likely to become more attractive to credit investors. Back when commodity prices were peaking, production volumes were arguably the key drivers of Exploration & Production (E&P) companies’ equity valuations. The underlying logic was simple: the faster the company grew production, the more barrels of oil it could sell at high prices. Expansion strategies were justified by high internal rates of return, exceeding those of returning capital to shareholders.

Undoubtedly, oil poses more than a few headaches for ESG investors. Besides the obvious high carbon content of petroleum products, the industry as a whole has accrued a reputation as risky across a range of ESG measures. These include: environmental preservation, workers’ health and safety, executive pay and, as demonstrated by the Petrobras scandal, political corruption. Yet in spite of – or perhaps because of – its blatant shortcomings, the oil industry attracts long-term investors who are prepared to engage on ESG matters. Despite rising sales of electric cars and the risk of fossil-fuel deposits becoming stranded assets, the oil industry is not disappearing any time soon. According to OPEC, global oil demand should increase until at least 2040. (see figure 1). That said, even if OPEC’s own growth expectations of 109m barrels of daily intake by 2040 prove to be overly optimistic, engagement on ESG factors – including climate change scenarios - will remain as important as ever.