Fitch Expects to Rate Hess' Senior Unsecured Notes 'BBB'; Outlook Remains Negative
Fitch currently rates Hess as follows:
--Long-Term Issuer Default Rating (IDR) 'BBB';
--Senior unsecured notes/debentures 'BBB';
--Senior unsecured revolver 'BBB'.
The Rating Outlook is Negative.
KEY RATING DRIVERS
Hess' ratings are supported by the company's strong current liquidity (approximately $7.7 billion at June 30); high exposure to liquids (approximately 74% of 2015 production and 76% of reserves); track record as one of the better operators in the space; and good operational metrics. Hess' ratings are also supported by its credit-friendly equity raise earlier this year ($1.7 billion), as well as decent size and scale as an independent.
The Negative Outlook is driven by the loss of diversification associated with the previous sale of downstream, midstream and retail assets; the reduction in size in the upstream through asset sales and its impact on key credit metrics; and the potential for further outspending on growth projects that might meaningfully reduce the company's liquidity under a lower-for-longer oil price scenario.
While Hess' liquidity is currently very strong, the company has aggressively sold off a large number of assets as part of earlier restructurings (as calculated by Fitch, approximately $9 billion since 2009), which may limit its ability to liquidate additional assets under a lower-for-longer scenario without unfavorably impacting core credit metrics. Discretionary growth investments over the next several quarters, while likely accretive in a rising oil price environment might also limit financial flexibility if the downturn is prolonged.
FREE CASH FLOW (FCF) TRENDS
As calculated by Fitch, Hess' latest 12 months (LTM) FCF at June 30, 2016 was approximately -$2.4 billion, excluding noncontrolling interest payments and -$80 million, including noncontrolling interest payments. This considers capex of $3.1 billion and dividends of $312 million. At June 30, consolidated debt/EBITDA (which included $684 million of non-recourse debt of Hess Infrastructure Partners) was 3.6x and EBITDA/interest coverage was 4.6x. On a pro forma basis, using Fitch's most recent base case oil price assumptions ($42/bbl in 2016, $45/bbl in 2017, $55/bbl in 2018, and $65/bbl in 2019), as well as Hess' pending bond issuance and expected liability management actions, Fitch anticipates that Hess' debt/EBITDA leverage will decline to 3.1x in 2017 and 2.3x in 2018 (2.9x and 2.1x on a deconsolidated basis), which is consistent with an investment grade rating.
STRONG OPERATIONAL TRACK RECORD
As calculated by Fitch, Hess has been a solid performer in the independent E&P space, with a consistent track record of strong reserve growth at economical replacement costs, which are key indicators of health for an E&P company. Excluding 2015 results (which were distorted by large price-driven negative reserve revisions), Hess' long term full cycle netbacks averaged approximately $20/boe and organic reserve replacement averaged approximately 129%, both respectable numbers. Hess' 2015 reserve life shrank to 7.8 years from 11.7 years in 2014, but we expect this number will rise as incremental reserves are rebooked in a rising price environment and the ratio begins to benefit from rebased production numbers.
Hess also continues to move down the cost curve in key shale plays. In the Bakken, well completion costs have fallen 14% year-over-year (y-o-y) to $4.8 million per well in the second quarter of 2016 (2Q16), versus $5.6 million a year ago and $13.4 million in early 2012. Days to spud a well have also dropped from 45 in 2011 to 16 days in 2Q. The company continues to have one of the highest 30 day IP rates in the space. Despite its drop in size following restructurings, it still retains good geographical diversity, with core positions in the onshore shale (Bakken, Utica); offshore GoM; the North Sea; Southeast Asia; and offshore West Africa, as well as a midstream business in the Bakken. It is important to note that several of these regions are Production Sharing Contracts (PSC) regimes which offer a partial cash flow hedge in lower priced environment.
Hess has a track record as one of the more successful independent E&Ps in the exploration space, highlighted by its most recent success in offshore Guyana (Liza). Given the size of Liza's resource (gross recoverable resource of 800 million to 1.4 billion boe) and Hess' non-operator status in the play (30% WI), the pace of spending and funding decisions on Guyana will be important factors in the company's future credit profile.
AMPLE CURRENT LIQUIDITY
Hess' liquidity is very strong. Total liquidity at June 30 was approximately $7.7 billion, including approximately $3.1 billion in cash; $4 billion in undrawn revolver commitments which mature in January 2020; and another $619 million in committed lines. Separately, Hess Infrastructure Partners (HIP) has its own $400 million revolver which is non-recourse to Hess but consolidated in its financial statements. At June 30, total debt to capitalization was 23.6%. The company's maturity wall is manageable.
STRATEGIC TRANSFORMATION COMPLETE
Hess has completed its transition to a pure play E&P company from a small integrated oil company, with its earlier exit from refining and trading, the sale of its retail business for $2.8 billion in September of 2014, and the sale of a 50% stake of its Bakken Midstream to GIP for $3 billion in mid-2015. The only piece left is an IPO of the equity stake in the Bakken midstream master limited partnership (MLP). Recent market conditions may contribute to a delay in the midstream IPO process; however, total proceeds expected from such an event are small. In the future, when MLP market valuations recover, Fitch expects the MLP is likely to provide an ongoing valuable source of liquidity to Hess parent through dropdowns of logistics assets.
Fitch's key assumptions within our rating case include:
--Base Case WTI oil prices of $50/bbl in 2016, $60/bbl in 2017, $65 in 2018, and $70/bbl in 2019;
--Stress Case WTI oil prices of $40/bbl in 2016, $45/bbl in 2017, and $50/bbl thereafter;
--Base Case Henry Hub natural gas prices of $2.75/mcf in 2016, $3.00/mcf in 2017, and $3.25/mcf in 2018;
--Stress Case Henry Hub natural gas prices of $2.25/mcf in 2016, flatlining at $2.75/mcf thereafter;
--Base Case cumulative production growth of 1.7% from 2015-2019;
--Stress Case cumulative production growth of -4.6% from 2015-2019;
--Capex of less than $3 billion in 2016;
--Minimal growth in dividend and minimal asset sales in the Base Case;
--Flat dividends and $150 million in annual asset sales in the Stress Case.
Positive: No positive rating actions are currently contemplated given the reduction in Hess' size, scale and diversification associated with recent company restructuring and weakening credit metrics associated with low oil prices. However, future developments that could lead to positive rating actions include:
For an upgrade to 'BBB+':
--Increased size, scale, and diversification, and;
--Sustained debt/boe 1p in the Negative: Future developments that could lead to negative rating action include:
--Sustained debt/EBITDA above approximately 2.2x;
--Sustained debt/flowing barrel >$18,000;
--Sustained debt/boe 1p above approximately $4.8/boe.
To remove the Negative Outlook at 'BBB':
--A credit-friendly method to fund deficit spending that helps bridge the credit profile through an extended price recovery may also alleviate ratings pressure. Fitch would anticipate downgrading the credit to the 'BBB-' level absent evidence of a price recovery by the end of 2016.
Hess' total liquidity at June 30 was approximately $7.7 billion, including approximately $3.1 billion in cash; $4 billion in undrawn revolver maturing in January 2020, and another $619 million in availability from committed lines. Net debt to cap was just 11%. The company's maturity wall is manageable. Hess' main financial covenant is a maximum debt-to-capitalization ratio of 65% contained in its revolver, and the company had ample headroom on this at June 30. Covenant restrictions across Hess' debt instruments are light. There are no financial covenants beyond the debt-to-cap covenant contained in the revolver. Other non-financial covenants contained in the bond indentures include restrictions on mergers and asset sales, limitations on sale leasebacks and cross default provisions.
Hess' other obligations are manageable. Hess' qualified pension was underfunded by $115 million at year-end (YE) 2015, versus an underfunding level of $199 million the year prior. The main drivers of the improvement were actuarial gains, partly offset by lower returns on plan assets. For 2016, expected pension contributions were $27 million, of which $13 million had been paid as of June 30. Hess' Asset Retirement Obligation (ARO) linked to environmental remediation stood at approximately $2.2 billion at Sept. 30, and was up slightly y-o-y.