S&P: Germany-Based Oil And Gas Producer Deutsche Erdoel AG Bond Rated 'B+'; Issuer Rating Affirmed; Outlook Stable
OREANDA-NEWS. S&P Global Ratings said today that it affirmed its 'BB-' long-term corporate credit rating on Germany-based oil and gas company Deutsche Erdoel AG (DEA). The outlook is stable. At the same time, we assigned an issue rating of 'B+' to the proposed €400 million senior unsecured notes due in 2022 to be issued by DEA Finance S. A. and guaranteed by DEA. The recovery rating is '5', indicating our expectation of modest recovery prospects in the lower half of the 10%-30% range. The rating on the bond is subject to the successful closing of the transaction and our review of the final documentation. The rating on DEA continues to reflect our view of the company's fair business risk profile and aggressive financial risk profile. In our view, the main drivers for DEA's business risk are its midsize production and reserves that are spread across fields in countries with low and higher risk assessments. At present, the majority of production and earnings before interest, taxes, depreciation, amortization, and exploration (EBITDAX) is derived from very low risk countries: Germany and Norway. However, from 2018, we expect an increased contribution from Egypt and Algeria, which we view as very high risk countries of operation. We also note that in 2015, DEA sold its assets in the U. K. and purchased assets in Norway. This resulted in a 20% increase in 2P (proved and probable) reserves to 575 million barrels of oil equivalent (mmboe) from 476 mmboe in 2014. On a pro forma basis (excluding U. K. assets and including Norway), DEA produced 140,000 barrels of oil equivalent per day (boepd) in 2015, achieving EBITDAX of about €1.36 billion. We understand that this production rate is likely to reduce to about 126,000 boepd in 2016. This decrease is primarily explained by the natural decline of mature production in Germany--where DEA is typically the field operator--and Norway, as well as the sale of interests in Egypt. Our assessment of DEA's business also reflects our view of generally average profitability compared with its global peer group, in terms of return on capital and unit operating cash generation. However, we see some indicators of improving operating efficiency; for example, finding and development (F&D) costs had been higher than average, but were more in line with peers in 2015. DEA's three-year average F&D costs during 2012-2014 were assessed at about $35/boe, but improved to below $15/boe in 2015. DEA's future production profile will depend on its ability to access and develop new fields. The company is planning to offset depleting production in Germany and Norway by investing in these countries, as well as through production from new fields in Egypt and Algeria that are expected to come on stream in 2017. The successful start-up of these fields, in our view, will be crucial for achieving organic growth in 2017-2020. Another potential area of growth is acquisitions, likely focused on current core regions such as Norway and Germany. DEA's management plans to achieve 200,000 boepd by 2020 and we understand this target may be reached through the purchase of typically producing assets. Although LetterOne Holdings S. A.--the sole owner of DEA--may again provide some equity financing for acquisitions, we do not exclude that they may also be partly funded with debt. In the next year or so, the combination of modestly declining production and the current period of low oil and gas prices will continue to weigh on the financial profile of the company. We forecast FFO to debt of slightly higher than 20% on a three-year weighted-average basis over 2016-2018. We anticipate declining production in 2016 and 2017; total annual production in 2016 is forecast at 126,000 boepd, decreasing to 110,000 boepd in 2017. As North African projects under development start producing, we see potential for growth in 2018 and project production to improve to above 112,000 boepd. We do not incorporate any acquisitions in our base-case forecast that would help DEA achieve its public target of production at 200,000 boepd in 2020. We understand the company will manage acquisitions within the framework of its financial policy--namely reported net debt to EBITDA typically less than 2.5x. However, major debt-funded acquisitions may lead to an increase in financial leverage beyond our assumptions, which could result in a downward adjustment of our financial risk profile assessment. Our base case assumes:Brent price at $40/boe in 2016, $45/boe in 2017, and $50/boe in 2018 onward. We also assume a Henry Hub price of $2.5/million British thermal units (Btu) in 2016, $2.75/million Btu in 2018, and $3.0/million Btu from 2018.Euro/U. S. dollar rate at about €0.9 per dollar for 2016-2018.A slight decrease in total production from 144,000 boepd in 2015 (on pro forma basis) to 126,000 boepd in 2016, and then to 110,000 boepd in 2017 due to a natural decline in Germany and Norway and a farm-down agreement in Egypt, under which a third party acquired an interest in DEA's license. We anticipate production growth in 2018, after assets in start-up operations in Egypt, resulting in projected production of about 112,000 boepd. Adjusted returns on capital and EBITDA margins are forecast to improve over 2016-2018 with operating efficiencies from new assets and a cost-cutting program. EBITDAX margin is forecast at 55% in 2016, strengthening to 60% in 2018.Estimated capital expenditure (capex) of about €750 million in 2016, €660 million in 2017, and €700 million in 2018. Based on these assumptions, we arrive at the following credit measures:Adjusted EBITDAX of above €800 million in 2016 and 2017 and about €900 million in 2018.FFO to adjusted debt of about 19% in 2016, increasing to 23% in 2018.Breakeven to modestly positive free operating cash flow (FOCF) and discretionary cash flow resulting in weak corresponding debt ratios on a three-year weighted-average basis for 2016-2018. The stable outlook reflects our forecast of broadly breakeven FOCF in the next year or so and moderating net leverage--with S&P Global Ratings-adjusted three-year average debt to EBITDA comfortably below 4x and FFO to debt at 20% or above--as oil prices increase modestly in line with our price assumptions and new production begins. We see some risk that DEA's expansion strategy could result in aggressively funded acquisitions. Such purchases and leveraging could result in a downgrade, especially if FFO to debt were well below 20% or debt to EBITDA were over 4x for a protracted period. Further sustained reductions in oil prices below our assumptions of $40/bbl for the remainder of 2016 and $45/bbl in 2017 could also increase the risk of a downgrade unless sufficiently offset by cost reductions or lower capital investment. Over the longer term, capex reductions could result in a meaningfully declining production profile, which could negatively affect our assessment of the business assets and also lead us to lower the ratings. We see limited likelihood of an upgrade over the next year or so unless DEA sustainably reduces leverage to below 3x with FFO to debt above 30%. Over time, a material increase in the scale and diversification of the reserves and producing assets, combined with moderate leverage, could lead to an upgrade.