TEXT-S&P rates Athabasca Oil 'CCC+'

Wed Nov 7, 2012 4:15pm EST

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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.
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