TEXT-S&P cuts Black Elk Energy Offshore rating to 'CCC+'
Sept 17 - Overview -- U.S. oil and gas exploration and production (E&P) company Black Elk Energy Offshore LLC has borrowed more under its credit facility than we anticipated, and its liquidity is very limited. -- We are lowering our corporate credit rating to 'CCC+'. -- The negative outlook reflects the likelihood for a downgrade if the company is not able to improve its liquidity. Rating Action On Sept. 17, 2012, Standard & Poor's Ratings Services lowered its long-term corporate credit ratings on Houston-based Black Elk Offshore Operations LLC (Black Elk) to 'CCC+' from 'B-'. The outlook is negative. We also lowered our rating on the company's senior secured notes to 'B-' from 'B'. The recovery rating on these notes is '2', indicating our expectation of substantial (70% to 90%) recovery in the event of a default. Rationale The ratings on Black Elk reflect our view of its "vulnerable" business risk and "highly-leveraged" financial risk, incorporating the company's small reserve and production base, high operating costs, and acquisitive growth strategy. The company is geographically concentrated in the Gulf of Mexico region, and operates in a highly cyclical, capital-intensive, and competitive industry. We view Black Elk's reserve and production base as small relative to many of its E&P peers. As of year-end 2011, proved reserves were about 45.2 million barrels of oil equivalent (mmboe), 60% natural gas, and nearly 57% proved developed. These reserves are concentrated in the shallow-water Gulf of Mexico, which Standard & Poor's views as a challenging region due its typically steep decline curves, and resulting high reinvestment requirements to maintain reserve and production levels. The company has made five significant acquisitions since the fourth quarter of 2009 to replace and increase production and reserves. As of year-end 2011, Black Elk had a proved developed reserve life of less than five years, which we view as short. Black Elk also has a relatively high cost structure, with cash operating costs (lease operating expenses, workover expense, production taxes, and general and administrative expenses) of about $38 per boe. With depreciation, depletion, and amortization at $8.57 per boe, Black Elk's all-in unlevered cost is about $46.14 per boe or $7.69 per mcfe for the first half of 2012. To buffer itself from higher costs and provide cash flow stability, we expect Black Elk will continue to hedge a material amount of its projected production. Based on our crude oil and natural gas price assumptions ($85 per barrel of oil in 2012 and $80 in 2013 and $2.50 per thousand cubic feet (Mcf) natural gas in 2012 and $3.00 per mcf in 2013), we forecast that Black Elk will generate between $75 million to $100 million of EBITDA over the next 12 months, and have debt of about $270 million, including standard analytical adjustments. Under these assumptions the company's adjusted debt leverage will be about 3.0x debt to EBITDA. We forecast funds from operations (FFO) of approximately $50 million, which is not adequate to fund projected capital expenditures of $40 million over the next 12 months, and escrow funding of approximately $30 million. Operating cash flows will benefit from Black Elk's exposure to crude oil, which should be about 40% of production, and because oil on the Gulf Coast receives a premium to NYMEX benchmark pricing. Liquidity In our assessment, the company has "weak" sources of liquidity, reflecting the following expectations and assumptions: -- We believe expected sources of liquidity will cover expected uses of liquidity by less than 1.2x over the next 12 months. -- As of Aug. 7, 2012, Black Elk had about $7 million available under its $70 million revolving credit facility that matures in December 2013 and about $17 million in cash. Black Elk also maintains a $125 million facility to support letters of credit relating to plugging and abandonment activities. -- We expect the company will generate insufficient operating cash flow to cover its anticipated capital expenditures and escrow requirements for asset retirement obligations. -- Black Elk's covenants limit it to a maximum leverage ratio of 2.5x, a minimum interest coverage ratio of 3x, minimum SEC PV-10 to consolidated leverage ratio of 1.4x, and a maximum capital spending program not to exceed 30% of the prior year's EBITDAX. Recovery analysis For the complete recovery analysis, see Standard & Poor's recovery report on Black Elk to be published on RatingsDirect after this release. Outlook The negative outlook reflects the potential for Black Elk's liquidity to deteriorate further. We would consider a negative rating action if the company faces additional weakening of its liquidity resulting from failure to curtail capital spending, operational problems that reduce production, or materially lower crude oil prices. We would consider a positive rating action if the company is able to improve liquidity to about $40 million while maintaining production. Given its current low level, the company's leverage is not an impediment to positive rating actions. Related Criteria And Research -- Key Credit Factors: Global Criteria For Rating The Oil And Gas Exploration And Production Industry, Jan. 20, 2012 -- Standard & Poor's Raises Its U. S. Natural Gas Price Assumptions; Oil Price Assumptions Are Unchanged, July 24, 2012 -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- 2008 Corporate Criteria: Our Rating Process, April 15, 2008 Ratings List Downgraded; Outlook Negative To From Black Elk Energy Offshore Operations LLC Corporate Credit Rating CCC+/Negative/-- B-/Stable/-- Black Elk Energy Offshore Operations LLC Black Elk Energy Finance Corp. Senior Secured B- B Recovery Rating 2 2 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.