OREANDA-NEWS. Fitch Ratings has affirmed Spanish oil and gas company Repsol, S.A.'s Long-term Issuer Default Rating (IDR) at 'BBB'. Fitch has also affirmed subsidiary Talisman Energy Inc.'s Long-term IDR at 'BBB-'. The Outlooks are Stable. A full list of rating actions is available below.

Repsol's ratings are supported by the company's sound business diversification with a strong downstream segment and a larger and more geographically diversified upstream segment after the acquisition of Talisman. The ratings are constrained by high leverage relative to peers and uncertainty over the profitability of upstream production, mainly in North America and the North Sea.

Fitch views the strategic and operational ties between Repsol and Talisman as strong, but due to the lack of direct debt guarantees and cross default clauses in Repsol's debt documentation, we rate Talisman, using a top-down approach, one notch below Repsol's rating.

KEY RATING DRIVERS
Larger Upstream with Talisman
The acquisition of Talisman in May 2015 has significantly increased Repsol's hydrocarbon production profile. Average oil and gas production (including JVs) stood at 525 thousand barrels of oil equivalent per day (kboepd) in 2Q15, 55% higher yoy. Output stood at 660kboepd in June 2015 once Talisman production was fully accounted for.

Talisman's assets are mainly located in developed countries, which contributed to an increase in oil and gas production from OECD countries in total output to 29%, from 12% for Repsol, prior to the acquisition. In Fitch's view, the acquisition therefore supports Repsol's credit profile and partly mitigates the company's historical reliance on Latin America.
Challenges Remain
The acquisition of Talisman brings also a number of challenges for Repsol. Fitch downgraded Talisman to 'BBB-' from 'BBB' in September 2014 due to its weakened production and reserve profiles, fairly high finding, development & acquisition costs, increased exposure to natural gas, remaining non-core asset sale obstacles and potentially higher leverage metrics without targeted asset sales. A prolonged weakness in oil and gas prices may also put pressure on Talisman's unconventional oil and gas production in North America and assets in the North Sea, which have higher production costs.

Stretched Credit Metrics in 2016
Under Fitch oil and gas price deck (USD55/bbl in 2015, USD65/bbl in 2016 and USD75/bbl in 2017 and USD80/bbl long-term and NBP gas prices of USD6/mcf in 2015 and 2016, USD7/mcf in 2017 and USD8/mcf long-term), we expect stretched credit metrics in 2016 with funds from operations (FFO) adjusted net leverage of around 3.2x, before recovering to below 3.0x in 2017, a level commensurate with the 'BBB' rating level. This is under the assumption that the upstream segment will see improved results in 2016 as more favourable hydrocarbon prices will offset lower downstream margins. We expect that further improvement in the upstream segment results post-2016 and a stable contribution of the downstream segment will result in deleveraging.

Strategic Update Key
Fitch expects that the combined entity to have greater flexibility regarding the timing and allocation of capital expenditure. Coupled with strong vertical integration, this should help maintain a healthy balance sheet with FFO adjusted net leverage below the 3.0x threshold for a 'BBB' rating.

Repsol recently announced it plans to maintain upstream capex in 2016 on a similar level compared with 2015 despite higher oil and gas output. The company also increased its estimate for synergies from Talisman acquisition to USD350m from USD220m. We also include in our forecasts the planned disposals of EUR0.9bn in 2015-2016 and issue of EUR3bn of hybrid notes in 2H15-2016, which should further mitigate weaker upstream segment results and the impact of Talisman acquisition. Yet, we will only be able to fully assess the impact of Talisman acquisition on Repsol's ratings once the company announces its updated strategy in 4Q15.

Strong Refining Margins in 2015
Repsol's upstream business faced headwinds in 1H15 due to the weak oil prices and no production from Libya. The weaker upstream results were mitigated by downstream performance, which benefitted from higher utilisation rates and improved refining margins.

Lower fuel prices, coupled with GDP growth, resulted in higher global demand for fuel products. With output from the new refineries in the Middle East lower than initially expected, in 1H15 European refiners experienced refining margins last seen before the financial crisis of 2008.

Repsol has increased its earnings guidance for the downstream segment twice so far in 2015, most recently to EUR3.2bn-EUR3.4bn, vs. EBITDA of EUR1.3bn in 2014. Although we view the current exceptionally positive refining environment as temporary, we still expect downstream performance in 2016-2018 to be stronger than in the last two years, supporting Repsol's business and financial profile.

Top-Down Approach to Talisman
Fitch expects Repsol will reinforce Talisman's near-term capitalisation and liquidity position. Talisman's ratings are therefore driven by the subsidiary's linkage with Repsol due to their strong strategic and operational ties. At the same time, the lack of direct debt guarantees and hence strong legal ties are reflected in Talisman being rated one notch below Repsol's via Fitch's top-down rating approach.

KEY ASSUMPTIONS
-Fitch's key assumptions within our rating case for the issuer include:
-Brent prices of USD55/bbl in 2015, USD65/bbl in 2016, USD75/bbl in 2017 and USD80/bbl long-term
-West Texas Intermediate (WTI) prices of USD50/bbl in 2015, USD60/bbl in 2016 and USD70/bbl long term
-EUR5bn capex in 2016
-EUR0.9bn divestments in 2015-2016
-EUR3bn of hybrid bond issue in 2H15-2016

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- FFO adjusted net leverage of around 2.5x and FFO fixed charge cover of 8x (2014: 2.8x) on a sustained basis.
- Stable FFO margin greater than 10% (2014: 4%).
- Capex at no more than 100% operating cash flow.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- FFO adjusted net leverage above 3.0x and FFO fixed charge cover of 6x and below on a sustained basis.

LIQUIDITY
At 30 June 2015 Repsol had a cash position of EUR2.5bn (excluding cash at JV) and undrawn credit lines amounting EUR5.8bn against short-term debt of EUR4.8bn (excluding EUR2.7bn of related-party balances). We expect Repsol to issue EUR3bn of hybrid facilities in 2H15-2016 as part of its financing for the acquisition of Talisman. This will improve the debt maturity profile of Repsol. The company issued EUR2bn hybrid facilities in 1H15.

FULL LIST OF RATING ACTIONS

Repsol S.A.
Long-term IDR affirmed at 'BBB'; Outlook Stable
Senior unsecured debt affirmed at 'BBB'
Short-term IDR affirmed at 'F3'

Repsol International Finance
Senior unsecured debt affirmed at 'BBB'
Commercial paper affirmed at 'F3'
Hybrid capital instruments affirmed at 'BB+'

Talisman Energy Inc.
Long-term IDR affirmed at 'BBB-'; Outlook Stable
Senior unsecured debt affirmed at 'BBB-'
Short-term IDR affirmed at 'F3'
Commercial paper affirmed at 'F3'.