Key takeaways
- Domestic trends drive U.S. market moves: Over the past week, U.S. markets looked through geopolitics and went back to the usual domestic drivers, including AI optimism, Federal Reserve expectations, and the May jobs report released Friday.
- The longer story behind energy credit: Energy credit outperformance is not primarily tied to the spike in oil prices; it reflects a more credit-friendly sector structure.
- Oil price regimes underpin energy sector sensitivity: When oil prices are above breakeven (that is, the minimum price to balance the total cost of production), then the oil price itself matters less for energy sector performance; below breakeven, energy credit becomes much more sensitive to changes in oil prices.
Last week, despite seeing little tangible progress toward resolving the Iran conflict, U.S. markets quickly reverted to their familiar domestic anchors: AI capex optimism and the Federal Reserve outlook.
It was, on balance, a strong week for risk markets, helped by renewed enthusiasm around AI spending and IPO demand, until Friday’s post-payroll sell-off reminded investors that, in this market, good news can still be bad news. A stronger labor report prompted markets to reprice toward a more hawkish Fed hiking interest rates as early as this year.
This capped a week in which geopolitical tension mattered less than the usual mix of domestic micro and macro forces, particularly given already rich valuations in risk assets. The macro risks have not changed much: either a growth slowdown driven by a lingering energy supply shock, or an overheating economy that pushes inflation higher and puts upward pressure on both yields and risk assets.
Within credit markets, one sector that’s shown ongoing strength amid macro turbulence is energy.
Energy outperformance: More about credit discipline than higher oil prices
Figure 1: Energy sector spread outperformance started before the Iran conflict
Higher prices have helped sustain spread tightening, especially in the USD HY Index. But the bigger driver, in our view, has been the sector’s shift toward a more disciplined, credit-friendly posture from a capital management standpoint, a trend that will likely persist. That shows up in three ways.
First, unlike in past periods of rising oil prices, U.S. oil rig counts have remained relatively inelastic. Figure 2 shows that since the post-COVID recovery and the 2022 energy price spike, the number of operating U.S. oil rigs has been broadly stable despite large swings in oil prices. That is a sharp contrast with the pre-2020 period, when the relationship was much tighter, and even more so relative to the pre-2015 “wildcatting” phase of the shale revolution. Some of this reflects better operational efficiency, but absent a prolonged period of elevated prices, near-term growth in rig counts still looks unlikely.
Figure 2: U.S. rig counts have become more inelastic to moves in oil prices
Figure 3: Over the past decade there has been consolidation within the E&P component of the energy sector
Figure 4: The high yield energy sector now has lower net leverage than the overall index, even before the EBITDA tailwind from current energy prices
Energy credit’s oil beta is regime-dependent
A second way to show that credit-friendly capital management, rather than just higher oil prices, has driven outperformance in energy credit is to compare relative sector performance across different oil price regimes.
We use $50/barrel on the 12-month West Texas Intermediate (WTI) crude oil contract as an approximate breakeven threshold for oil production. Figure 5 shows the monthly excess returns from being long HY energy versus the USD HY Index above and below that threshold. Figures 6 and 7 repeat the same exercise for emerging market (EM) corporates and EM sovereigns, using changes in spread differentials rather than excess returns.
Figure 5: Oil prices matter for HY energy performance, but only when they are below the breakeven price
Figure 6: The relationship between energy sector performance vs. the index in high and low oil price regimes also holds for EM corporates
Figure 7: The relationship doesn’t hold for EM sovereigns, whose need to maintain access to U.S. dollar funding through cycles is important
The takeaway for both HY and EM corporates is straightforward. Once oil prices are above breakeven, further moves in oil tend to matter less for credit performance.
In options terms, the put option embedded in energy firms’ credit is then deep out of the money, so its delta is low and changes in oil prices have a smaller effect on spreads. Below breakeven, the opposite is true: The energy sector becomes much more sensitive to oil prices, and relative performance beta rises materially.
Interestingly, Figure 7 shows that this relationship does not hold for oil-exporting EM sovereigns. Two factors help explain why. First, unlike corporates, sovereigns typically hold substantial U.S. dollar reserves that help service external debt and reduce the risk of spread stress when oil prices fall. Second, EM sovereigns’ effective fiscal breakeven is often lower than that of EM corporates: They can continue to collect export revenues without the same immediate weakening in their cash flows or balance sheets. That makes sovereign spreads less mechanically tied to oil prices, especially over shorter horizons.
