Scale matters: navigating EM oil credit in volatile markets

As we all know, the ongoing conflict in the Middle East has significantly disrupted the global oil supply – and this has been reflected in pricing. 

A barrel of Brent crude rose from around US$70 prior to the conflict, to a brief 52-week high of $126 in late April and is at $109 as of May 15. Given this level of volatility, it’s not a surprise that investors are asking the question: what happens from here?

For investors in emerging market (EM) debt, one of the key concerns is how the conflict is affecting the operational competitiveness of corporate issuers and oil producers in particular. Our view is that understanding the vastly differing characteristics of EM oil industry participants is one way of identifying potential opportunities in this space. 

For a true sense of the stresses in the oil markets, we have preferred to focus on the dated Brent prices (for immediate delivery), as opposed to the futures price, even if the ranges for both have been similar recently. 

This is because fluctuating prices create opportunities and challenges for the global oil industry. Specifically, oil credits are highly exposed to changes in the price of Brent, resulting in periods of induced commodity price volatility. Such a characteristic, however, results in different market treatments between small-to-medium-scale oil exploration and production companies and larger operators within the sector.

Scale matters

In periods of high oil price environments, for example, small-to-medium producers typically can offer credit investors with an opportunity to acquire attractive yield while also providing the ability to capture positive real rates of return. Due to their smaller scale, these oil producers typically have lower operating profit per barrel (netbacks) and breakevens, therefore, leading to greater downside risks in times of weaker oil prices. 

Debt from such smaller operators such as these typically trades at a considerable discount to that of major oil companies. In the haste of falling oil prices, many times the market will treat debt from smaller issuers as largely equal vis-à-vis one another and so unfairly disregard the differences in quality and creditworthiness. As a result, this provides an attractive investable window once oil stabilizes and the market disruptions clear.

The contrast here is with major oil producers which benefit from their large-scale and vertically integrated operations. With their greater production volumes, dilution of costs, reduced breakevens and strong access to capital markets, these companies typically enjoy higher credit ratings.

Debt from these issuers will generally trade at much lower yields with fewer of the violent swings in sentiment their smaller peers experience. Specifically, the major oil producers are well placed to survive instances of deep economic dislocation.

The EMD universe is a broad one with winners and losers from spiking high oil prices. Frontier Sub Saharan African producers such as Angola, Nigeria and Gabon stand to gain the most from the current dislocations, with conservative $60 oil price assumptions in their respective 2026 budgets. In Central/South America, Brazil has steadily become the dominant regional energy producer/exporter. Meanwhile, oil importers such as Turkey will have to grapple with wider current account deficits and higher inflation which may lead to tighter monetary policy. Increasingly we believe many EM countries may now have to raise interest rates to combat inflation from both higher food and energy prices.