DBRS Downgrades Trilogy Energy Corporation to B (low), Negative Trend

DBRS Limited (DBRS) has today downgraded the Issuer Rating and the $300 million Senior Unsecured Notes (the Notes) rating of Trilogy Energy Corporation (Trilogy or the Company) to B (low) from B, and has maintained the trends at Negative. The recovery rating of the Notes remains unchanged at RR4. The Notes are effectively subordinated to the Company’s secured bank facility (the Credit Facility).

On February 11, 2015, DBRS changed the trend of Trilogy to Negative from Stable, reflecting the expected deterioration of the Company’s key credit metrics under the weak crude oil and North American natural gas pricing environment and the expected decline in production levels. The trend change also reflected the risk of a potential breach of the Credit Facility’s financial covenants under a prolonged low commodity pricing scenario. In May 2015, the Company amended its financial covenants, which alleviated the short-term covenant breach risk. However, should the current weak pricing outlook persist or deteriorate further, covenant breach risk is expected to heighten toward the second half of 2016 and into 2017 as the amended financial covenants come under pressure. To address the negative impact of the weak commodity prices and the decline of production in 2015 on its balance sheet and liquidity profile, Trilogy: (1) proactively eliminated its dividend program ($53 million in 2014), (2) curtailed capital expenditures (capex) significantly with the intent to remain free cash flow neutral going forward, (3) achieved considerable asset dispositions ($49 million for the nine months ended September 30, 2015 (9M 2015), and a USD 85 million disposition of certain Duvernay assets in November 2015) and (4) implemented operating cost-reduction measures. Pro forma the Duvernay disposition, the Company is expected to be drawn approximately $270 million on its Credit Facility by year-end 2015 ($355 million drawn as of September 30, 2015).

However, despite Trilogy’s balance sheet and liquidity preservation initiatives to-date, the Company’s key credit metrics have deteriorated materially in 9M 2015 as netbacks have been constrained under a low commodity pricing environment given the Company’s cost structure and declining production profile. This has resulted in a material year-over-year decline in EBITDA (62%) and operating cash flow (69%) in 9M 2015. Pro forma the USD 85 million asset divestiture, year-end 2015 key credit metrics are expected to improve moderately relative to 9M 2015 but are still expected to no longer support the B rating. Going forward, DBRS does not expect Trilogy’s key credit metrics to improve significantly over the next 12 months without an immediate, material improvement in liquids and natural gas prices, which is unlikely. Although the Company has hedged some production in 2016 (3,000 barrels per day at a West Texas Intermediate price of $77.18 ) that should provide a cushion, it is not expected to be significant enough to offset the impact of a prolonged weak pricing environment, particularly for North American natural gas prices (approximately 70% of 2015 production). As a result, with a significantly weaker financial risk profile to-date and a challenging outlook going forward, DBRS views that Trilogy’s credit risk profile is no longer commensurate with a B rating.

The current B (low) rating also factors in the Company’s current liquidity position and its business risk profile that is underpinned by Trilogy’s production and proved reserves size, moderate capex flexibility, limited geographic diversification and relatively weaker netbacks because of its production mix and cost structure. In 2015, Trilogy’s business risk profile declined modestly due to a decreasing production profile (approximately 20% year-over-year decline expected) and a higher natural gas-weighted production mix (approximately 70% versus 60% in 2014). DBRS recognizes that the decline in production and liquids-mix in 2015 was a result of Trilogy’s capex curtailment below sustaining levels in order to protect its balance sheet and liquidity. However, should the pricing environment remain low and lead to capex remaining below sustaining levels going forward, this could result in a continued decline in production volumes and further pressure on earnings.

Trilogy’s liquidity is supported by its $450 million Credit Facility. Based on the current liquidity available, which has improved moderately following the USD 85 million asset disposition in November 2015, Trilogy is expected to have sufficient liquidity to fund near-term capex, working capital and operations, given its flexible capex program. The last borrowing base review was completed in November 2015. However, Trilogy expects to utilize approximately 60% ($270 million) of its Credit Facility by year-end 2015, which is viewed to be relatively high by DBRS. Available liquidity could change materially following subsequent semi-annual borrowing base reviews, with the next review expected in Q2 2016. A lower commodity pricing outlook by the lenders in Q2 2016 versus the Q4 2015 review, combined with pressure on the determination of reserves based on current market conditions, could further negatively impact the borrowing base. The Negative trend reflects DBRS’s concerns of prolonged weakness in key credit metrics and liquidity if the depressed commodity pricing outlook further weakens and persists.

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 Criteria: 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.