CHICAGO--(BUSINESS WIRE)--Fitch Ratings has downgraded Energy XXI's ratings as follows:
Energy XXI Gulf Coast Inc.
--Long-term Issuer Default Rating (IDR) to 'CCC' from 'B';
--Senior secured first lien revolver to 'B/RR1' from 'BB/RR1';
--Senior secured second lien notes to 'B/RR1' from 'BB/RR1';
--Senior unsecured notes to 'CCC-/RR5' from 'B-/RR5'.
Energy XXI LTD
--Long-term IDR to 'CCC' from 'B-';
--Convertible notes to 'CC/RR6' from 'CCC/RR6';
--Convertible perpetual preferred to 'CC/RR6' from 'CCC/RR6'.
KEY RATING DRIVERS
Key drivers for the downgrade are: in Fitch's view, inadequate hedge coverage for calendar 2016; higher interest costs per unit which have increased estimated EXXI cash breakevens; weaker cash flow forecasts and credit metrics following changes to Fitch's oil & natural gas price decks; and heightened refinancing risk for near term maturities, including the company's $750 million 9.25% 2017 notes.
DECREASED FORWARD HEDGE COVER
A key factor in Fitch's previous rating commentary was that maintenance of the rating was contingent on the company's ability to lock in 2016 production at economic prices. This has not materialized to date, and weakness in the forward curve could continue to limit the opportunity for the company to hedge at meaningful levels in the near term.
After monetizing in-the-money hedges for approximately $102 million in proceeds over the nine months ending March 31, 2015, EXXI currently has 14 mbbl/d of calendar 2016 oil production volumes hedged (approximately 18% of oil volumes assuming flat production), with downside protection via WTI puts at $51.43/bbl. As of June 30, 2014, EXXI had approximately 65% of next 12 months oil production economically hedged, provided a higher degree of certainty around near term cash flow. The current hedge book generates very little cash flow protection at Fitch's base case price deck and highlights the potential for increased volatility in cash flow measures in the near term.
Fitch estimates total fiscal year (FY) 2016 hedge contribution of $30 million, or approximately 6% of FYE16 EBITDA including hedges. This is primarily due to the contribution from approximately 6.5 mbbl/d of collars with floors at $75/bbl and $80/bbl for WTI and LLS, respectively, in the balance of calendar 2015 (EXXI fiscal year end is June 30).
HIGHER UNIT COSTS FOLLOWING SECOND LIEN ISSUANCE
At Fitch's base case oil price EXXI is set up for significantly lower cash netbacks per barrel driven by lower revenues and higher interest costs per unit of production. Based on updated projections, Fitch estimates that the full-cycle cash breakeven for EXXI has increased to approximately $75/bbl, from $65/bbl in December 2014, driven largely by the higher interest costs from the second-lien financing in March 2015. Increases in interest costs are modestly offset by expected decreases in service costs. Taken together, these estimates decrease our degree of confidence in the ability of the company to economically produce its reserve base in the near term.
EXXI Gulf Coast's issuance of $1.45 billion of 11% second-lien notes will add approximately $160 million per year in interest payments. Assuming production is roughly flat at 59 thousand barrels of oil equivalent (mboe) per day in FY2016 (last nine months average is 58.8 mboe per day), this leads to interest costs of $18.4/boe, up substantially from $8.5/boe as of FY14.
NEAR TERM LIQUIDITY ADEQUATE
EXXI executed several liquidity-enhancing transactions in the first half of 2015. In June, EXXI entered into an agreement to sell its Grand Isle offshore oil gathering system to CorEnergy Infrastructure Trust for $245 million. On July 1, the company announced the sale of its East Bay field for $21 million to a private buyer. As previously stated, in March, the company sold $1.45 billion of second lien notes at an 11% coupon. Pro forma for these transactions, total liquidity is estimated at between $900 million and $1 billion, including $125 million available on the first-lien revolving credit facility.
While Fitch believes near term liquidity will be adequate, particularly in a lower capex environment, recent changes to our price deck, an elevated leverage forecast, and higher interest burden from the second-lien notes (72% of expected base case 2016FY EBITDA) have introduced longer term concerns about the viability of the capital structure.
UPDATED RECOVERY ANALYSIS
EXXI Gulf Coast recoveries are estimated as outstanding ('RR1'--100%) at the first and second-lien secured level but below average ('RR5'--13%) at the unsecured level. Recoveries at the senior unsecured level have declined since the last review, driven partially by the upsized issuance of $1.45 billion second-lien secured debt given their priority status over the unsecured notes. The current 13% estimated recovery contrasts to a 25% estimated recovery for unsecured creditors cited in the last review. EXXI LTD debt and preferred stock is structurally subordinated to the assets at EXXI Gulf Coast, and receives no recovery value in our analysis ('RR6' --0%).
Lower recovery estimates are also influenced by reduced value estimates for oil and gas reserves. Recovery values are based on estimated liquidation values of proved (1P) reserves. Fitch begins with a standard value of $12.50/boe for an average producer based on our long term price deck ($70/bbl oil, $3.75/mcf natural gas). Fitch makes adjustments for location and quality, oil & gas mix, as well as adjustments related to the recent decline in commodity prices.
REVISED FINANCIAL COVENANTS
Under EXXI's amended first-lien credit agreement, EXXI Gulf Coast is required to maintain first-lien net leverage of below 1.25x and a maximum secured net leverage ratio of no more than 3.75x. Fitch does not expect these financial covenants to restrict the company's financial flexibility in the near term, given base case EBITDA projections and the company's significant cash balances following asset sales and second-lien financing.
However, the amended agreement includes a clause whereby first-lien debt accelerates to a date 210 days prior to the maturity of EXXI Gulf Coast's $750 million in notes due December 2017. Further capital market access and refinancing opportunities for EXXI could be limited and on more punitive terms.
Fitch's key assumptions within our rating case for the issuer include:
--WTI oil prices of $50/bbl in 2015, $60/bbl in 2016, increasing to $70/bbl in 2018;
--Lower service costs in FY16 driven by contract renegotiations and other cost savings;
--No additional hedge positions beyond the values reported on June 10, 2015.
Negative: Future developments that may lead to negative rating actions include:
--An inability to successfully refinance senior notes due 2017;
--A material decline in production that compounds the revenue effects of lower oil and gas prices;
--Failure to maintain liquidity of $200 million during the current downcycle;
--Continued weak forward oil prices, leading to an inability to meaningfully hedge 2016 oil volumes.
Positive: Future developments that may lead to positive rating actions include:
--Improvements in full-cycle cost structure through lower lease operating expenses, FD&A, or other cost reductions;
--Positive free cash flow generation and subsequent debt reduction;
--Meaningful amounts of hedging leading to greater visibility on near term cash flow.
Additional information is available on www.fitchratings.com
Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 28 May 2014)
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