DBRS Confirms Stability Rating of Bonavista Energy Trust at STA-5 (middle)

DBRS has today confirmed the stability rating of Bonavista Energy Trust (Bonavista or the Trust) at STA-5 (middle), which reflects the Trust’s balanced production profile, low cost structure and conservative payout ratio. The rating is limited somewhat by its relatively high balance sheet leverage based on debt to capital, although debt to cash flow is comparable to its peers.

The Trust has taken a more conservative approach to distributions than its peers, given its target payout of 50% to 60% of operating cash flow (48% for the six months ended June 30, 2008, down from 68% in 2006). This is in line with its objective to maintain a sustainable business model by replacing reserves depleted by production through re-investment. Monthly per unit distributions of $0.30/unit have been maintained since October 2006, when a 9% cut (from $0.33) was made due to weakening natural gas prices. The current distribution level remains above Bonavista’s $0.28/unit base distribution rate with any increase above that rate designated as a supplementary distribution (a unique feature among royalty trusts) based on realized commodity prices in excess of budget prices. The base distribution assumes realized oil prices of $80.00/barrel at Edmonton for light crude and natural gas prices of $8.00/mcf at AECO, and should be achievable based on current market conditions.

While Bonavista has indicated that its structure may change post-2011 due to the proposed taxation of income trusts, final implementation concerning capitalization and payout ratios will be further reviewed as additional details surface. Further, in response to the Alberta government’s proposed increased royalty regime, the Trust believes its average royalties will only increase by 3% to 4%, though Bonavista will continue to monitor the impact of the new royalty regime, as final implementation details are still uncertain. In both instances, DBRS does not believe the changes will have a material impact on the Trust’s stability rating in the near term.

Bonavista’s rating reflects the following strengths: (1) The Trust’s balanced production profile (currently 47% liquids/53% natural gas) provides an element of stability for distributions. (2) Despite escalating industry-wide costs, Bonavista’s focus on maintaining a low cost structure, as reflected in production costs and indirectly in depreciation, depletion and amortization (DD&A) (the latter as a proxy for its low finding and development (F&D) costs), has led to higher profitability and higher netbacks for the Trust. Bonavista’s return on capital and netbacks compare favourably to its peers. (3) Bonavista has a large undeveloped land base (1.2 million net acres and prospect inventory of more than 700 locations) that provides opportunities for development and growth, reducing the need for acquisitions in the near term, and compares well relative to its peers. (4) Credit metrics have improved from 2007 as a result of strong cash flow, helped by the robust commodity prices and an equity issue of $214 million in April 2008.

Limitations for the Trust include: (1) Cash flow remains largely dependent on volatile oil and gas prices, causing fluctuations in distributable income. However, this is partially mitigated by Bonavista’s balanced production profile and its hedging policy. The Trust put hedges in place for approximately 32% of 2008 and 25% of 2009 forecasted production using mostly costless collars. Bonavista’s board has authorized hedging of up to 60% of production/year, providing a platform for cash flow stability and a means to protect acquisition economics. (2) Bonavista’s seven-year proved reserve life index remains shorter than the more than eight-year average of its peers. (3) After a three-year span of impressive reserve replacement (averaging 235% mostly through acquisitions), Bonavista’s reserve additions covered about 93% of production for the past two years, which is still considered adequate relative to its peers. The Trust is operating in mature basins and thus faces challenges to replace production both internally and through acquisitions, though this is partially mitigated by Bonavista’s large undeveloped land base. (4) At June 30, 2008, approximately 22.3 million units were issueable upon exchange of the exchangeable shares, representing about 24% of total units outstanding, of which more than 80% was owned by management. These will eventually be exchanged into units, and thus place gradual upward pressure on distributions in order to maintain the same payout ratio.

DBRS expects the Trust to maintain its $0.28/unit base distribution rate. The additional $0.02/unit distribution provides a buffer for temporary declines in commodity prices, though this is partially mitigated by Bonavista’s balanced production profile and hedging arrangements. The Trust is forecasting 2008 cash flow to be around $735 million, which is expected to cover 90% of its forecasted capex of $490 million and distributions of $329 million, with modest external financing therefore required. As of June 30, 2008, Bonavista had $368 million available under its $1 billion credit facility expiring in August 2010 to support financing requirements. DBRS expects leverage and cash flow coverage metrics to remain near current levels over the near term. While Bonavista continues to look for well priced acquisitions, its acquisition history suggests that any additional leverage resulting therefrom would be relatively modest.

Note:
All figures are in Canadian dollars unless otherwise noted.