Morningstar DBRS Confirms Ratings on ARC Resources Ltd. at BBB, Stable Trends

DBRS Limited (Morningstar DBRS) confirmed ARC Resources Ltd.'s (ARC or the Company) Issuer Rating and Senior Unsecured Notes rating at BBB, both with Stable trends.

KEY CREDIT RATING CONSIDERATIONS
ARC's operating performance in 2023 was in line with Morningstar DBRS' expectations. Permitting delays experienced in in British Columbia in 2022 subsided, and production in 2023 was within the Company's annual guidance. Inflationary pressure on ARC's operating and capital costs also moderated in 2023, and a successful development program resulted in an improvement in the Company's reserve-related metrics relative to 2022. The Company further improved market access by entering into a second long-term supply agreement with Cheniere Energy, Inc. to deliver natural gas with access to European price benchmarks starting in 2029. Including the previously announced marketing arrangements, approximately 23% of the Company's production will have access to global markets once all the contracts are on line. Despite materially lower commodity prices, higher capital expenditures (capex), and higher dividend payments, ARC generated a free cash flow (FCF; cash flow after capex and dividends) surplus in 2023. ARC directed the FCF surplus primarily to shareholder distributions.

For 2024, ARC has budgeted capex of $1.75 billion to $1.85 billion, including $500 million for Attachie Phase I, which is on schedule for completion in 2024. Based on its base-case commodity price assumptions, Morningstar DBRS expects ARC to generate an FCF surplus in 2024 that is expected to increase in 2025 as spend on Attachie Phase I winds down. Morningstar DBRS expects the Company to direct the surplus entirely towards shareholder distributions. Nevertheless, Morningstar DBRS expects the Company to maintain its lease-adjusted debt-to-cash flow ratio between 1.0 times (x) and 1.50x. Morningstar DBRS notes that ARC’s financial risk profile is strong and expects it to continue to support the ratings even if commodity prices trend below Morningstar DBRS' base-case assumptions.

CREDIT RATING DRIVERS
A rating upgrade is not likely in the medium term absent a material improvement in ARC’s business risk profile. Such an upgrade would likely occur if production increased to 450,000 barrels of oil equivalent per day and/or the Company’s proven, developed, producing reserve life index increased to six years while maintaining lease-adjusted debt-to-cash flow ratio at around 1.0x. While unlikely, a negative rating action would be possible if the Company’s reserve metrics deteriorate and/or the Company’s lease-adjusted debt-to-cash flow ratio deteriorates materially and is consistently above the expected range of 1.0x to 1.50x.

EARNINGS OUTLOOK
Morningstar DBRS expects earnings in 2024 to be comparable with 2023 as the impact of lower crude oil price assumptions is largely offset by higher production. Morningstar DBRS also expects the Company's operating and transportation costs to remain relatively stable.

FINANCIAL OUTLOOK
Based on Morningstar DBRS' base-case price assumptions, Morningstar DBRS expects ARC to generate a FCF surpluses in 2024 and 2025. The Company is likely to prioritize shareholder distributions and/or growth initiatives given that it has achieved its stated leverage target.

CREDIT RATING RATIONALE
The credit ratings are underpinned by ARC's scale in the liquids-rich Montney resource play, competitive cost structure, and conservative financial policy. Constraints on ARC’s ratings include limited geographic diversification and a lower proved developed reserve life index with corresponding higher decline rates. The Stable trends reflect Morningstar DBRS’ expectation that the Company's financial risk profile will remain supportive of the ratings.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
Environmental Factors
Morningstar DBRS considered carbon and greenhouse gas (GHG) emissions costs as a relevant environmental factor for ARC. This factor is relevant because ever-increasing environmental regulations in Canada targeting the reduction of GHG emissions will likely limit ARC’s growth potential and add costs for all oil and gas companies in Canada. ARC’s balance sheet strength, relatively lower carbon footprint because of its natural gas-weighted production, and ongoing emission reduction initiatives provide the Company with the financial flexibility to navigate the energy transition path.

Social and Governance Factors
There were no Social or Governance factors that had a significant or relevant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at (January 23, 2024), https://dbrs.morningstar.com/research/427030.

BUSINESS RISK ASSESSMENT (BRA) AND FINANCIAL RISK ASSESSMENT (FRA)
(A) Weighting of BRA Factors
In the analysis of ARC Resources Ltd., the BRA factors were considered in the order of importance contemplated in the methodology.

(B) Weighting of FRA Factors
In the analysis of ARC Resources Ltd., the FRA factors were considered in the order of importance contemplated in the methodology.

(C) Weighting of the BRA and the FRA
In the analysis of ARC Resources Ltd., the BRA carries greater weight than the FRA.

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

Morningstar DBRS applied the following principal methodology:
-- Global Methodology for Rating Companies in the Oil and Gas and Oilfield Services Industries (August 16, 2023), https://dbrs.morningstar.com/research/419228/

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

A description of how Morningstar DBRS analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/397223.

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 info-DBRS@morningstar.com.

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS had access to the accounts, management, and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

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

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.

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