NEW YORK--(BUSINESS WIRE)--The U.S. shale revolution has shifted the importance of achieving scale versus diversification for smaller high yield entities in North America, according to Fitch Ratings.
Achieving scale within a play and diversification across plays have always been important rating factors for enhancing the credit quality of smaller high yield E&Ps. However, the dynamics of shale plays have shifted in favor of scale over diversification as efficiency gains are possible in shale plays as an operator achieves scale when efficiency gains become possible.
An onshore E&P company's ability to realize efficiency gains has become increasing correlated with growth in cash flow per barrel. These gains are mainly accomplished by establishing a sizable position in a basin and achieving well completion and other cost and drilling efficiencies that can lead to enhanced growth prospects and better unit economics. Scale can also lower costs by improving negotiating leverage with service companies. Basin-focused entities tend to achieve competitive cash netbacks and full-cycle realizations despite production mix due to their ability to wring out efficiencies.
As a result, Fitch would tend to view a small high yield operator with a basin and efficiency focus more favorably than a similarly sized company spread across multiple basins with limited opportunity to improve its position on the efficiency curve. This is generally consistent with the equity market outperformance of "pure play" E&P companies relative to peers with weaker basin positions and undifferentiated opportunities.
However, basin focus does have credit quality limitations in certain situations. Fitch considers size, scale, and diversification in E&P credit ratings and places increasing importance on these factors as companies move up the ratings scale. While basin focus and efficiencies generally improve credit quality at the high yield level, they are typically not sufficient to achieve investment-grade ratings.
Additional information is available on www.fitchratings.com.
The above article originally appeared as a post on the Fitch Wire credit market commentary page. The original article, which may include hyperlinks to companies and current ratings, can be accessed at www.fitchratings.com. All opinions expressed are those of Fitch Ratings.