Morningstar DBRS Confirms Obsidian Energy Ltd.'s Issuer Rating and Senior Unsecured Notes Ratings at B (high) with Stable Trend and a Recovery Rating of RR4

DBRS Limited (Morningstar DBRS) confirmed the Issuer Rating and the rating on the Senior Unsecured Notes of Obsidian Energy Ltd. (Obsidian or the Company) at B (high) with Stable trends and a recovery rating of RR4.

KEY CREDIT RATING CONSIDERATIONS
Obsidian's earnings and cashflow in 2023 declined relative to 2022 as a result of lower commodity prices, however, they were in line with Morningstar DBRS' expectations. The Company had a successful development program and was able to replace more than 150% of its annual production in 2023. As a result of the decline in commodity prices, the netbacks and reserve recycle ratio weakened in 2023 but remained strong for the current rating. Production in Q1 2024 was slightly higher compared with Q1 2023 because of the Company's continued development program. Obsidian plans to increase its production to 50,000 boe/d by end of 2026, and expects the majority of growth to be led by Peace River region while maintaining production levels at the Cardium and Vikings assets. As a part of its growth strategy, the Company announced the acquisition of the Peavine and Gift Lake fields in the Peace River regions for a total consideration of $80.5 million funded through term loan and draws on its bank facility, which closed in June 2024. The acquisition is expected to increase the production levels by approximately 1,700 boe/d. Despite the increase in leverage, the Company's financial metrics remain supportive of the ratings.

Morningstar DBRS notes that Obsidian had to shut down its production in two of its fields in Peace River region in May 2024 as a result of a blockade set up by the Woodland Cree First Nation (WCFN). An agreement was reached in June, resulting in a production loss for about a month. The two fields had a combined production of 5,725 boe/d. Morningstar DBRS believes that the impact on overall production should be minimal and expects the Company to achieve its average production guidance range of 35,650 boe/d to 37,150 boe/d for 2024.

Despite the decline in commodity prices, the Company's credit metrics remain strong. Obsidian was able to generate a modest free cash flow (FCF; cashflow after capital expenditure (capex) and dividends) surplus in 2023. The Company also increased the size of its Senior Secured Credit facility (Credit Facility) to $260.0 million from $240.0 million, which has improved its liquidity position modestly. Based on Morningstar DBRS' base-case commodity price assumptions and the Company's annual production and capex guidance, Morningstar DBRS expects Obsidian to generate a modest FCF surplus in 2024. Morningstar DBRS notes that the Company has hedged around 50% of its AECO exposure as a result of subdued natural gas prices. Morningstar DBRS expects the Company to use part of its cash flow surplus to reduce its borrowings. Morningstar DBRS expects Obsidian's financial risk profile to be remain strong and provide an uplift to the overall ratings under its base case commodity price assumptions, thereby supporting the Stable trends. Morningstar DBRS further expects the Company will maintain its lease-adjusted debt-to-cash flow ratio below 2.0 times (x) over the forecast horizon.

CREDIT RATING DRIVERS
A rating upgrade would require a material improvement in Obsidian's size as measured by production. Material deterioration in the Company's lease-adjusted debt-to-cash flow ratio, which could be caused by significantly lower oil prices or a material deterioration in liquidity, could trigger a negative rating action.

EARNINGS OUTLOOK
Based on Morningstar DBRS' base-case commodity price assumptions and the expected increase in the Company's production levels following their active development program and acquisition in Peace River, Obsidian is expected to generate a modest cash flow surplus.

FINANCIAL OUTLOOK
Morningstar DBRS expects operating cash flow in 2024 to be modestly lower than in 2023 as a result of lower anticipated earnings. After factoring in the Company's budgeted capex and dividend payments, Morningstar DBRS expects Obsidian to generate a modest FCF surplus in 2024. As a result of debt-funded acquisition in Peace River, leverage metrics are expected to weaken slightly, but still remain supportive of the ratings.

CREDIT RATING RATIONALE
Obsidian's ratings are supported by its (1) higher netbacks from its oil-weighted production mix; (2) relatively lower decline rates, providing the Company with the ability to flex capital expenditures (capex) in a volatile price environment; and (3) modest financial risk profile, which, under Morningstar DBRS' base-case commodity price assumptions, provides an uplift to the rating. Obsidian's rating is constrained by its size (2024 production guidance of 36,400 barrels of oil equivalent per day (boe/d)), relatively higher operating costs, some exposure to heavy-light price differentials, and relatively higher asset retirement obligations.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
Environmental (E) Factors
The following Environmental factor(s) had a relevant effect on the credit analysis: Morningstar DBRS considered carbon and greenhouse gas (GHG) costs as a relevant environmental factor for Obsidian. This factor is relevant because the ever-increasing environmental regulations targeting the reduction of GHG emissions will likely limit the growth potential and add costs for all oil and gas companies.

There were no Social/Governance factors that had a relevant or significant 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 (January 23, 2024) at https://dbrs.morningstar.com/research/427030.

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

(B) Weighting of FRA Factors
In the analysis of Obsidian, the FRA factors are considered in the order of importance contemplated in the methodology.

(C) Weighting of the BRA and the FRA
In the analysis of Obsidian, the BRA and FRA carry approximately equal weight.

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 (April 15, 2024), https://dbrs.morningstar.com/research/431177.

Morningstar DBRS credit ratings may use one or more sections of the Morningstar DBRS Global Corporate Criteria (April 15, 2024), https://dbrs.morningstar.com/research/431186, which covers, for example, topics such as holding companies and parent/subsidiary relationships, guarantees, recovery, and common adjustments to financial ratios.

The following methodologies have also been applied:
-- Morningstar DBRS Global Corporate Criteria (April 15, 2024), https://dbrs.morningstar.com/research/431186

-- Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024), https://dbrs.morningstar.com/research/427030

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/431153.

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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