Morningstar DBRS Assigns Issuer Rating of B With a Stable Trend to Bonterra Energy Corp.

DBRS Limited (Morningstar DBRS) assigned an Issuer Rating of B with a Stable trend to Bonterra Energy Corp. (Bonterra or the Company). Morningstar DBRS also assigned a provisional credit rating of (P) B with a Stable trend to the Second Lien Notes based on Recovery Rating of RR4 to be issued by Bonterra.

KEY CREDIT RATING CONSIDERATIONS
Bonterra's primary producing assets are in Pembina Cardium in Alberta. The Company has access to adequate gathering and processing infrastructure in its primary development area to accommodate its moderate medium-term growth plans. For the nine-month period ended September 2024, liquids accounted for approximately 56% of the Company's production, the majority of which is light oil that realizes higher prices/netbacks. Liquids also accounted for approximately 62% of the Company's reserves for YE2023, which should allow it to maintain a liquids-rich production profile.

Bonterra's operations lack the benefit of scale, and consequently its operating (including transportation) costs are relatively high compared with its larger liquids-weighted peers. As a result of continued inflationary pressure, Morningstar DBRS expects operating costs to remain elevated through 2025. The Company has a modest decline rate of approximately 25% as its production mix is dominated by light oil. For 2023, Bonterra was able to replace 89% of its proved reserves, with a proved reserve life index of 15.5 times (x). The Company's natural gas production is primarily linked to the AECO pricing benchmark, with limited ability to directly access the export markets. Morningstar DBRS notes that the Company maintains hedging of approximately 30% of its production, which provides a cushion in the low commodity price environment. The Company's average commodity price realizations are also susceptible to the West Texas Intermediate - Edmonton price differential for crude oil. Bonterra had a decommissioning obligation of $123.1 million as of YE2023, the payments for which are expected to be made between 2024 and 2058. For 2023, the Company's total decommissioning expenditure was $9.1 million.

As a result of higher commodity prices, the Company generated a material free cash flow (FCF; cash flow after capital expenditure (capex) and dividends) surplus over the last three years. The Company used the FCF surplus to reduce debt, and its financial risk profile has improved substantially. Bonterra also ventured into the Charlie Lake and Montney oil plays in 2024 and brought into production four wells in Charlie Lake and two wells in Montney. Morningstar DBRS views the Company's diversification as a positive development for its business risk profile. This expansion reduces its reliance on a single core area, while providing exposure to higher-margin, liquid-rich opportunities with strong capital efficiency. By broadening its asset base, Morningstar DBRS expects the Company to enhance its operational resilience and mitigate the impact of potential production or market disruptions in any one region. Morningstar DBRS views the Company's financial policy as conservative and expects its financial risk profile to remain supportive of the credit ratings.

CREDIT RATING DRIVERS
A credit rating upgrade would require a material improvement in the Company's size as measured by production. A material deterioration in Bonterra's lease-adjusted debt-to-cash flow above 2.5x on a sustained basis or a material deterioration in liquidity could trigger a negative credit rating action.

EARNINGS OUTLOOK
Bonterra has budgeted average production in the range of 14,600 barrels of oil equivalent per day (boe/d) to 14,800 boe/d for 2025, supported by ongoing development in its key assets including Cardium, Charlie Lake, and Montney. The Company anticipates a liquid weighting of approximately 52% to 54%, reflecting its focus on higher-margin crude oil and natural gas liquids production. While commodity price volatility remains a risk, Morningstar DBRS expects Bonterra's hedging program, which includes fixed-price contracts and collars for a portion of its output, to provide some cash flow stability. Bonterra's strategic focus on improving capital efficiencies, particularly in Charlie Lake and Montney, along with disciplined cost management may position the Company to sustain FCF despite potential market challenges. The Company, however, remains exposed to downside risks from fluctuating natural gas prices and transportation bottlenecks in Western Canada, which could weigh on earnings if realized prices decline below Morningstar DBRS' base-case price assumptions.

FINANCIAL OUTLOOK
Morningstar DBRS expects operating cash flow in 2025 to be modestly lower than in 2024 because of the assumption of lower crude oil prices. After factoring in the Company's budgeted capex of $65 million to $75 million, Morningstar DBRS expects Bonterra to generate a modest FCF surplus in 2025. Morningstar DBRS expects Bonterra to maintain its lease-adjusted debt-to-cash flow ratio below 2.0x.

CREDIT RATING RATIONALE
The credit ratings are underpinned by Bonterra's (1) light oil-weighted production mix; (2) relatively diversified asset base; and (3) relatively strong financial risk profile, which, under Morningstar DBRS' base-case commodity price assumption, provides an uplift to the Issuer Rating. Bonterra's credit ratings are constrained by its small scale of operations (average annual production of 14,586 boe/d for Q3 2024) and relatively higher cost structure.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS

Environmental (E) Factors
The following environmental factor had a relevant effect on the credit analysis: Carbon and Greenhouse Gas (GHG) Costs. 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 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 Factors in Credit Ratings (August 13, 2024) at https://dbrs.morningstar.com/research/437781.

BUSINESS RISK ASSESSMENT (BRA) AND FINANCIAL RISK ASSESSMENT (FRA)

(A) Weighting of BRA Factors
In the analysis of Bonterra, the BRA factors were considered in the order of importance contemplated in the methodology.

(B) Weighting of FRA Factors
In the analysis of Bonterra, 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 Bonterra, the BRA and the 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 & Gas, Oilfield Services, Pipeline, and Midstream Energy Industries (August 12, 2024), https://dbrs.morningstar.com/research/437739

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 methodology has also been applied:
-- Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Factors in Credit Ratings (August 13, 2024) https://dbrs.morningstar.com/research/437781

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.

A provisional credit rating is not a final credit rating with respect to the above-mentioned security and may change or be different than the final credit rating assigned or may be discontinued. The assignment of a final credit rating on the above-mentioned security is subject to receipt by Morningstar DBRS of all data and/or information and final documentation that Morningstar DBRS deems necessary to finalize the credit rating.

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 https://dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.

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