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Sustained Sub-$50 Oil Could Hurt Some HY E&P Ratings

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Monday, July 31, 2017 9.25AM / Fitch Ratings 

A sustained sub-$50 crude oil price scenario through 2018 will likely drive weaker operating profiles and lower production forecasts for some high yield oil exploration and production (E&P) companies, pressuring their ratings, Fitch Ratings says. For most, however, credit quality is expected to improve if prices remain at or above $50 per barrel. 

Fitch expects that further rating actions for high-yield E&P issuers will be focused and not generalized across the entire sector. However, we believe twelve months or more of oil prices sustained at or below $45/bbl could pressure ratings at select high-yield issuers. Prolonged oil price pressure would likely worsen negative free cash flow profiles for more vulnerable E&P companies, with increasing calls on liquidity and the potential for lower EBITDA to push leverage above base case expectations. 

In a sustained $40/bbl environment, operating conditions would be more challenging. Ratings could come under pressure during a shorter period (as little as 6 to 12 months) for firms with high exposure to oil prices, limited liquidity runways, or weak cost positions. 

E&P issuers with greater leverage sensitivity to low oil prices include MEG Energy, Denbury Resources and California Resources. Fitch would expect any downgrades in an extended sub-$50/bbl scenario to be focused on E&P's with weaker liquidity, higher full-cycle costs, and limited hedge protection. 

Most high yield E&P issuers in our coverage universe are likely to survive, and in select cases thrive, when oil prices remain above $50 per barrel. Survivors of the 2016 industry shake-out, when many high yield E&P companies filed for bankruptcy protection, generally continue to benefit from higher quality assets, good cost positions and lower debt levels than the debt-heavy players in the early shale period. 

Using Fitch's base case price deck (West Texas Intermediate: $50/bbl in 2017, $52.5/bbl in 2018) forecasts for most issuers point to better cash flow generation and credit metrics, based on stable-to-improving cost structures and deleveraging through volume growth and margin expansion. 

We consider a variety of oil and natural gas price scenarios to test the survivability and relative positioning of E&P companies. Additional scrutiny is given to the volume forecasts and credit metrics in the next 12-24 months, particularly if bridge liquidity or capital market access to refinance near-term maturities are viewed as concerns. 

A deeper look at the impact of lower oil prices and their impact on E&P issuers can be found in the report "High Yield E&P Scenario Analysis," published today at www.fitchratings.com. 

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