TEXT-S&P rates Athabasca Oil 'CCC+'
Overview -- We are assigning our 'CCC+' long-term corporate credit rating to Athabasca Oil Corp. (AOC). -- We are also assigning our 'B' issue-level rating to the company's proposed senior secured second-lien bonds, with a '1' recovery rating. -- The rating reflects our view of the company's regionally focused upstream operations, its small (albeit growing) production base, the associated weak forecasted cash flow generation, and inability to internally fund its stated conventional and oil sands growth objectives. -- The developing outlook reflects our view that, based on AOC's prospective competitive position, there is almost an equal likelihood of its credit profile strengthening or deteriorating during our forecast period. Rating Action On Nov. 7, 2012, Standard & Poor's Ratings Services assigned its 'CCC+' long-term corporate credit rating to Calgary, Alta.-based upstream producer Athabasca Oil Corp. (AOC). The outlook is developing. At the same time, Standard & Poor's assigned its 'B' issue-level rating to The company's proposed senior secured second-lien bonds, with a '1' recovery rating, indicating an expectation of very high (90%-100%) recovery for debtholders in a default scenario. Rationale The rating on AOC reflects Standard & Poor's view of the company's regionally focused upstream operations, its small (albeit growing) production base, the associated weak forecasted cash flow generation, and inability to internally fund its stated conventional and oil sands growth objectives. We believe that offsetting these weaknesses somewhat are AOC's ability to sell portions of its vast undeveloped acreage and its liquidity position, which we believe is enhanced by both its proposed C$600 million senior secured bond issue; and the company's ability to sell its 40% interest in the Dover property through its put-call agreement with its joint venture partner, Phoenix Energy Holdings Ltd. (previously, Cretaceous Oilsands Holdings Ltd.; a wholly owned subsidiary of PetroChina International Investment Co. Ltd.). AOC focuses on the development of conventional oil and gas and in-situ bitumen. It operates two business segments: the light oil division and thermal oil division. AOC's conventional oil and gas operations are concentrated in northwest Alberta, and its bitumen resources are in Dover, Dover West, Hangingstone, Birch, and Grosmont (all in the Athabasca oil sands fairway). In our opinion, the company's vulnerable business risk profile reflects its regionally focused upstream operations and low forecast production, which we do not expect to generate sufficient operating cash flow to support growth objectives during our 2012-2013 forecast period and beyond. Due to the limited scope of its operations and low levels of cash flow generation, we believe AOC would be unable to adjust its operating strategy to offset normally occurring industry events, such as hydrocarbon price volatility, unanticipated operational issues, or material capital cost overruns. Although we believe the company should be able to continue increasing its conventional oil and gas production in the near and medium term, in our opinion, its relatively small reserves (which includes its total proven reserves and probable oil sands reserves) and production base will continue to hamper AOC's competitive position. In addition, the company's reserves base incorporated in our assessment of its competitive position includes a much higher component of probable oil sands related reserves than other companies in Standard & Poor's Canadian oil and gas ratings universe. In our view, the high proportion of probable reserves in the reserves base we incorporate in our assessment of the company's business risk profile heightens its operational risk exposure. Although these factors limit the prospective business risk profile, we believe the organic growth prospects inherent in AOC's 4.3 million net acres of undeveloped land, as well as its projected conventional oil and gas production growth could likely support a 'B-' rating beyond the near term. The company has amassed a considerable land position, including both conventional and unconventional resources, which we believe provide an internal growth profile reflective of a stronger rating than the current 'CCC+'. In our view, the company should be able to continue ramping up its conventional oil and gas production beyond its forecast 10,000-11,000 barrels of oil equivalent per day expected production exit rate at year-end 2012. Nevertheless, Standard & Poor's believes the company's production levels will not generate sufficient cash flow to support its organic growth objectives for several years. Despite the low levels of expected cash flow generation, we believe AOC's conventional oil and gas operations are in areas with a competitive cost profile, so it should be able to generate positive netbacks in a midcycle hydrocarbon price environment if the company's full-cycle costs remain consistent with regional averages. In our opinion, AOC's highly leveraged financial risk profile reflects our forecasted negative free cash flow generation, as our estimates of the company's funds from operations (FFO) will remain insufficient to support its growth objectives during our forecast period and beyond. Based on Standard & Poor's hydrocarbon price, heavy oil price differential, inflation and exchange rate assumptions for 2012-2014, we expect AOC's capital expenditures, as it continues to increase its conventional oil and gas operations, and begins developing its in-situ resources, will significantly outpace our FFO estimates well beyond our forecast period. Although we believe AOC's fully adjusted pro forma debt-to-EBITDA following the proposed C$600 million debt issue will remain above 9.0x at year-end 2012, cash flow protection metrics should improve materially by year-end 2013, as increasing production and cash flow generation should offset the company's relatively low balance sheet leverage. Liquidity In our view, AOC's liquidity will be adequate to support its expected spending in 2012 and 2013. Our assessment of the company's liquidity position assumes both its proposed C$600 million bond issue and sale of its 40% ownership interest in the Dover oil sands project occurs during our liquidity assessment period. Without these transactions, liquidity would be significantly weaker, given the large disparity between forecast FFO and anticipated capital expenditures. Recovery analysis For the complete recovery analysis, see the recovery report to be published on RatingsDirect on the Global Credit Portal following this research report. Outlook The developing outlook reflects Standard & Poor's view that, based on the company's prospective competitive position, there is almost an equal likelihood of its credit profile strengthening or deteriorating during our forecast period. If AOC's production and cash flow profile strengthen in the future, we believe the company's business and financial risk profiles could support a 'B-'rating, assuming debt remains relatively stable. The company's cash flow protection metrics should strengthen materially as cash flows continue increasing relative to fairly stable debt levels. We believe AOC should be able to continue increasing its conventional oil and gas production as it ramps up the development of the assets in its light oil division. Although forecast FFO will likely remain well below our estimated near- and medium-term capital expenditures for the company, cash flow protection metrics should strengthen by year-end 2013 and beyond. Under our assumptions, we believe AOC's fully adjusted debt-to-EBITDA could trend below 6.5x by year-end 2013. If the company is able to continue improving its cash flow protection metrics, as it increases its oil and gas production, we would raise the rating to 'B-'. Conversely, we believe the company's credit profile is also vulnerable to near-term deterioration, because the small scale of its operations limits its ability to absorb unexpected adverse events, which we believe could occur due to the oil and gas industry's inherent volatility. Furthermore, AOC's prospective liquidity relies heavily on anticipated asset sales and its proposed debt issuance, so we believe the company will have limited ability to fund material cost overruns if capital expenditures increase above the levels expected from 2012-2014. As a result, if the company's liquidity position were to weaken materially, such that it would not be able to increase or sustain its operations, we would lower the rating. Related Criteria And Research -- Key Credit Factors: Global Criteria For Rating The Oil And Gas Exploration And Production Industry, Jan. 20, 2012 -- Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 -- Canadian Oil Sands Projects: How We Rate Them, And Why, March 17, 2011 Ratings List Ratings Assigned Athabasca Oil Corp. Corporate credit rating CCC+/Developing/-- Proposed senior secured bonds B Recovery rating 1 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.