DBRS Downgrades Athabasca Oil Corporation, Changes Trend to Negative

DBRS Limited (DBRS) has downgraded the Issuer Rating and the Senior Unsecured Second-Lien Notes (the Notes) rating of Athabasca Oil Corporation (Athabasca or the Company) to B (low) from B and changed the trend to Negative from Stable. The recovery rating remains unchanged at RR4. The previously assigned B rating was predicated on Athabasca’s significant liquidity position to fund its capex to achieve meaningful production growth, which was expected to result in a material improvement to the Company’s weak financial risk assessment (FRA) and business risk assessment to a level that is commensurate with the B rating category. Today’s ratings downgrade reflects key challenges for Athabasca under a prolonged low commodity pricing environment, including (1) a declining liquidity position that no longer supports the B rating, (2) no material improvements expected over the next two years to the Company’s FRA because of its high leverage and low cash flow growth potential despite the expected production ramp-up and (3) heightened refinancing risk in 2017. The trend change reflects DBRS’s concern of continued deterioration in liquidity should commodity prices remain weak on a sustained basis and/or if there are any significant delays in Athabasca’s production ramp-up. A further material decline in liquidity could lead to additional negative rating action. The trend may be changed to Stable if the Company’s planned production growth is successfully executed, the FRA is strengthened and the heightened refinancing risk is mitigated.

Athabasca’s liquidity position includes cash and cash equivalents ($687 million as at September 28, 2015), an approximately $134 million promissory note receivable (maturing in August 2016), $125 million in available credit facilities and a USD 50 million delayed term loan. The liquidity position has weakened significantly since the closing of the Dover Put/Call Option in August 2014. This was a result of the significant free cash flow deficits ($485 million LTM June 30, 2015), underpinned by the Company’s high growth capex levels and weak operating cash flows that are reflective of its nominal production volumes. Although the decline in liquidity was expected given the Company’s aggressive growth capex to date, material cash flow growth may be challenging under a low pricing environment even when considering the expected ramp-up in production. As a result, the Company’s FRA is not expected to be commensurate with the previously assigned B rating going forward.

The Company’s production growth is contingent on the ramp-up of Hangingstone Project 1 (Hangingstone) and the continued development of the Light Oil division. Hangingstone achieved first oil in July 2015 and expects to ramp up production to the design capacity of 12,000 barrels per day (bbl/d) by late 2016 (exit production guidance of 3,000–6,000 bbl/d for 2015; 3,200 bbl/d in September 2015). If achieved as planned, this would represent meaningful production growth to a level that is more commensurate with the current rating. In addition, capex at Hangingstone is expected to be minimal following the completion of the construction phase in Q1 2015, which would significantly reduce the negative pressure on the Company’s liquidity profile. However, positive free cash flow contribution from the project will likely be minimal in 2016 because of the project’s high operating and transportation expenses on a per barrel basis during ramp-up relative to the current low pricing environment. The project has met key production milestones to date, but execution risk for the full ramp-up to the project’s design capacity remains.

In the Light Oil division, the Company’s production is expected to be moderately higher as a result of the investments to date (exit production guidance at 7,000–8,000 barrels of oil equivalent per day for 2015; 2015 capex guidance of $203 million). The Company has achieved some cost improvements through greater drilling efficiencies and service cost reductions; however, drilling and completions costs remain relatively high under low commodity prices, particularly with the Duvernay. As a result, DBRS expects the Company to manage its Light Oil capex going forward to reduce the pressure on its liquidity profile.

Athabasca also faces significant refinancing risk in 2017, as (1) its $125 million revolving credit facility (undrawn as of June 30, 2015) matures in April 2017, (2) the USD 225 million Term Loans become payable in May 2017 if the Notes have not been redeemed or refinanced prior and (3) the $550 million Notes mature in November 2017. As at June 30, 2015, the Company was in compliance with all of its financial covenants. The Company’s financial covenants are asset coverage based; therefore, material asset impairments and/or reduction in reserves valuation could heighten covenant breach risk. In such event, this would have a material, negative impact on the Company’s liquidity position.

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 Companies in the Oil and Gas Industry and DBRS Recovery Ratings for Non-Investment Grade Corporate Issuers, which can be found on our website under Methodologies.

This rating is endorsed by DBRS Ratings Limited for use in the European Union.