NEW YORK--(BUSINESS WIRE)--Liquidity positioning is a key credit indicator in 2015 with high-yield North American (N.A.) exploration and production (E&P) companies facing a trade-off between near-term liquidity and long-term reinvestment, according to Fitch Ratings. However, as the market begins to signal a price recovery, unit economics will begin to drive credit quality.
High-yield E&P companies face a trade-off between liquidity and long-term reinvestment. Fitch Ratings evaluated the liquidity prospects for a sample of 10 high-yield N.A. E&P companies in a sustained $50/barrel (bbl) oil and $3/thousand cubic feet (mcf) gas environment. Fitch found significant variance in the liquidity outlooks of companies in our sample. Key differentiators included hedge positions, existing liquidity, including cash, and changes to capex guidance.
Capex cuts are probably the most direct way to increase liquidity in 2015. However, Fitch believes the credit effects of announced E&P capex adjustments vary by company. Based on historical replacement costs, high-yield E&P companies generally appear to be investing below replacement levels in 2015 to conserve liquidity, foregoing growth in reserves and production. These companies will likely need to realize significant cost/efficiency improvements to maintain their asset base at current capex guidance. Investing at less than full replacement can be a double edged sword - while it conserves current liquidity, it also has the potential to weaken future liquidity by negatively impacting a company's reserves and borrowing base.
The median company in Fitch's high-yield sample has a forward full-cycle oil price of $86/bbl, which is 30% higher than the Fitch-calculated median oil price of $66/bbl for a broader set of N.A. E&P companies. This is primarily driven by significantly higher interest costs on a barrel of oil equivalent (boe) basis. In our high-yield sample, full-cycle oil costs ranged from $62/bbl to $95/bbl, implying that none of the companies can recover full-cycle costs at $50/bbl, or at the current forward oil curve (about $55/bbl average West Texas Intermediate for 2015-2016). However, Fitch estimates all of the companies in the high-yield sample will cover their half-cycle costs at $50/bbl, allowing them to generate sufficient cash flows to meet operating costs and debt service requirements over the near term.
As prices recover, however, unit economics will begin to drive credit quality. The Fitch-calculated full-cycle costs provide a longer term view of the companies' relative ability to invest through the cycle and their economic inflection points. Notably, none of the high-yield N.A. E&P companies in Fitch's sample could meet their full-cycle costs ($62-$95/bbl) at the current forward oil curve. Fitch believes that, in an extended downcycle, capital costs and full-cycle economics will take an increasingly important role in determining E&P company credit quality and their positioning heading into a price recovery.
The full report, "High-Yield E&P Stress Test (Examining Exposure to the Downturn)", is available at www.fitchratings.com.
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.
Applicable Criteria and Related Research: High-Yield E&P Stress Test (Examining Exposure to the Downturn)