DBRS Morningstar Confirms Ratings of Cenovus Energy Inc., Stable Trends

DBRS Limited (DBRS Morningstar) confirmed Cenovus Energy Inc.’s (Cenovus or the Company) Issuer Rating and Senior Unsecured Debt rating at BBB and the Company’s Preferred Shares rating at Pfd-3. All trends are Stable. The ratings confirmations are underpinned by the Company’s (1) significant size (production of 804.8 thousand barrels of oil equivalent per day (Mboe/d) and upgrader/refinery throughput of 554.1 thousand barrels (bbl) per day in Q3 2021); (2) integrated upstream and downstream operations; and (3) long-life, low-cost oil sands assets at Foster Creek and Christina Lake and contracted production in Asia-Pacific. Cenovus’s ratings are constrained by its (1) exposure to lower-margin heavy and thermal oil, (2) high concentration of oil-producing assets in Western Canada, and (3) rising environmental cost pressures. The Stable trends acknowledge the improvement in the Company’s financial risk profile in 2021 and reflect DBRS Morningstar’s expectation that the Company’s key credit metrics will remain supportive of the ratings.

Cenovus has made material progress on integrating the assets acquired from Husky Energy Inc. (Husky) with integration costs trending in line with the Company’s guidance at the time of the acquisition. Cenovus has already captured over $1.0 billion of its targeted $1.2 billion in annual operating and capital cost synergies in 2021 and on a run rate basis has now achieved its $1.2 billion target. The majority of the operating cost synergies are from workforce reductions and efficiency gains from the application of Cenovus’s low-cost operating strategies to Husky’s thermal projects. Progress made on achieving the capital cost synergies has allowed Cenovus to reduce sustaining capital to its target of approximately $2.4 billion (versus $3.0 billion combined for standalone Husky and Cenovus). As a result, Cenovus expects to meet its budgeted capital expenditure (capex) and dividend payments in 2022 at a West Texas Intermediate (WTI) price of USD 45 per bbl. Cenovus has also optimized its portfolio by selling its retail fuel business, Tucker thermal assets, and certain other upstream assets for gross proceeds of approximately $2.0 billion (majority of proceeds expected in 2022).

Stronger commodity prices have resulted in Cenovus generating a material free cash flow surplus (FCF; cash flow after capex and dividends) of $3.7 billion in the first nine months of 2021 (9M 2021). The Company has prioritized deleveraging and has reduced its gross debt by approximately USD 900 million since the close of the Husky acquisition. Consequently, Cenovus’s key credit metrics have improved materially in 2021 and ahead of DBRS Morningstar’s expectation at the time of the last review in January 2021. Cenovus expects to continue to prioritize deleveraging with approximately 50% of the expected FCF surplus directed toward the balance sheet until it achieves its net debt target of $8.0 billion (Q3 2021: $11.0 billion). Based on its base case commodity price assumptions (see “DBRS Morningstar Updates Oil and Natural Gas Price Forecasts: Stronger Fundamentals Prompt Upward Revisions,” dated November 12, 2021 ) and asset sales announced by the Company in Q4 2021, DBRS Morningstar expects Cenovus to reach its net debt target in 2022. While shareholder distributions/business reinvestment will likely trend higher post-achievement of the target, DBRS Morningstar expects the Company to continue to maintain net debt at or below its target.

Cenovus expects its production to remain flat at approximately 780 Mboe/d in 2022 (net of the impact of the Tucker divestiture) with budgeted capex of between $2.6 billion and $3.0 billion (including the Superior refinery rebuild). DBRS Morningstar expects the Company to generate a material FCF surplus in 2022 and 2023 despite DBRS Morningstar’s expectation that the WTI price of crude oil will decline to the upper end of DBRS Morningstar’s mid-cycle pricing band of USD 50 to USD 60 per bbl in 2023. DBRS Morningstar expects the impact of lower WTI prices on FCF surplus in 2023 to be partially offset by stronger earnings at the downstream segment as operating margins improve toward pre-pandemic levels and the Superior refinery is placed in service. DBRS Morningstar expects the Company’s liquidity position to remain strong with its committed credit facilities totalling $6.0 billion remaining largely unutilized.

While the Company’s financial risk profile is improving, the impact of the improvement on Cenovus’s ratings will be tempered by ever-increasing environmental regulations that are adding costs and risks for Canadian oil and gas (O&G) companies, particularly the large developers of more carbon-intensive developments such as Cenovus. Additional environmental regulations could add further cost pressures for Cenovus and the O&G industry as a whole. DBRS Morningstar notes that Cenovus has committed capital under its latest five-year plan toward its target of reducing absolute greenhouse gas (GHG) emissions (5% by 2026 and 35% by 2035) with a long-term ambition to reach net zero GHG emissions by 2050. A rating upgrade would require (1) the Company to reduce gross debt and improve its lease-adjusted debt-to-cash flow ratio to consistently around or below 1.70 times (x) (9M 2021 annualized: 2.20x), and (2) return to a more normalized operating environment with low risk to demand from the pandemic and material unwinding of production cuts by OPEC and its alliance of key non-OPEC producers. The Company’s financial risk profile is strong for the current rating and a negative rating action is unlikely unless oil prices and the Company’s key credit metrics drop materially below DBRS Morningstar’s expectations for an extended period.

ESG CONSIDERATIONS
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/373262.

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

The principal methodologies are Rating Companies in the Oil and Gas and Oilfield Services Industries (August 16, 2021; https://www.dbrsmorningstar.com/research/383104) and DBRS Morningstar Criteria: Preferred Share and Hybrid Security Criteria for Corporate Issuers (October 21, 2021; https://www.dbrsmorningstar.com/research/386355), which can be found on dbrsmorningstar.com under Methodologies & Criteria. Other applicable methodologies include the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (February 3, 2021; https://www.dbrsmorningstar.com/research/373262).

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 under Related Documents or by contacting us at [email protected].

The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.

Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.

For more information on this credit or on this industry, visit www.dbrsmorningstar.com or contact us at [email protected].

DBRS Limited
DBRS Tower, 181 University Avenue, Suite 700
Toronto, ON M5H 3M7 Canada
Tel. +1 416 593-5577