CHICAGO–(BUSINESS WIRE)–Fitch Ratings has affirmed Devon Energy Corporation’s (Devon; NYSE: DVN) Long-term Issuer Default Rating (IDR) at ‘BBB+’. The Rating Outlook is Stable.
Approximately $9.2 billion of standalone debt is affected by today’s rating action, excluding approximately $2.8 billion of EnLink Midstream, LLC (NYSE: ENLC; general partner) and Enlink Midstream Partners, LP (NYSE: ENLK; limited partner) 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 large North American onshore reserve and production base, increasing exposure to liquids, and conservative financial policy. Offsetting factors include the potential for a lower-for-longer oil price scenario, execution risk associated with the development of its U.S. onshore reserve base, and possibility that management accelerates drilling activity ahead of supportive pricing signals. Fitch recognizes, however, that Devon reported favorable first half 2015 exploration and production (E&P) cost improvements, production efficiency gains, and capex reductions that help alleviate Fitch’s near-term operating and cost concerns. Another consideration is the financial flexibility provided by drop downs to and unit sales of Devon’s EnLink affiliates.
The company reported year-end 2014 net proved reserves of nearly 2.8 billion barrels of oil equivalent (boe) and production of 674 thousand boe per day (mboepd; 53% liquids). This resulted in a year-end reserve life of over 11 years. Second-quarter 2015 (2Q15) production was down quarter-over-quarter to 674 mboepd (60% liquids) from 685 mboepd (60% liquids) mainly due to a pullback in Eagle Ford activity and continued declines in the Anadarko and Barnett. The Fitch-calculated three-year all-in reserve replacement rate was about 120% with an associated finding, development, and acquisition (FD&A) cost of approximately $28.93/boe. Unhedged cash netbacks ($20.68/boe in 2014) have generally exhibited positive trends over the past several years mainly due to increased liquids production. However, materially lower oil prices during the first half of 2015 have pushed unhedged cash netbacks sharply lower to approximately $7.33/boe. Notably, the company’s solid hedge position provided about $9.26/boe of netback uplift resulting in a hedged cash netback of $16.59/boe.
Latest 12-month (LTM) metrics demonstrate the early effects of lower price realizations with consolidated debt/LTM EBITDA increasing to nearly 2.0x from 1.6x at year-end 2014. The Fitch-calculated standalone Devon debt/proved (1p) reserves, debt/proved developed (PD) reserves, and debt/flowing barrel metrics were about $3.35/boe, $4.45/boe, and $13,655, respectively, as of June 30, 2015.
RETURNS, FREE CASH FLOW FOCUS IN DOWNCYCLE
Devon, consistent with other North American independent E&P peers, is focused on optimizing returns and aligning capital spending with cash flow, including EnLink-related proceeds, via cost reductions, capital efficiency, and production improvements. The company has budgeted about $4 billion in E&P capital spending, a roughly 25% year-over-year reduction. However, management expects average annual production to remain relatively stable, while oil production is anticipated to grow 25% – 35% (revised up from 20% – 25% initially). Devon believes that oil production will continue to exhibit growth in 2016, albeit at lower levels with an E&P capital spend of $2 – $2.5 billion. Fitch expects this oil growth to continue to come from well productivity gains, continued growth in the Permian, and a full ramp-up of Jackfish 3. Fitch anticipates, however, that natural gas will decline.
CASH FLOW METRICS WIDEN DUE TO WEAK PRICES
Fitch’s base case projects that Devon, on a standalone basis, will be approximately $400 – $500 million free cash flow (FCF) negative in 2015. Fitch notes that its FCF estimate considers nearly $400 million in common dividends. The Fitch base case results in 2015 debt/EBITDA of 2.4x, on a consolidated basis, and 2.2x, excluding EnLink distributions to non-controlling interests and associated non-recourse debt. Standalone debt/1p reserves, debt/PD reserves, and debt/flowing barrel metrics are forecast to remain solid at approximately $3.55/boe (subject to price-induced reserve revisions), $4.75/boe, and $14,560, respectively. Fitch’s base case WTI and Henry Hub price forecast assumptions of $60/barrel and $3.25/mcf in 2016, respectively, suggest that Devon will continue to take a measured approach to capital spending, but selectively increase drilling activity. The Fitch base case forecasts that the company’s 2016 free cash flow and leverage profiles will be generally consistent with 2015.
Devon maintains a combination of swaps and collars to manage cash flow variability and support development funding in 2015. No oil and gas volumes are currently hedged for 2016.
Fitch’s key assumptions within the rating case for the issuer include:
–WTI oil price that trends up from $50/barrel in 2015 to $60/barrel in 2016 and a long-term price of $70/barrel;
–Henry Hub gas that trends up from $3/mcf in 2015 to $3.25/mcf in 2016 and a long-term price of $3.75/mcf;
–Oil & gas production of 677 mboepd in 2015, consistent with the upper end of guidance, followed by modestly higher production thereafter;
–Oil mix increases to 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 the Permian and, over the medium-term, Eagle Ford;
–Capital spending forecast below $4.2 billion in 2015, generally consistent with guidance, followed by a balanced capital program and, potentially, some price-induced increases in drilling activity;
–Enlink growth-oriented capital spending and associated distribution improvements assumed throughout the forecast with Devon’s Access Pipeline dropped down in 2016.
Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
–Increased 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.
Fitch does not anticipate a positive rating action in the near term given the current weak pricing environment.
Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
–Mid-cycle debt/EBITDA, excluding EnLink distributions to noncontrolling interests and associated non-recourse debt, of 1.5x-2.0x on a sustained basis;
–Mid-cycle debt/flowing barrel of above $15,000-$17,500 and/or debt/PD over $5.00 – $5.50/boe, excluding EnLink non-recourse debt, on a sustained basis;
–A persistently weak oil & gas pricing environment without a corresponding reduction to capex;
–Acquisitions and/or shareholder-friendly actions inconsistent with the expected cash flow and leverage profile.
Fitch does not expect a negative rating action in the near term given the steps taken by management to pay down acquisition-related debt ahead of the downcycle and balance capital spending with cash flows. Another consideration is the financial flexibility provided by EnLink.
ADEQUATE LIQUIDITY POSITION; ENLINK PROVIDES ADDED FLEXIBILITY
Cash-on-hand was $1.7 billion as of June 30, 2015. Additional liquidity is provided by the company’s $3.0 billion syndicated, senior unsecured credit facility principally due October 2019 and CP program sized to the credit facility. There were no outstanding borrowings under the facility, but $170 million in CP borrowings were outstanding at quarter end. Fitch notes that the company used a portion of the recently issued $750 million 5.0% senior notes to temporarily repay a portion of the previously outstanding CP balance ($948 million as of March 31, 2015), but intends to use a majority of the net proceeds to repay the $500 million floating rate senior notes due December 2015,
Fitch recognizes that EnLink provides considerable financial flexibility and liquidity potential. Midstream MLPs tend to be more resilient than E&P in oil & gas price downcycles particularly when their contract mix is weighted towards long-term, fee-based contracts. 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 $500 million, $350 million, $875 million, and $700 million due in 2015, 2016, 2018, and 2019, respectively. These maturities represent the company’s floating rate notes due December 2015 and 2016, 8.25% senior notes due July 2018, 2.25% senior notes due December 2018, and 6.30% senior notes due January 2019. Devon addressed its 2015 floating rates note maturity with its recent $750 million debt issuance in June.
The main financial covenant, as defined under the credit agreement, is a maximum debt-to-capital ratio of 65% (22.1% as of June 30, 2015). Other customary covenants consist of additional lien limitations, transaction restrictions, and change in control provisions. Fitch notes that total capitalization, as defined in the financial covenant, is adjusted to add back noncash financial write-downs (e.g., full cost ceiling impairments or goodwill impairments) that will help moderate the covenant-related effects of the downcycle.
Devon’s defined benefit pension plan was about $228 million underfunded, equal to an 83% funded status, at year-end 2014. Fitch believes that the expected size of service costs and contributions is manageable relative to fund flows from operations. Other contingent obligations total approximately $13 billion on a multi-year, undiscounted basis mainly comprised of purchase obligations ($5.3 billion, subject to condensate market prices), operational agreements ($5.1 billion), asset retirement obligations ($1.4 billion), drilling and facility obligations ($446 million), and lease obligations ($405 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 that 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 40% related to commitments between Devon and EnLink.
FULL LIST OF RATING ACTIONS
Fitch affirms 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 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)
Dodd-Frank Rating Information Disclosure Form