Overview -- We are revising our outlook on U.S. exploration and production company Quicksilver Resources Inc. to negative from stable to reflect a decline in our assessment of the company's liquidity position. -- We are affirming our 'B-' corporate credit rating on Quicksilver. -- The negative outlook reflects our view that liquidity could deteriorate below levels that are appropriate for the rating. Rating Action On Dec. 17, 2012, Standard & Poor's Ratings Services revised its outlook on Fort Worth, Texas-based Quicksilver Resources Inc. to negative from stable. We also affirmed our 'B-' corporate credit rating on the company. Rationale The outlook revision reflects our updated assessment of Quicksilver's liquidity, following the company's third-quarter results and a higher level of capital spending year-to-date than we had previously anticipated. As of Sept. 30, 2012, Quicksilver's liquidity (cash and borrowing base availability) was $305 million. We project that liquidity will remain at a similar level through the end of 2012 but drop to $260 million at year-end 2013, assuming capital spending of about $485 million in 2012 and $161 million in 2013. However, at the end of 2014, when the company's letters of credit obligations increase to over $300 million, we estimate liquidity will fall to essentially $0. Our assessment of the company's liquidity does not factor in proceeds from potential asset sales or joint venture agreements, which the company continues to actively pursue. Our ratings on Quicksilver reflect the company's "vulnerable" business risk, "highly leveraged" financial risk, and "less than adequate" liquidity. Our assessment of the company's business risk is based on its participation in the cyclical and capital-intensive exploration and production (E&P) industry and its vulnerability to the currently weak natural gas and natural gas liquids (NGLs) markets (given that natural gas and NGLs account for about 80% and 18%, respectively, of its total current production and proven reserve base). Based on actual third-quarter realized prices and costs, Quicksilver's unhedged operating income (EBIT) is negative, while it still carries relatively high debt given acquisition activity over the past few years. The ratings also reflect the company's relatively large proven reserve base for the rating category, low cost structure, and above market-priced hedges on more than half of its natural gas production through 2015. We classify Quicksilver's financial risk as highly leveraged, given the company's aggressive debt levels and the volatility in its cash flows. We estimate the company will generate about $400 million in EBITDA this year, resulting in a debt to EBITDA ratio of 5.5x at year-end. In 2013, we anticipate that EBITDA will decline to $260 million, resulting in a debt to EBITDA deteriorating to 8.5-9.0x. We believe some combination of asset sales, joint ventures, capital spending reductions, and equity issuance will likely be necessary to prevent further deterioration of the company's credit protection measures. Quicksilver has announced plans to form and IPO an upstream master limited partnership (MLP), as well as its intention to enter into joint ventures to develop assets in its emerging basins, particularly in the Horn River Basin (Canada). We do not factor in any potential proceeds from the MLP or joint ventures into our model; if implemented, however, they could improve Quicksilver's credit measures and liquidity, depending on how they are structured. Our projections incorporate the following expectations and assumptions: -- We use a price assumption for Henry Hub natural gas of $3/mmBtu in 2013 and $3.50/mmBtu thereafter. Our assumption for West Texas Intermediate (WTI) crude oil is $80/bbl for 2013 and $75/bbl thereafter. We assume NGLs are priced at 50% of WTI in 2013 and 57% thereafter. -- We have incorporated Quicksilver's hedges into our projections. The company currently has over 60% of its 2013 and 70% of its 2014 natural gas production hedged at prices above $5/mmBtu. -- We forecast that Quicksilver's production will decline about 15% in 2012 to about 358 million cubic feet equivalent per day (mmcfe/d), and remain flat in 2013 as the ramp up in Horn River natural gas volumes offsets declines in the Barnett shale. Liquidity We view Quicksilver's liquidity position as less than adequate. Key elements of Quicksilver's liquidity profile include: -- As of Sept. 30, 2012, Quicksilver had $7.4 million in cash on its balance sheet. -- As of Sept. 30, 2012, the company had $299 million of availability on its $850 million borrowing base on its credit facility maturing in 2016. -- Recently amended covenants on the credit facility require Quicksilver to maintain a minimum EBITDA-to-cash interest expense ratio of 1.5x through March 31, 2014, which steps up to 2.0x as of June 30, 2014, and to 2.5x thereafter; and to maintain a maximum senior debt-to-EBITDA ratio of 2.5x beginning Sept. 30, 2012. -- We expect Quicksilver to remain in compliance with these covenants for at least the next 12-18 months. -- We estimate the company's capital expenditures will total $161 million in 2013 and $200 million in 2014, which exceed our operating cash flow estimates by about $80 million and $130 million, respectively. -- We anticipate the deficits will be funded by drawing down its borrowing base and potential proceeds from asset sales or joint ventures. Recovery analysis Our rating on Quicksilver's senior unsecured debt is 'CCC+' (one notch lower than the corporate credit rating). The recovery rating on this debt is '5', indicating our expectation of modest (10% to 30%) recovery for lenders in the event of a default. The issue rating on Quicksilver's subordinated debt is 'CCC' (two notches lower than the corporate credit rating). The recovery rating on this debt is '6', indicating our expectation of negligible (0% to 10%) recovery for lenders in the event of a default. For the complete recovery analysis, see our recovery report on Quicksilver published Feb. 14, 2012, on RatingsDirect. Outlook Our negative outlook reflects our expectations that although we expect Quicksilver's liquidity to remain above $200 million over the next 12 to 18 months, it could deteriorate significantly at the end of 2014 without the company realizing proceeds from asset sales or joint ventures, or restructuring its letters of credit obligations. However, the company has indicated publicly that it expects to have a joint venture agreement in place around year-end 2012. We could lower the rating if liquidity drops below $200 million, which would most likely occur if the company does not finalize a joint venture. We could revise the outlook to stable if we believe the company will be able to preserve liquidity above $200 million for a sustained period. Related Criteria And Research -- Criteria For Assigning 'CCC+', 'CCC', 'CCC-', and 'CC' Ratings, Oct. 1, 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 -- 2008 Corporate Criteria: Analytical Methodology, April 15, 2008 Ratings List Ratings Affirmed; Outlook Revised To Negative To From Quicksilver Resources Inc. Corporate Credit Rating B-/Negative/-- B-/Stable/-- Ratings Affirmed Quicksilver Resources Inc. Senior Unsecured CCC+ Recovery Rating 5 Subordinated CCC Recovery Rating 6 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.