DBRS Comments on Husky Energy Inc.’s Strategic Growth Initiatives

DBRS notes today that Husky Energy Inc. (Husky or the Company) has announced a number of major strategic growth initiatives including: (1) an asset acquisition; (2) capex and production guidance for 2011; (3) sanctioning of Phase 1 of the Sunrise project; (4) retention of its Southeast Asia assets; and (5) the intention of an equity issuance of $1 billion combined with an agreement to pay dividends in shares to Husky’s principal shareholders (approximately 70.5% ownership) from Q1 2011 to year-end 2012. These initiatives are intended to reverse the decline in Husky’s production and maintain its relatively strong credit metrics during a planned high capex period over the medium term.

DBRS believes that these strategic initiatives, appropriately implemented, can be accomplished at the Company’s current A (low) rating and expects to review Husky’s long-term plans and publish a detailed report in early Q1 2011. The following strategic growth initiatives were announced today:

(1) An agreement to acquire crude oil and natural gas properties in Alberta and northeast British Columbia from ExxonMobil Canada Ltd. (Exxon Canada) for $860 million, with 21,900 barrels of oil equivalent per day (boe/d) of gross production (74% natural gas) and 104 million boe of gross proved reserves. The transaction metrics of $39,269 per flowing barrel and $8.27 per boe are reasonable relative to recent transactions. The agreement is subject to final closing and regulatory approvals.

The Exxon Canada property acquisition follows the acquisition of natural gas properties in west central Alberta from Talisman Energy Inc. (Talisman) that is expected to provide approximately 10,800 boe/d of gross production and 37 million boe of gross proved reserves to Husky. The Talisman property acquisition is expected to close during Q4 2010.

(2) (a) Capex guidance of $4.865 billion (including the Exxon Canada property acquisition) in 2011, a 23% increase compared with forecast 2010 capex of $3.955 billion (including the Talisman property acquisition). The increase is mainly for upstream properties in western Canada (including Sunrise) and Southeast Asia. (b) Production guidance in the range of 290,000 boe/d to 315,000 boe/d (gross) for 2011 compared with forecast 2010 gross production in the range of 285,000 boe/d to 295,000 boe/d. The 4.3% increase (using the range midpoints) is forecast to be due to increased natural gas production, which would marginally reduce Husky’s liquids weighting (using the range midpoints) from 70% in 2010 to 68% in 2011.

(3) Sanctioning of the $2.5 billion Phase 1 component of the Sunrise in-situ oil sands project in northern Alberta has been announced. Phase 1 is expected to produce about 60,000 barrels per day (b/d) of bitumen (30,000 b/d net to Husky) at a cost of approximately $42,000 per flowing barrel with construction expected to commence in 2011 and start-up and first oil production expected in 2014. Husky has included $415 million of capex for Sunrise in its 2011 guidance, up from $70 million forecast for 2010. The applicable amount of downstream capex required is not disclosed.

Husky has a joint venture agreement with BP plc (BP, rated “A”) consisting of two 50/50 operating partnerships: a Canadian upstream partnership involving the Sunrise project (with Husky as operator) and a U.S. downstream partnership (with BP as operator). The two partners effectively share capital requirements, costs and revenues on a 50/50 basis. BP has committed to funding the first $2.5 billion capex of Sunrise. The bitumen produced at Sunrise would be transported for processing to refineries owned by the U.S. downstream partnership.

(4) Retention of Husky’s oil and gas interests in Southeast Asia. These interests include nine million barrels of gross proved oil reserves at year-end 2009 and 10,700 b/d of gross liquids production in Q3 2010 from the producing Wenchang oil field in the South China Sea; the Liwan and Liuhua fields in the South China Sea; and the Madura BD and MDA gas fields and the North Sumbawa II production sharing contract in Indonesia. Husky has included $1.18 billion of capex in Southeast Asia in its 2011 guidance, up from $500 million forecast for 2010. Total project costs, including for development of the Liwan 3-1 natural gas development that is anticipated to produce first gas in late 2013 and ramp up through 2014, have not been disclosed.

(5) Announcement of the intention of a $1 billion common equity issue by way of a public common share offering and a private placement for their pro rata share to Husky’s principal shareholders, Mr. Li Ka-shing and Hutchison Whampoa Limited, which together owned approximately 70.5% of the Company prior to this offering. In addition, Husky’s principal shareholders have agreed to take their dividends (approximately $0.7 billion per year currently) in shares from Q1 2011 to the end of 2012. Finally, the Company plans to explore hybrid and other financing options as required to support Husky’s growth while retaining its strong investment grade credit profile during a period of significant capex.

BUSINESS RISK PROFILE IMPLICATIONS
DBRS believes that the pending asset acquisitions from Talisman and Exxon, which add a combined 33,000 boe/d of gross production, are initial steps in reversing Husky’s declining production trend in recent years (289,400 boe/d gross in the first nine months of 2010 (9M 2010) compared with the peak of 376,600 boe/d gross in 2007), largely related to much lower production offshore the east coast of Canada and the impact of reduced capex in a lower natural gas price environment in western Canada.

While retention of the Southeast Asia interests and sanctioning of Sunrise provide opportunities for medium term production and reserve growth, these projects also involve execution risk and the potential for delays and cost overruns. Husky’s reserve replacement performance has historically been poor relative to those of its peers. Whether these projects will contribute to improved reserve replacement and cost metrics will be determined by their successful execution.

FINANCIAL PROFILE IMPLICATIONS
DBRS notes that Husky has maintained one of the most conservative financial profiles among its peers over the past several years, including in the weak economic environment of 2009. The Company’s total debt-to-capital ratio was 22% at September 30, 2010, while its total cash flow-to-debt ratio was 1.31 times for the 12 months ending September 30, 2010. The $1 billion equity issuance, which will offset the impact of the Q4 2010 acceleration in capital investment (total capex and acquisitions of $3.955 billion planned for 2010 compared with $2.3 billion spent in 9M 2010), combined with the principal shareholders’ agreement to reinvest their dividends in common shares (which could amount to a further $1.4 billion of retained equity in 2011 and 2012 combined based on the current dividend) demonstrates the Company’s commitment to maintaining a strong financial profile despite the potential for a more aggressive growth capex program over the medium 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 the DBRS website under Methodologies.