DBRS Assigns Provisional Rating of B to Trilogy Energy Corp, Trend Stable

DBRS has today assigned a provisional Issuer Rating of B with a Stable trend to Trilogy Energy Corp. (Trilogy or the Company). DBRS has also assigned a provisional rating of B with a Stable trend and a provisional recovery rating of RR4 to Trilogy’s proposed Senior Unsecured Notes (the Notes). The Notes, estimated at up to $300 million, are effectively subordinated to the Company’s secured bank facility (the Bank Facility). Proceeds from the Notes are to be initially used to pay down the Bank Facility, providing necessary liquidity for future exploration and development investments to ramp up production volumes.

The assigned ratings reflect the Company’s continued successful effort to transition away from lower-margin dry gas drilling to higher-margin liquids-rich gas (NGL) and oil drilling. With the majority of capex allocated toward oil/NGL projects and achievement of above-average production per well, Trilogy has improved its production mix significantly over the past three years, becoming less susceptible to weak natural gas prices (34% oil and NGL in terms of total production (net of royalties) in the first nine months ended September 30, 2012 (9M 2012) versus 18% (net of royalties) in 2010; 39% versus 20%, respectively, on a gross basis). Trilogy’s flagship asset, the Kaybob Montney oil play in west-central Alberta (9,240 barrels of oil equivalent (boe/d) in Q3 2012; 28% of total production), is considered one of North America’s top-ranked plays in terms of profitability.

As over 95% of earnings and cash flow are currently generated from the Kaybob area, reliability of production from this area will be one of the primary driving factors for rating stability. Trilogy has faced meaningful challenges related to infrastructure in the Kaybob area, as evidenced by oil battery expansion delays and unplanned plant outages. It remains to be seen whether the Company will be able to develop a track record of maintaining reasonable plant run times with the expansion of oil battery capacity to 20,000 barrels per day (b/d) of production in June 2012 (from 3,000 b/d in December 2011).

Trilogy’s financial profile remains weak relative to DBRS-rated peers, primarily due to capex programs (which included non-recurring midstream asset investments) that can be considered aggressive when measured against cash flow, resulting in material free cash flow deficits and a pressured balance sheet. DBRS expects the Company to continue to pursue a high level of capex to grow production volumes. This will likely result in neutral free cash flow or modestly negative cash flow going forward despite an expected increase in operating cash flow (due to rising production volume growth) and a drop in midstream asset investments after the completion of the oil battery project in Q2 2012.

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodologies are Rating Oil and Gas Companies (April 2011) and DBRS Criteria: Rating Leveraged Finance, which can be found on our website under Methodologies.