TEXT-S&P rates QR Energy LP
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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