CHICAGO--(BUSINESS WIRE)--Fitch Ratings has affirmed Devon Energy Corp.'s (Devon; NYSE: DVN) long-term Issuer Default Rating (IDR) at 'BBB+'. The Rating Outlook has been revised to Negative from Stable.
The Negative Outlook reflects the downward revision of Fitch's oil & gas price assumptions on Feb. 24th and its impact on Devon's forecasted credit metrics, asset sale and gross debt reduction execution risk, and operational momentum loss concerns.
The Rating Outlook would most likely be revised to Stable if the company executes planned non-core asset sales and targeted E&P debt reduction, as well as establishes a credit-conscious plan to address projected 2016 core production declines. Fitch views Devon's proactive management of its capital structure positively and recognizes that, if executed, Devon's gross debt reduction plan would generally exceed measures taken by U.S. independent exploration and production (E&P) peers to address their respective long-term capital structures.
Approximately $10 billion of standalone debt is affected by today's rating action, excluding approximately $3.1 billion of EnLink Midstream Partners, L.P. (NYSE: ENLK; rated 'BBB-' with a Stable Outlook) debt. The EnLink debt is consolidated on Devon's balance sheet for accounting purposes, but remains non-recourse to the company. A full list of rating actions follows at the end of this press release.
KEY RATING DRIVERS
Devon's ratings reflect its strong plan to defend its credit rating, large North American onshore reserve and production base, increasing exposure to liquids, favourable liquidity and maturity profile, and conservative financial policy. Offsetting factors include the forecasted negative free cash flow (FCF) and elevated leverage metrics profile in 2016, execution risk associated with its non-core asset divestiture and gross debt reduction plan, and production profile declines associated with asset sales and lower activity levels. Fitch recognizes, however, that Devon reported favorable 2015 E&P cost improvements and production efficiency gains that, along with the maintenance of development activity in its core STACK and Delaware Basins, help to alleviate some operational momentum loss and cost concerns.
Fitch considers the steps taken by the company to date, including operating and capital cost reductions and a 75% dividend cut, to be generally consistent with or exceed its U.S. independent E&P peers. Another consideration is the financial flexibility provided by Devon's EnLink affiliates.
The company reported year-end 2015 net proved reserves (1p) of nearly 2.2 billion barrels of oil equivalent (boe; 87% related to core reserves), which is down nearly 21% year-over-year mainly due to price revisions. Production increased by roughly 1% year-over-year to 680 mboepd (core production totalled 560 mboepd and increased 15% year-over-year), but liquids mix rose considerably to 60% (61% core) in 2015 from 52% (54% core) in 2015 mainly due to liquids-directed U.S. onshore development and the continued ramp-up of Jackfish. This resulted in a year-end reserve life of nearly nine years. Materially lower oil prices have pushed unhedged cash netbacks sharply lower to approximately $5.84/boe in 2015 from $20.68/boe in 2014. Notably, the company's solid 2015 hedge position provided about $9.75/boe of netback uplift resulting in a hedged cash netback of $15.59/boe.
Year-end 2015 metrics demonstrate the effects of lower price realizations with consolidated debt/latest 12 months (LTM) EBITDA increasing to approximately 2.5x from 1.6x at year-end 2014. Fitch calculates standalone Devon debt/proved (1p) reserves, debt/proved developed (PD) reserves, and debt/flowing barrel metrics were about $4.60/boe, $5.55/boe, and $14,755, respectively, as of Dec. 31, 2015.
METRICS WIDEN DUE TO PRICES: DEBT PLAN PROVIDES COUNTERBALANCE
The Fitch base case, assuming a West Texas Intermediate (WTI) and Henry Hub prices of $35/barrel and $2.25/mcf, respectively, results in 2016 debt/EBITDA of 7.7x before any potential E&P gross debt reductions, excluding EnLink distributions to non-controlling interests and associated non-recourse debt. Standalone debt/1p reserves, debt/PD reserves, and debt/flowing barrel metrics, excluding the impact of non-core U.S. upstream asset sales, are forecast to widen to approximately $4.95/boe, $6.20/boe, and $16,255, respectively.
The company is in the process of selling approximately $2 billion in non-core U.S. upstream assets and recently raised nearly $1.5 billion in equity proceeds with at least a portion of funds anticipated to be used for debt repayment. Assuming all proceeds are used to reduce E&P debt to roughly $6.5 billion, Fitch's base case 2016 debt/EBITDA would drop to 5.0x. Standalone debt/1p reserves, debt/PD reserves, and debt/flowing barrel metrics, excluding the impact of non-core U.S. upstream asset sales, would also experience improvements to approximately $3.20/boe, $4.05/boe, and $10,600, respectively.
The Fitch base case forecasts credit metrics will improve considerably in 2017 and 2018, respectively. Cash flow-based metrics tend to be generally consistent with at least a 'BBB' rating by 2018 under various debt reduction scenarios.
Devon had gas swaps representing less than 5% of 2016 natural gas production guidance, as of Feb. 16, 2016. The company also had Western Canadian Select basis swaps for less than 5% of 2016 core Canadian oil production.
Fitch's key assumptions within the rating case for Devon include:
--WTI oil price that trends up from $35/barrel in 2016 to a long-term price of $65/barrel;
--Henry Hub gas that trends up from $2.25/mcf in 2016 to a long-term price of $3.25/mcf;
--Oil & gas production of 619 mboepd in 2016, consistent with guidance, followed by an asset sale- and activity-linked production decline in 2017 and an increasing production profile thereafter;
--Oil mix increases to 42% in 2016 from 40% in 2015 with ongoing growth thereafter mainly due to a combination of lower natural-gas focused activity (e.g., Barnett) and ongoing development of core U.S. onshore positions;
--E&P capital spending forecast around $1 billion in 2016, generally consistent with guidance, followed by a measured capital program providing for some price-induced increases in drilling activity;
--EnLink capital spending between $550 million-$600 million and some distribution improvements assumed throughout the forecast;
--Non-core asset sales at the upper end of management's $2 to $3 billion targeted range in 2016 with upstream proceeds assumed to be allocated to gross debt reduction.
Positive: No upgrades are currently contemplated given the weak oil & gas price outlook and Devon's changing production profile. Future developments that may, individually or collectively, lead to a positive rating action include:
For an upgrade to 'A-':
--Material increase in size, scale, and diversification of Devon's operations with some combination of the following metrics;
--Mid-cycle debt/EBITDA, excluding EnLink distributions to noncontrolling interests and associated non-recourse debt, under 1.0x - 1.25x on a sustained basis;
--Mid-cycle debt/flowing barrel below $12,000 and/or debt/PD under $4.50/boe, excluding EnLink non-recourse debt, on a sustained basis.
To remove the Negative Outlook at 'BBB+':
--Execution of planned non-core asset sales and targeted gross debt reduction of at least $2 billion-$2.5 billion;
--Establishment of a credit-conscious plan to address production declines and loss of operational momentum;
--Mid-cycle debt/EBITDA, excluding EnLink distributions to noncontrolling interests and associated non-recourse debt, under 2.0x on a sustained basis;
--Mid-cycle debt/flowing barrel below $15,000 and/or debt/PD under $5.00/boe, excluding EnLink non-recourse debt, on a sustained basis.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
--Failure to execute planned non-core asset sales and targeted gross debt reduction materially below $2 billion;
--Unclear plan to address production declines and loss of operational momentum;
--Mid-cycle debt/EBITDA, excluding EnLink distributions to noncontrolling interests and associated non-recourse debt, of 2.0x-2.5x on a sustained basis;
--Mid-cycle debt/flowing barrel above $15,000-$17,500 and/or debt/PD over $5.00 - $5.50/boe, excluding EnLink non-recourse debt, on a sustained basis;
--Acceleration of capital spending and drilling activity ahead of securing a favorable portfolio of hedges and/or supportive market pricing outlook that reduces financial flexibility.
ADEQUATE LIQUIDITY POSITION; ENLINK PROVIDES ADDED FLEXIBILITY
Pro forma cash-on-hand is estimated to be $2.9 billion, including the approximately $1.5 billion in equity proceeds and $850 million STACK acquisition payment, as of Dec. 31, 2015. Additional liquidity is provided by the company's $3 billion syndicated, senior unsecured credit facility (approximately $2.4 billion of availability of Dec. 31, 2015) principally due October 2019. The company also maintains a commercial paper program sized to the credit facility.
Fitch recognizes that EnLink provides considerable financial flexibility and liquidity potential as demonstrated in the recent Felix Energy-related Tall Oak midstream acquisition. Midstream MLPs tend to be more resilient than E&P in oil & gas price down cycles, particularly when their contract mix is weighted towards long-term, fee-based contracts. However, the prospects for a persistently low hydrocarbon price environment has generally softened midstream equity market prices over the past year, which may reduce the attractiveness of EnLink funding. About 80% of EnLink cash flows are fee-based with Devon contracts representing a significant portion.
MANAGEABLE MATURITIES PROFILE AND LEVERAGE COVENANT
The company has a manageable maturities profile with $350 million, $875 million, and $700 million due in 2016, 2018, and 2019, respectively. These maturities represent the company's floating rate notes due December 2016, 8.25% senior notes due July 2018, 2.25% senior notes due December 2018, and 6.30% senior notes due January 2019.
The main financial covenant, as defined under the credit agreement, is a maximum debt-to-capital ratio of 65% (23.7% as of Dec. 31, 2015). Fitch notes that total capitalization is adjusted to add back noncash financial write-downs, which helps moderate the potential covenant-related effects of the downcycle. Other customary covenants consist of additional lien limitations, transaction restrictions, and change in control provisions.
Devon's defined benefit pension plan was underfunded by about $249 million at year-end 2015. Fitch believes that the expected size of service costs and contributions is manageable relative to mid-cycle fund flows from operations. Other contingent obligations total approximately $10.7 billion on a multi-year, undiscounted basis mainly comprised of condensate purchase obligations ($3.9 billion, subject to market prices), operational transport and processing agreements ($4.6 billion), asset retirement obligations ($1.4 billion), drilling and facility obligations ($189 million), and lease obligations ($443 million).
Purchase obligations are primarily related to contractual commitments to purchase condensate to blend with its Canadian heavy oil production and facilitate transportation. Fitch believes the contracts help to mitigate volumetric procurement and heavy oil transportation risks while limiting contractual price risk via contractual market price provisions. Operational agreements represent midstream fixed-fee arrangements with about 37% related to minimum volume commitments between Devon and EnLink.
FULL LIST OF RATING ACTIONS
Fitch has affirmed the following ratings:
Devon Energy Corporation
--Long-term IDR at 'BBB+';
--Senior unsecured notes at 'BBB+';
--Senior unsecured credit facility at 'BBB+';
--Short-term IDR at 'F2';
--Commercial paper at 'F2'.
Devon Financing Corporation U.L.C.
--Senior unsecured notes at 'BBB+'.
Ocean Energy, Inc.
--Long-term IDR at 'BBB';
--Senior unsecured notes at 'BBB'.
The Rating Outlook is revised to Negative from Stable.
Additional information is available on www.fitchratings.com.
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
Short-Term Ratings Criteria for Non-Financial Corporates (pub. 13 Aug 2015)
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