TEXT-S&P revises Forest Oil Corp outlook
-- U.S. energy exploration and production company Forest Oil Corp. could exceed our 4x leverage target in 2013 without meaningful growth in its liquids production.
-- We are affirming all of our ratings, including the 'BB-' corporate credit rating, on Forest. At the same time, we are revising the outlook to negative from stable.
-- The negative outlook reflects weak natural gas prices, and uncertainties regarding the company's ability to grow its liquids-production to acceptable levels while managing its cost profile. Rating Action On March 2, 2012, Standard & Poor's Ratings Services revised its outlook on Denver-based Forest Oil Corp. (Forest) to negative from stable and affirmed all of its ratings, including the 'BB-' corporate credit rating, on the company. Rationale The outlook revision reflects the potential for leverage to exceed our 4x downgrade threshold in 2013. Forest is levered primarily to very weak natural gas, and it is focusing its drilling program primarily on more profitable liquids (oil and natural gas liquids (NGLs). However, Forest is relatively new to some of its liquids-rich plays, including the Eagle Ford and Permian basins, adding some uncertainty around its liquids-production growth and drilling costs over the next couple years. Given that most of its production will continue to come from natural gas (we forecast about 70% over the next couple years) and its weak hedge book in 2013, Forest's profitability and credit measures will depend on a successful drilling program in its liquids-rich basins. At our price deck, which for oil and gas in 2013 is $70 per barrel and $3.25 per thousand cubic feet (Mcf), respectively, we forecast that Forest will need to increase oil production at least 20% from 2012 to 2013 to remain below our 4x downgrade trigger. We think this is achievable given its good acreage positions in prolific oil-rich basins, but we think it will depend on good production from its liquids-rich wells while maintaining cash costs in-line with current $2.44/Mcfe to $2.71/Mcfe guidance. If this occurs, we will revise the outlook to stable. The rating on Forest reflects the capital-intensive and cyclical nature of the E&P industry and a reserve mix that is weighted toward weak natural gas prices. Ratings also reflect the company's good liquidity, onshore geographic diversity, and the relatively low-risk nature of its drilling program. With the spin-off of its Canadian assets (Lone Pine), the company's remaining reserves are now levered exclusively to the U.S. We consider Forest to have an "aggressive" financial risk and "fair" business profile (as our criteria define the term). As of Dec. 31, 2011, Forest had about $1.9 billion in total adjusted debt, leaving last 12 months (LTM) debt to EBITDA at 3.5x. Standard & Poor's uses a price assumption for oil of $80/bbl in 2012 and $70 thereafter and for gas of $3/Mcf in 2012, $3.25/Mcf in 2013, and $4/Mcf thereafter. Incorporating Forest's 2012 hedge position of nearly two-thirds of expected gas production at about $5.30/Mcf, we forecast that leverage at year end will be in the low to mid 3x range, which we consider to be appropriate for the current rating category. However, under our 2013 pricing assumption, assuming production is flat versus 2012, and incorporating its soft hedges of about a third of gas production at an average of $4.02/Mcf, we currently forecast year-end 2013 leverage of nearly 4.5x, which is very aggressive. Under our current hydrocarbon pricing assumptions, and assuming a capital spending budget of nearly $600 million this year and $400 million next year, we currently forecast that Forest could outspend internally generated cash flow by up to $100 million in 2012 and between $75 million and $100 million in 2013 (on funds from operations (FFO) of about $375 million and $300 million, respectively, in 2012 and 2013). There is risk that its borrowing base could be reduced at its next redetermination given its exposure to natural gas. However, the company had ample availability of $1.15 billion on Dec. 31, 2011, and we think that Forest will be able to support our projected outspending of its internal cash flows even with a lower borrowing base. Standard & Poor's characterizes Forest's business profile as fair. Forest is one of the largest E&P companies in the 'BB-' rating category with 1.9 trillion cubic feet of reserves. Approximately 55% of these reserves are proved developed and an aggressive three-quarters are natural gas. Forest maintains a good cost structure, with levered breakeven costs about $5/Mcfe, which is in line to similarly rated peers. Its gas production primarily in the lower cost Haynesville has historically benefited its costs. However, over the next several years, we think that lifting costs could increase modestly due to slightly higher liquids production out of the Granite Wash, Eagle Ford, and Wolfcamp. However, improved profitability from its liquids should more than offset any increase in costs. Forest's business profile benefits from a strategy that emphasizes drill bit reserve replacement. The strategy means that Forest is unlikely to overpay for existing reserves but it also relies on exploration spending to discover future reserves, which can be risky. Over the past several years, the company's drill-bit reserve replacement has been more than 150%. We think that reserve replacement is likely to slow as the company gets larger, but we expect management's organic reserve replacement focus to continue. Liquidity We consider Forest's liquidity to be "strong". Our assessment of the liquidity profile incorporates the following expectations and assumptions:
-- On Dec. 31, 2011, Forest had approximately $1.15 billion of availability on its $1.25 billion borrowing base and $3 million of cash on hand.
-- We think Forest will spend $600 million in 2012. At this level, we believe sources of liquidity will exceed uses by more than 1.5x over the next year and that net sources of liquidity will remain positive even if EBITDA declines by more than 30%.
-- We believe that there is a risk that Forest's borrowing base could be lowered at its next redetermination given its exposure to natural gas. However, we believe that its decent hedges in 2012 should limit this reduction somewhat. Still, we think that Forest has sufficient availability that it will maintain strong liquidity under our current assumptions.
-- We view Forest as having a well-established and solid relationship with banks. Its revolver includes a maximum total debt to EBITDA of 4.5x. Recovery analysis The rating on Forest's secured notes is 'BB+' (two notches higher than the corporate credit rating), with a recovery rating of '1', indicating our expectations for very high (90% to 100%) recovery in the event of a payment default. The issue level rating on the unsecured notes is 'B' (two notches lower than the corporate credit rating), with a recovery rating of '6', indicating our expectation for negligible (0% to 10%) recovery in the event of payment default. For the complete recovery analysis, see Standard & Poor's recovery report on Forest, published Aug. 18, 2011. Outlook The outlook is negative because we believe Forest could possibly exceed leverage of 4x in 2013 if its liquids-rich drilling program performs below our expectations. For a stable outlook, we envision that Forest would need to increase oil production by more than 20% between 2012 and 2013 to generate profits necessary to maintain leverage below 4x. We think that Forest could also exceed our downgrade trigger if it adds debt to finance a more aggressive capital spending plan or an acquisition. We could revise the outlook to stable if its liquids focused drilling program is successful and costs are in-line, or below, current guidance. Ratings List Ratings Affirmed; Outlook Revised
To From Forest Oil Corp. Corporate Credit Rating BB-/Negative/-- BB-/Stable/-- Ratings Affirmed Forest Oil Corp. Senior Secured BB+ Recovery Rating 1 Senior Unsecured B
Recovery Rating 6
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