Fitch Ratings has assigned a rating of 'BBB+' to Devon Energy Corp.'s
(Devon; NYSE: DVN) $850 million senior unsecured notes. The notes have a
5.85% coupon and maturity date of Dec. 15, 2025. Net proceeds will be
used to fund a portion of the recently announced $1.9 billion
Anadarko/STACK acquisition and for general corporate purposes.
$2.5 BILLION IN ACQUISITIONS ANNOUNCED
Devon recently announced $2.5 billion in Anadarko/STACK and Powder River
Basin (PRB) acquisitions with just under half ($1.15 billion) of the
total transaction price to be debt-funded. Fitch estimates pro forma LTM
debt/EBITDA will increase to nearly 2.0x from over 1.7x. This excludes
EnLink distributions to non-controlling interests and associated
non-recourse debt. Management also commenced a non-core asset
divestiture program with expected proceeds of $2 billion to $3 billion.
Targeted non-core assets include the company's Access Pipeline in Canada
and select E&P assets - potentially Carthage, Miss-Lime, Granite Wash
and select Midland Basin assets - with production of 50-80 thousand boe
per day (mboepd - roughly 50% liquids).
The company is acquiring an acreage position in the Anadarko Basin's
oil-weighted STACK play from Felix Energy for $1.9 billion. Devon will
purchase 80,000 net acres (adjacent to its existing STACK position) with
multiple prospective formation zones and current production of 9 mboepd
(30% oil and 40% NGLs). Fitch believes this is an opportunistic acreage
acquisition that will not materially add to near-term production and
cash flow, but is likely to add value in the future. The transaction is
expected to close in early 2016.
The company is also acquiring a 253,000-acre position in the PRB's
oil-oriented region (adjacent to its existing PRB position) for $600
million. The largely undeveloped position has multiple pay zones with
current production of 7 mboepd (approximately 85% oil). Fitch believes
that the PRB acquisition is also an opportunistic acreage acquisition
that will not materially contribute to medium-term production and cash
flow. Fitch views the PRB as promising, but much earlier in development
than the STACK position. The transaction is expected to close by year
Fitch expects the acquisitions to be leveraging over the near term, but
anticipates management will repay debt in excess of the acquisition debt
amount. This should support the near-term credit profile given the
acquired assets' earlier stage of development, as well as the prospects
for a slower hydrocarbon price recovery. Fitch views Devon's plan to be
generally consistent with its 2014 GeoSouthern acquisition. That
transaction resulted in a near-term increase in gross debt followed by a
series of divestitures that funded debt repayment equivalent to the
acquisition debt amount.
The acquisitions are generally viewed as neutral-to-positive, since
near-term production and cash flow impacts will be moderate, asset
quality is generally being high-graded, and resource positions are
becoming more focused and scaled. Fitch recognizes that execution risk
associated with planned non-core asset sales remains. However, we
believe the risk is manageable given the number of peer and
financially-backed E&P companies that have a considerable amount of
capital looking to be deployed for M&A, as well as the fact that Devon
is likely to have multiple options for generating liquidity to pay down
debt if these specific transactions encounter any roadblocks.
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 its
non-core asset divestiture program and the development of its U.S.
onshore reserve base, and a possibility that management accelerates
drilling activity ahead of supportive pricing signals. Fitch recognizes,
however, that Devon reported favorable year-to-date 2015 exploration and
production (E&P) cost improvements, production efficiency gains, and
capex reductions that help alleviate our near-term operating and cost
concerns. Another consideration is the financial flexibility provided by
dropdowns 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 mboepd;
(53% liquids). This resulted in a year-end reserve life of over 11
years. Third-quarter 2015 production of 680 mboepd (61% liquids) was
largely consistent with the first half of the year. The Fitch-calculated
three-year all-in reserve replacement rate was about 78% 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 nine months of 2015 have pushed unhedged
cash netbacks sharply lower to approximately $7.28/boe. Notably, the
company's solid hedge position provided about $10.12/boe of netback
uplift resulting in a hedged cash netback of $17.40/boe.
Latest 12-month (LTM) metrics, as of Sept. 30, 2015, demonstrate the
early effects of lower price realizations with consolidated debt/LTM
EBITDA increasing to approximately 2.1x 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
$3.30/boe, $4.40/boe, and $13,300, respectively, as of Sept. 30, 2015.
CASH FLOW METRICS WIDEN DUE TO WEAK PRICES
The Fitch base case, assuming West Texas Intermediate (WTI) and Henry
Hub prices of $50/barrel and $2.75/mcf, respectively, results in 2015
debt/EBITDA of 1.9x, 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 $3.20/boe (subject to price-induced reserve
revisions), $4.25/boe, and $13,050, respectively.
Fitch's base case WTI and Henry Hub price forecast assumptions of
$50/barrel and $2.75/mcf in 2016, respectively, suggest that Devon will
materially reduce capital spending and selectively allocate the majority
of capital to its highest return drilling locations. The Fitch base case
forecasts that the company's 2016 debt/EBITDA metrics will increase to
approximately 2.5x. Fitch assumes management executes planned asset
sales and reduces debt in excess of the acquisition debt amount.
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 Devon include:
--WTI oil price that trends up from $50/barrel in 2015 to a long-term
price of $70/barrel;
--Henry Hub gas that trends up from $2.75/mcf in 2015 to a long-term
price of $3.50/mcf;
--Oil & gas production of 680 mboepd in 2015, consistent with guidance,
followed by relatively flat production in 2016 and modestly higher
--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 and Anadarko;
--Capital spending of around $4 billion in 2015, generally consistent
with guidance, followed by a more 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;
--Non-core asset sales at the upper end of management's $2 billion to $3
billion targeted range in 2016 with a large portion of proceeds assumed
to be allocated to debt reduction.
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.
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 above $15,000-$17,500 and/or debt/PD
over $5.00 - $5.50/boe, excluding EnLink non-recourse debt, on a
--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.
ADEQUATE LIQUIDITY POSITION; ENLINK PROVIDES ADDED FLEXIBILITY
Cash-on-hand was $1.7 billion as of Sept. 30, 2015. Additional liquidity
is provided by the company's $3 billion syndicated, senior unsecured
credit facility principally due October 2019 and CP program sized to the
credit facility. No CP or credit facility borrowings were outstanding as
of Sept. 30, 2015. Fitch notes that the company used a portion of the
$750 million 5.0% senior notes issued in June 2015 to repay a portion of
the previously outstanding CP balance, but intends to use the net
proceeds to repay the $500 million floating rate senior notes due
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 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 year-to-date, which
may reduce the near-term attractiveness of EnLink funding. About 80% of
EnLink cash flows are fee-based with Devon contracts representing a
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
$750 million debt issuance in June 2015.
The main financial covenant, as defined under the credit agreement, is a
maximum debt-to-capital ratio of 65% (21.9% as of Sept. 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
comprising 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 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 currently rates Devon Energy Corp. and its affiliates as follows:
Devon Energy Corporation
--Long-term Issuer Default Rating (IDR) 'BBB+';
--Senior unsecured notes 'BBB+';
--Senior unsecured credit facility 'BBB+';
--Short-term IDR 'F2';
--Commercial paper 'F2'.
Devon Financing Corporation U.L.C.
--Senior unsecured notes 'BBB+'.
Ocean Energy, Inc.
--Long-term IDR 'BBB';
--Senior unsecured notes 'BBB'.
Fitch has assigned the following rating:
Devon Energy Corporation
--Senior unsecured notes at 'BBB+'.
The Rating Outlook is Stable.
Date of Relevant Rating Committee: Dec. 7, 2015
Additional information is available on www.fitchratings.com
Corporate Rating Methodology - Including Short-Term Ratings and Parent
and Subsidiary Linkage (pub. 17 Aug 2015)
Recovery Ratings and Notching Criteria for Non-Financial Corporate
Issuers (pub. 07 Dec 2015)
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