-- We are assigning our 'B+' long-term corporate credit rating to Trilogy
-- We are also assigning our 'B' issue-level rating to the company's
proposed offering of up to C$300 million senior unsecured notes, with a '5'
-- The ratings reflect our view of Trilogy's operations in the highly
cyclical, capital-intensive industry; weak profitability compared with those
of peers; competitive cost profile; increasing liquids production; and
improving credit measures.
-- The stable outlook reflects our expectation that Trilogy's liquid
production and cash flow will rise in the next 12-18 months, lowering its
debt-to-EBITDAX measure below 2x through 2014.
On Nov. 30, 2012, Standard & Poor's Ratings Services assigned its 'B+'
long-term corporate credit rating to Calgary, Alta.-based independent oil and
gas exploration and production (E&P) company Trilogy Energy Corp. The outlook
is stable. At the same time, Standard & Poor's assigned its 'B' issue-level
rating to the company's proposed C$300 million senior unsecured notes with a
'5' recovery rating, indicating an expectation of modest (10%-30%) recovery
for debtholders in a default scenario.
The rating on Trilogy reflects Standard & Poor's view of the company's "weak"
business risk profile and "aggressive" financial risk profile. We view the
company's management as "fair". The ratings also reflect our view of Trilogy's
operations in a highly cyclical, capital-intensive, and competitive industry;
weak profitability compared to its peers; and limited geographic and
operational diversity. We believe the company's competitive cost structure and
increasing liquids production offset these weaknesses somewhat. In our
opinion, Trilogy's aggressive financial risk profile reflects the company's
improving credit measures and high fixed costs.
Trilogy is a midsize E&P company (it had about 64 million barrels of oil
equivalent of gross proved reserves at year-end 2011 and about 33,400
barrels per day production for third-quarter 2012) that operates mostly
in Alberta. About 95% of the company's reserves and production are from the
Kaybob region in Alberta. Pro forma the proposed notes offering, Trilogy will
have about C$730 million in adjusted debt (our adjustments include asset
retirement obligations [about C$139 million] and operating leases [about C$12
The company's cash flow is exposed to the highly volatile and
capital-intensive oil and gas E&P industry. In peak periods, hydrocarbon
prices rise markedly and large profits result. Currently, E&P companies are
benefiting from elevated oil prices; however, in the long term, the risk
remains that oil prices could decline.
Trilogy's profitability (per boe)is weaker than that of its 'B+' rated peers.
Nevertheless, in the next 12-18 months we expect it to improve because we
forecast liquids, which are more profitable than gas, to be about 50% of the
company's 2013 production from 40% in 2012. However, we forecast Trilogy's
profitability to remain weak compared to peers due to the Canadian crude
discount to West Texas Intermediate (WTI) and pressure on lighter natural gas
liquids prices. At the same time, low natural gas prices will continue to
weigh on the company's profitability.
We believe Trilogy's limited operational diversity is a credit weakness. The
company's existing operations are focused in the Kaybob region of Alberta. Any
production downtime in the region would hurt the company's production, since
Trilogy would be unable to replace production from elsewhere. For example,
infrastructure delays in the area lowered the company's 2012 expected
production to 34,000 bpd compared with the original 40,000 bpd.
Trilogy has a competitive cost structure. We expect the company's cash
operating costs (includes operating, transportation, and general and
administrative costs) to remain competitive and stable as it increases its
liquids production. We also expect Trilogy's future levered costs (combination
of cash operating costs, depreciation and exploration costs, and interest
expense) to remain a competitive C$32 per boe, allowing it to continue to
generate positive netbacks. If the company cannot maintain its competitive
cost structure as it increases production, a negative rating action could
We view as credit positive Trilogy's increasing liquids production due to
their higher netbacks compared with those of gas, and rising contribution to
future cash flow. Between the Kaybob's Montney oil pool and South-Montney Gas
development, we expect 2013 liquids production to be about 19,000 bpd, up from
approximately 12,500 bpd in third-quarter 2012. Montney oil pool production
has high netbacks (above C$40 per boe) when compared with the company's
consolidated netback of C$18 per boe. Therefore, we expect Trilogy's EBITDA
and funds from operations (FFO) to improve significantly in 2013 as Trilogy
brings the Montney oil pool production online. We believe the completion of
the infrastructure in Kaybob region should allow the company to be able to
grow its production without any significant bottlenecks in the near term. The
presence of multiple geological formations within its geographically
concentrated reserves provides significant opportunities for growth in the
Under our July 2012 price scenario, and assuming the current correlations
between WTI prices and realized crude prices hold (about 15%-20% discount),
Standard & Poor's expects Trilogy to generate EBITDA of C$375 million-C$425
million in 2013 and 2014. We expect the company to end 2014 with its
debt-to-EBITDA below 2x and its (FFO-fixed charges)-to-debt at 20%-30%. Our
assumptions include the following:
-- Standard & Poor's WTI price assumptions are US$85 per boe for 2012,
US$80 for 2013, and US$75 for 2014; Henry Hub gas price assumptions are
US$2.50 per million BTU for 2012, US$3.00 for 2013, and US$3.50 for 2014.
-- Production in 2013 and 2014 will increase 15%-20% with gas remaining
at 50%-55% of total production.
-- Unit full-cycle costs will be unchanged.
-- Fixed costs (maintenance capex and dividends) for 2013 and 2014 are
-- We expect that the company will fund its negative discretionary free
cash flow (free cash flow minus cash dividends) with debt.
Pro forma the proposed notes offering, we expect Trilogy's cash flow strength
to remain relatively strong compared with our guidelines for an "aggressive"
financial risk profile (total adjusted debt-to-EBITDA of 3x and total adjusted
FFO-to-debt of 30%). Its fixed charges are high, in our view, and include a
maintenance capex (to keep production flat) of C$150 million-C$180 million and
dividend of about C$50 million. Taking these fixed charges into account,
Trilogy's (FFO-maintenance capex-cash dividends)-to-debt drops to below 0%. If
we remove cash dividends, FFO and maintenance capex-to-debt still remains near
0%, which we believe is weak. However, we believe the company's lower
balance-sheet debt compared with that of similarly rated peers is beneficial;
we believe it offsets the risks associated with Trilogy's lack of diversity
and seasonal limitations on annual production common to most Alberta-based
We believe the company's liquidity is adequate, pro forma the C$300 million
notes offering. Our assessment of the liquidity profile incorporates the
following expectations and assumptions:
-- We expect Trilogy'ssources of liquidity, which includes funds from
operations, availability under the revolving facility, and proceeds from
notes, to be 1.2x total uses in the next 12-18 months.
-- We expect the company to fund its uses even if EBITDA dropped 15%, due
to a drop in hydrocarbon prices.
-- It has adequate flexibility in its capital program to reduce it to its
maintenance capital expenditure of C$150 million-C$180 million, to preserve
Trilogy has about C$62 million available under its C$650 million revolving
facility. Following the notes offering, its revolving facility will fall to
C$610 million and liquidity will increase to about C$300 million. We view the
company's sources of liquidity as including positive funds from operations and
credit line availability. We calculate minimum fixed charge for Trilogy at
about C$200 million (includes maintenance capex and dividends), which it
should be able to cover by its funds from operations.
Following the notes placement, we expect the facility's financial maintenance
covenants to include a maximum senior debt-to-EBITDA ratio of below 3x and
maximum consolidated debt-to-EBITDA ratio of below 4x.
For the complete recovery analysis, see the recovery report to be published on
RatingsDirect on the Global Credit Portal following this report.
The stable outlook reflects our view that Trilogy's capital spending program
in the Kaybob region will result in increased oil production and reserves.
Given its increasing liquids production, we foresee the company maintaining
credit protection measures that are adequate for the rating, with leverage
projected to be below 2x in the next two years. Because we factor expected
reserves and production growth into the ratings, there is little likelihood of
an upgrade during this period.
A positive rating action for Trilogy would depend on an improving business
risk profile: for example, as the company increases its reserves and expands
its operations such that its increased liquids production leads to the
doubling of netbacks. We would also expect that the balance-sheet profile will
not deteriorate materially through this period of growth.
We could lower the ratings if Trilogy cannot achieve the expected production
growth (15%-25%) in 2013, profitability deteriorates significantly either due
to lower realized commodity prices or higher cost profile, or if its
debt-to-EBITDA deteriorates to above the 4.0x-4.5x range. Trilogy's current
debt-to-EBITDAX ratio provides it with ample financial flexibility to outspend
its internally generated cash flow. Based on our forecasts we view a downgrade
as unlikely through 2014.
Related Criteria And Research
-- Methodology: Business Risk/Financial Risk Matrix Expanded, Sept. 18,
-- Revised Assumptions For Assigning Recovery Ratings To The Debt Of Oil
And Gas Exploration And Production Companies, Sept.14, 2012
-- Standard & Poor's Raises Its U.S. Natural Gas Price Assumptions; Oil
Price Assumptions Are Unchanged, July 24, 2012
-- 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
-- Recovery: Criteria Guidelines For Recovery Ratings On Global
Industrials Issuers' Speculative-Grade Debt, Aug. 10, 2009
-- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008
-- 2008 Corporate Criteria: Ratios And Adjustments, April 15, 2008
Trilogy Energy Corp.
Corporate credit rating B+/Stable/--
Senior unsecured debt
Sr unsecd nts due 12/31/2019 B
Recovery rating 5
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