DBRS Confirms Talisman Energy at BBB (high), Stable Trend

DBRS has today confirmed the Unsecured Debentures & Medium-Term Notes rating for Talisman Energy Inc. (Talisman or the Company) at BBB (high) with a Stable trend. The rating confirmation reflects the Company’s continued improved financial profile helped by substantial divestiture programs since 2006, and progress made on the operational front, primarily to deliver on production growth (albeit marginal to date) from continuing operations. Talisman has continued to strengthen its balance sheet and to re-invest in growth assets in the North Sea (N. Sea) and in Southeast Asia (S.E. Asia), which have generally generated the highest returns among its operating regions. The Company has also accelerated lower cost, longer life unconventional shale gas developments, principally in Pennsylvania Marcellus, as a strategic move to augment its gas-weighted conventional operation in North America (N. America). Shale gas will assume increasing importance, expected to represent about half of the region’s gas volumes in 2011 (about one-sixth of total output) from 25% in 2010 (achieved in Q2 2010) and a minimal position in early 2009. As a result, the Company projects 5% to 10% overall production growth in 2011, which DBRS expects should be achievable to some extent, including the recent acquisition outlined below.

However, the estimated $3.5 billion of shale gas investments have added substantially to the cost base as the full impact of the program has yet to materialize. Reserve replacement cost (three-year average of $38.08/boe) remains high among its peers, albeit improved slightly from 2008 when the program commenced. Similarly, reserve life of about 9.1 years remains below the industry average, although this was impacted by non-core divestitures and higher production in 2009.

During the Company’s growth phase, balance sheet leverage will likely creep up, although still within the parameters of the current credit rating. Debt-to-capital will likely remain below the low end of the Company’s guidance range of 35% to 45% and debt-to-cash flow will likely remain well below 2.0 times (below 1.5 times estimated by DBRS), respectively, helped by hedges covering about 35% of 2010 planned volumes. DBRS expects the Company to continue to focus on improving capital efficiency, its cost base and its production reliability. Improvement has been seen in H1 2010 and 2009 with marginally higher gross production volumes (both up 2%) from continuing operations (down 3% including discontinued operations).

On August 3, 2010 (see separate press release), the Company agreed to acquire certain oil-weighted assets through a share purchase of BP Exploration Company (Colombia) Limited (the Colombia Purchase) in a joint bid with Ecopetrol S.A. (ECP). As the Company’s share of the proposed acquisition costs of US$930 million (including estimated working capital adjustment) will be funded with cash on hand (approximately $2.5 billion at June 30, 2010), DBRS expects minimal impact on the Company’s credit metrics. Although the transaction will raise the Company’s political risk exposure slightly, this risk is considered manageable and in line with the Company’s corporate strategy to expand its presence in South America (S. America), principally Colombia (rated BBB (low)) and Peru (rated BBB (low)). ECP, a 51% joint venture partner and the operator, is a leading oil and gas company in Colombia and is majority owned by the government. It is also a partner with Talisman in several blocks in Colombia and Peru. The transaction will add proved reserves of approximately 47 million boe and more than 12,000 boe/d (3% of current production) of production, net to Talisman. The Company targets to grow production to at least 50,000 boe/d in S. America.

DBRS expects that the acquisition, together with the Company’s capex program ($4.6 billion, potentially reduced to $4.3 billion to $4.4 billion), will be funded by operating cash flow, proceeds from asset sales (expected to be $1.9 billion in 2010, with $1.5 billion received) and cash on hand. As a result, the Company’s adjusted total debt-to-capital ratio (31% at June 30, 2010, or 25% excluding operating leases) and adjusted total debt-to-cash flow (1.16 times for the 12 months (LTM) ended June 30, 2010) will remain unchanged, although these ratios on a net of cash basis will weaken slightly. Nevertheless, these are still strong levels for Talisman’s current long-term debt rating.

The Colombia Purchase is an affirmation of Talisman’s increased focus in S. America with a view to develop a new core area. S.E. Asia remains a growth area with 8% to 10% annual growth projected for the next four to five years. The U.K. will continue to generate significant free cash flow to augment growth in other areas, while Norway is expected to be self-funding based on existing projects. Based on WTI of US$78.39/b and NYMEX of US$4.92/mcf and hedges in place at above current commodity prices, the Company should be able to fund the bulk of its capex with cash flow supplemented by asset disposal proceeds. The Company also maintains sufficient liquidity through its unused credit facilities of $2.8 billion and substantial cash balances (net $1.5 billion after the Colombia Purchase) at June 30, 2010. In view of indicative $4 billion capex in 2011 and continued shale gas and internal exploration programs, the Company will likely refinance $350 million of the Canadian dollar denominated debt (swapped to US$304 million) due in early 2011.

The Company’s ability to successfully develop its unconventional gas resource plays in N. America and longer-life reserves in S.E. Asia remains crucial to its commitment to generating a more predictable production and reserve profile and a lower-cost structure in the near- to medium-term. Overall stable production levels and credit metrics are expected in 2010, with more sustainable growth from 2011. Currently, close to three-quarters of the Company’s production and proved reserves are located within the Organization for Economic Cooperation and Development (OECD) countries, with over 40% in N. America.

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.