DBRS Confirms 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 was previously confirmed on July 20, 2009, following the Trust’s proposed acquisition of oil and gas properties from EnCana Corporation (the Transaction). The Transaction closed on August 20, 2009 (effective date of April 1, 2009) for $698 million and was financed by 40%/60% debt and equity, with a modest impact on the Trust’s financial metrics. It is also expected to be slightly accretive to per unit cash flow. To enhance its liquidity position, Bonavista added a $400 million credit facility to its existing $1 billion facility and raised $421 million through a fully underwritten equity issuance (for 25,000,000 additional trust units).

The Transaction added approximately 11,400 gross barrels of oil equivalent per day (boe/d) of predominantly gas-weighted assets (78%), representing a strategic move to propel the Trust to a higher gross production level (+22%) of approximately 62,000 boe/d (net of royalties of about 51,000 boe/d; 61% gas-weighted versus 57% as of September 30, 2009) after the southeast Saskatchewan disposition, potentially improving economies of scale. The purchase price of approximately $60,880 per flowing barrel of production and $18.58/boe of proved reserves, while relatively high compared with current commodity pricing, is acceptable, given the expected relatively low operating cost per boe and substantially lower finding and development and onstream costs projected on future developments. Furthermore, the acquired properties are characterized by high working interests and operatorship with extensive infrastructure. These properties added 136,000 net acres of undeveloped land to Bonavista’s increasingly important central Alberta core area, 77% of which is freehold with a minimum five-year term and a favourable royalty structure equating to 80% of Alberta’s New Royalty Framework. As a result, the lower cost base should provide higher netbacks relative to the Fund’s existing operations. On a proforma basis, the Trust’s proved reserve life index increased to 7.8 years (7.4 years in 2008), although this is still low in comparison with its DBRS-rated peers.

The Trust maintains a more conservative approach to distributions than its peers, given its target payout of 50% of operating cash flow (52% for the nine months ended September 30, 2009 (9M 2009)). This is in line with its objective to maintain a sustainable business model by maintaining production and replacing reserves depleted through re-investment. On a five-year average basis, 85% of production was replaced internally, ahead of most of its peers. With the sharp drop in commodity prices and weaker economic environment, the Trust cut distributions from $0.30/unit to $0.20/unit in January 2009 and subsequently to $0.16/unit in March 2009, a level that DBRS expects the Trust to maintain. Bonavista currently forecasts 2009 cash flow at the $460 million to $470 million level, which covers the forecasted capex of $250 million (excluding the Transaction) and distributions of $218 million. In the post-Transaction period following the related financing, DBRS expects the Trust’s balance sheet leverage and cash flow coverage ratios to weaken slightly from current levels. Debt-to-capitalization rose to approximately 34%, but remains at reasonable levels. Extrapolated from the Trust’s forecast for 2009, DBRS estimates proforma debt-to-cash flow at about 1.9 times from 1.19 times for the last 12 months to March 31, 2009 (LTM to March 31, 2009) when the Transaction was announced. While relatively higher than its peers, this ratio is within the parameters of the current stability rating in a lower commodity pricing environment. In addition, the Trust maintains sufficient liquidity through a $1.4 billion three-year credit facility to August 2011 ($544 million undrawn currently).

Bonavista’s rating also reflects the following strengths: (1) The Trust’s relatively balanced production profile (proforma 39% liquids/61% natural gas) provides an element of stability for distributions, notwithstanding current low gas prices. (2) Despite escalating industry-wide costs in recent years, Bonavista’s focus on maintaining a low cost structure, as reflected in production costs ($13.96/boe for 9M 2009) and indirectly in depreciation, depletion and amortization ($16.88/boe) – the latter as a proxy for its low finding and development costs – has led to higher profitability and higher netbacks for the Trust. (3) Bonavista has a large undeveloped land base (1.2 million net acres post-Transaction) that provides opportunities for development and growth, reducing the need for acquisitions in the near term, and compares well relative to its peers.

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 the Trust’s relatively lower payout targeted at about 50% of operating cash flow and hedging policies. Hedges are in place for approximately 23% of 2009 and 25% of 2010 forecasted production using mostly costless collars. Bonavista’s board has authorized hedging of up to 60% of forecast production, providing a measure of cash flow stability and a means to protect acquisition economics. (2) Bonavista’s proforma 7.8 year proved reserve life index, while improved, remains shorter than the average of its DBRS-rated peers. However, its return on equity remains above average. (3) The Trust is operating in mature basins and will continue to face challenges to replace production both internally and through acquisitions, though this is partially mitigated by its large undeveloped land base. (4) At September 30, 2009, approximately 21.0 million units were issueable upon exchange of the exchangeable shares, representing about 17% of total units outstanding, of which over 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. However, the management ownership, among the highest of its trust peers, also contributes to Bonavista’s consistent and improving performance.

In response to the Alberta government’s increased royalty regime, the Trust believes its average royalties will only increase by about 4%. 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. DBRS does not believe that the changes will have a material impact on the Trust’s stability rating in the near term.

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

The applicable methodology is Rating Oil and Gas Companies, which can be found on our website under Methodologies.

This is a Corporate rating.