TEXT-S&P summary: Murphy Oil Corp.
The 2011 production decline at its Kikeh field in Malaysia, about 30% of 2011 production, and its impact on overall production point to the need for greater diversity of reserves and are a significant factor in the company's growing focus on onshore resource plays. Mechanical issues on several Kikeh wells were the main driver of a 19% fall in oil production in 2011. Although much of this decline was offset by increased natural gas production at its Tupper field in Canada, the weak outlook for natural gas prices limits the benefit of that growth. We expect future operational results to become more consistent as Murphy shifts its focus to resource plays and development drilling. In particular, Murphy's Eagle Ford, Seal, and Montney plays should provide more consistent operational results.
An offset to Murphy's modest scale are the benefits from its historical focus on crude oil and natural gas liquids, as well as the higher natural gas prices received for its Sarawak (Malaysia) production. Murphy's estimated 2011 profitability of about $26 of unhedged EBIT per barrel is one of the highest in the investment-grade category. Murphy's operating costs of about $17.00 per barrel are also consistent with higher rated, oil-weighted peers, and support its strong profitability. Murphy's all-in, leveraged costs, about $40 per barrel historically, are higher than peers, but remain adequate at our long-term price assumption of $75 crude oil.
Our assessment of Murphy's financial risk reflects a history of conservative financial policies. We expect adjusted debt leverage to average around 1.0x or less based on Standard & Poor's long-term price assumptions of $75 per barrel crude oil and $3.50 per mmbtu natural gas. Our forecast assumes Murphy would reduce capital spending in a $75 price environment and that current operating costs would decline as well. As a result, under our long-term assumptions, funds from operations (FFO) should be about $3 billion to $3.5 billion, generating strong FFO-to-debt of 75% or greater. In addition, debt-to-debt-plus equity would remain around 20% or less, and EBITDAX coverage of interest expense would average over 20x.
We view Murphy's liquidity position as "strong." Our assessment of Murphy's liquidity includes the following factors:
-- The company had cash on hand of $672 million as of June 30, 2012.
-- Murphy had Canadian Government securities of $471 million as of June 30.
-- We estimate that Murphy has most of its $1.5 billion credit facility due 2016 available.
-- Murphy, as do most E&P companies, has the ability to materially reduce capital spending if needed, while continuing to generate cash flow.
-- Murphy has good access to capital markets thanks to its conservative financial policies, and would be able to utilize them if needed.
We expect Murphy to maintain strong cash and marketable security levels as a buffer against its higher risk exploration strategy and its lack of hedging. We also expect Murphy to remain well within its debt leverage covenant of 60%.
The stable outlook reflects expectations that Murphy will maintain adjusted debt leverage of about 1x or less and FFO-to-adjusted debt of 75% or better. In addition, we expect the performance of the Kikeh field to improve and that Murphy will be able to successfully accelerate growth of its onshore resource plays.
We could lower ratings if adjusted FFO to debt falls below 30%, which we do not expect at our current price assumptions. It would take a prolonged period of low crude oil and gas prices, below $60 per barrel and $2 per mmBtu, or a significant decline in production to reach that threshold given the company's low debt levels.
An upgrade is unlikely over the next 24 months given Murphy's limited scale of operations and shorter reserve life relative to other investment-grade peers. Murphy would likely need to reach 2 billion barrels of oil equivalent, roughly 4 times its current reserve base, before we would consider an upgrade.
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