TEXT-S&P rates QR Energy LP

Tue May 15, 2012 11:53am EDT

Overview	
     -- U.S. oil and gas master limited partnership QR Energy L.P.      
  is planning to issue $300 million of senior unsecured notes due 2020. 	
     -- We are assigning our 'B' corporate credit rating to QR Energy.	
     -- We are also assigning our 'B-' senior unsecured rating and '5' 	
recovery rating to the proposed note offering.	
     -- The stable outlook reflects our expectation that QR Energy's exposure 	
to liquids, good hedge book, and highly developed reserve base should enable 	
it to sustain adjusted debt leverage less than 3x over the next several years, 	
excluding material acquisitions.	
	
Rating Action	
On May 15, 2012, Standard & Poor's Ratings Services assigned its 'B' corporate 	
credit rating to independent exploration and production (E&P) company QR 	
Energy L.P. (QRE). The outlook is stable.	
	
We also assigned a 'B-' issue rating (one notch lower than the corporate 	
credit rating) to QRE's proposed $300 million senior unsecured notes due 2020, 	
which operating subsidiary QRE Finance Corp. will co-issue. We assigned the 	
notes a '5' recovery rating, indicating expectations of modest (10% to 30%) 	
recovery in the event of a payment default. 	
	
Rationale	
The ratings on QRE reflect a reserve base that is small relative to the 	
company's speculative-grade E&P peers, an aggressive financial policy 	
evidenced by a reserve replacement strategy that relies heavily on 	
acquisitions, its relatively high dividend payout to shareholders, and its 	
high cost structure. Our ratings also reflect QRE's good liquids exposure, and 	
good hedge book over the next several years that should provide some stability 	
against hydrocarbon volatility, a high percentage of lower risk proved 	
developed reserves, and modest capital spending requirements. 	
	
We consider the company's business risk profile as "vulnerable" and its 	
financial risk profile as "aggressive." As a master limited partnership (MLP), 	
QRE distributes nearly all available cash flows to unitholders on a quarterly 	
basis. In order to sustain stable cash flows, QRE's operates with a mostly 	
proven reserve base, taking on very little exploration risk and nominal 	
capital expenditures. Also, it acquires reserves in very mature basins where 	
the geology is well known and where wells have been operated for many years. 	
QRE prefers to hedge a majority of its future production at the time it 	
acquires reserves, to provide stability to meet its distributions. The company 	
generally aims to hedge 65%-85% of its projected oil and gas production for 	
the next three to five years. Nevertheless, it must rely heavily on 	
acquisitions to increase production because of the limited organic growth 	
prospects of its mature reserve base. This acquisition-focused growth strategy 	
exposes QRE to risks in accessing capital markets as well as potentially 	
overpaying for its assets.	
 	
QRE had a relatively small reserve base of approximately 451 billion cubic 	
feet equivalent (Bcfe) at year-end 2011, with 56% of reserves exposed to oil 	
and natural gas liquids (NGLs), which are enjoying robust prices compared with 	
natural gas. QRE has a relatively high percentage (68%) of proved developed 	
reserves, and therefore a low-risk production profile. The company's reserves 	
are mainly in the Permian Basin in Texas, the Ark-La-Tex area, and the 	
mid-continent region.	
	
On April 20, 2012, the company closed on its previously announced $226 million 	
acquisition of predominantly oil properties from Prize Petroleum LLC. Most of 	
the properties have a long life with low decline rates and are located in the 	
Ark-La-Tex area, with estimated proved reserves of 12.8 million barrels of oil 	
equivalent. 	
	
Given the maturity of the company's reserves, QRE's cost structure is 	
relatively high due to its need to employ secondary and tertiary 	
well-enhancement techniques. We estimate all-in levered break-even costs were 	
approximately $6.80 per thousand cubic feet equivalent (mcfe) as of year-end 	
2011, and cash operating costs of $4.11 per mcfe are also high compared with 	
peers. 	
	
	
QRE's aggressive financial risk profile incorporates adjusted debt levels of 	
approximately $540 million. Based on production estimates of 31,660 Mmcfe, our 	
price decks--for oil of $85 per barrel (bbl) in 2012, $80/bbl in 2013, and 	
$75/bbl thereafter and for natural gas of $2/mcf in 2012, $2.75/mcf in 2013, 	
and $3.5/mcf in 2014--we expect leverage slightly less than 3x over the next 	
couple years (about 2.7x at year-end 2012). We have not incorporated the 	
impact of acquisitions to production or cash outflows and have assumed that 	
natural gas production will represent slightly less than half of total 	
production in 2012 and 2013. Our assumptions incorporate QRE's current hedges, 	
which represent approximately 75% of total projected production in 2012 and 	
79% of production in 2013.	
	
Liquidity	
We consider QRE's liquidity "adequate" reflecting the following assumptions 	
and expectations:	
     -- We expect that sources of liquidity will exceed uses by more than 1.2x 	
over the next year, excluding acquisitions. This includes our assumption that 	
capital spending will total about $61 million and that distributions will 	
total nearly $97 million in 2012.	
     -- Pro forma for the notes issuance and the Prize acquisition, we expect 	
QRE's liquidity will include about $383 million of availability on its $655 	
million borrowing base facility due 2017 and $21 million of cash on its 	
balance sheet as of March 31, 2012.	
     -- The company has a maximum leverage covenant of 4x and a minimum 	
current ratio of 1x. At our price assumptions for oil and natural gas, we do 	
not expect QRE to have any issues meeting these requirements over the next 	
several years.	
	
Recovery Analysis	
Please see the recovery report on QRE to be published on RatingsDirect 	
following the release of this report.	
	
Outlook	
The stable outlook reflects our expectation that QRE will maintain total 	
adjusted debt to EBITDA of about 3x. We also expect that the company will 	
maintain adequate liquidity due to its decent hedge book and that the company 	
will continue to fund acquisitions prudently through a combination of debt and 	
equity. We will consider a downgrade if leverage exceeds 5x. We could raise 	
the rating to 'B+' if QRE increases reserves to at least 700 Bcfe with 	
leverage in the 3.5x-4.5x range.	
	
Related Criteria And Research	
     -- Standard & Poor's Lowers Its U.S. Natural Gas Price Assumptions; Oil 	
Price Assumptions Are Unchanged, April 18, 2012	
     -- Key Credit Factors: Global Criteria For Rating The Oil And Gas 	
Exploration And Production Industry, Jan. 20, 2012	
	
Ratings List	
New Ratings	
QR Energy L.P.	
 Corporate credit rating            B/Stable/--	
	
QR Energy L.P.	
QRE Finance Corp.	
 Senior unsecured	
  $300 mil. notes due 2020          B-	
   Recovery rating                  5
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