Fitch Downgrades Pacific Exploration and Production to 'B-'; Places Ratings on Watch Negative

CHICAGO--()--Fitch Ratings has downgraded Pacific Exploration and Production Corp. (Pacific) foreign and local long-term Issuer Default Ratings (IDRs) to 'B-' from 'B+'. Fitch has also downgraded to 'B-/RR4' from 'B+/RR4' its long-term rating on Pacific's outstanding senior unsecured debt issuances totalling approximately USD4 billion with final maturities in 2019 through and 2025. These ratings have been placed on Rating Watch Negative.

KEY RATING DRIVERS

The downgrade reflects Fitch's expectations that the company's capital structure will continue weakening over the near term as a result of the agency's slower oil price recovery expectations published on Nov. 9, 2015. Fitch expects Pacific's leverage as measure by total debt to EBITDA to be near 6 times (x) in 2016 if West Texas Intermediate (WTI) oil price averages $50 per barrel over that period. This would result in Pacific triggering its 4.5x gross leverage maintenance covenants on approximately $1.3 billion of bank facilities maturing in 2017. Further, leverage could remain elevated passed 2016 and the company may have difficulties servicing its debt maturities, which start in 2017 and average approximately $1 billion every two years between 2017 and 2025.

Pacific credit metrics have been materially affected by the sharp decline in oil prices, as well as the company's debt increase during 2015. Total and net debt/EBITDA for the latest 12 months (LTM) ended September 2015 have increased to 4.3x and 3.9x, from 1.9x and 1.8x, as of year-end 2014. This was mostly due to due to the decline in global oil prices as well as Pacific's debt increase of more than USD600 million during first-half 2015. Positively, Pacific reported zero short-term debt as of September 2015.

Pacific expects to use its internal cash flow generation to finance capital expenditures and its liquidity position could improve upon successful divestitures of none core assets. These divestitures include its interest in midstream assets and other infrastructure assets, which the company could sell to improve liquidity without affecting its operations. Fitch does not expect these sales to generate enough cash to service the company's debt amortization in 2017. Furthermore, the marked reduction in capital expenditure, while positively reducing the company's short term cash burn, could have an impact on the company's long-term production and reserve replacement.

The Negative Rating Watch reflects the delay in the sale of none-core assets to bolster liquidity and the potential long-term negative effects the reduction in capex may have on the company's ability to replace production. Pacific's ratings could be downgraded if the company fails to divest interests in non-core assets to maintain adequate liquidity in a timely fashion. The decrease in production in light of Fitch's revised price deck could be more severe than initially anticipated given the capex reduction Pacific is implementing to preserve liquidity. Fitch expects Pacific's 2015 capex to be between $800 million to $1 billion, down from a historical average of approximately of approximately $2 billion per year.

Fitch's base case assumes that Pacific's production declines in 2016 and 2017 as a result of capex reduction and the expiration of the Pirir-Rubiales field, which today accounts for approximately 35% of Pacific's total production. This field reverts back to Ecopetrol in June of 2016. At a $50/bbl average price in 2016, Fitch expects Pacific's EBITDA would be slightly below USD900 million, interest expense approximately USD300 million and total debt of approximately USD5.2 billion.

Pacific has already hedged approximately 7.6 million barrels, or approximately 15% of its expected 2016 production at an average strike price floor and ceiling of $54 and $62 per barrel, respectively, and expects to hedge the maximum amount of its 2016 production as possible. The company's current hedge position of 15% is low when compared to that of similar small independent U.S. exploration and production companies, which on average had hedged more than 40% of their 2016 expected production since June 2015. This leaves Pacific with a higher exposure to the potential continuity of low global oil prices next year.

KEY ASSUMPTIONS

--Fitch's price deck for WTI oil prices of $50/bbl for 2015 and 2016, recovering to $60/bbl in 2017;

--Piriri-Rubiales field reverts to Ecopetrol in 2016;

--Production declines on a year-over-year basis in 2016 and 2017;

--Company manages to negotiate covenants with banks to avoid acceleration;

--Pacific manages to divest non-core assets between 2016 and 2017 and uses a portion of the proceeds to reduce debt.

RATING SENSITIVITIES

A negative rating action would be triggered by any combination of the following events:

--A continuous deterioration of the company's capital structure and liquidity as a result of either a decrease in production as a result of capex curtailment or persistent low oil prices;

--Failure to divest interests in non-core assets in a timely fashion to bolster liquidity;

--A significant reduction in the reserve replacement ratio could affect Pacific's credit quality given the current proved reserve life of approximately 9 years when excluding Pirir-Rubiales production.

A positive rating action is unlikely in the medium term.

LIQUIDITY

Adequate Liquidity Position: The company's liquidity position as of Sep. 30, 2015 is adequate, with Pacific reporting $489 million of cash on hand an zero short-term debt. The company's debt amortization schedule is spread between 2017 and 2025 with an average of $1 billion coming due every two years. Pacific's liquidity could remain relatively stable provided the company succeeds at running a balanced FCF over the next two years which would potentially stabilize the credit; break even FCF is possible with Fitch's new price deck if the majority of the company's capex is considered discretionary and is cut without further erosion of production. Liquidity could improve if the company succeeds at selling some none-core assets.

Fitch has downgraded and placed the following ratings on Rating Watch Negative:

Pacific Exploration and Production Corp.

--Foreign and local currency IDRs to 'B-' from 'B+';

--International senior unsecured bond ratings to 'B-/RR4' from 'B+/RR4'.

Date of Relevant Rating Committee: Nov. 12, 2015.

Additional information is available on www.fitchratings.com.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=993930

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=993930

Endorsement Policy

https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Contacts

Fitch Ratings
Primary Analyst
Lucas Aristizabal
Senior Director
+1-312-368-3260
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Xavier Olave
Associate Director
+1-212-612-7895
or
Committee Chairperson
Daniel R. Kastholm, CFA
Managing Director
+1-312-368-2070
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com

Contacts

Fitch Ratings
Primary Analyst
Lucas Aristizabal
Senior Director
+1-312-368-3260
Fitch Ratings, Inc.
70 W. Madison Street
Chicago, IL 60602
or
Secondary Analyst
Xavier Olave
Associate Director
+1-212-612-7895
or
Committee Chairperson
Daniel R. Kastholm, CFA
Managing Director
+1-312-368-2070
or
Media Relations:
Alyssa Castelli, +1 212-908-0540
alyssa.castelli@fitchratings.com