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 (Senior Notes) rating at BBB, both with Stable trends.

KEY CREDIT RATING CONSIDERATIONS
ARC's operating performance in 2024 was in line with Morningstar DBRS' expectations. Despite voluntary natural gas production curtailments because of low natural gas prices, production in 2024 was only marginally lower than the Company's initial annual guidance range. The Company successfully commissioned the first phase of Attachie in October 2024 and expects production to ramp up toward its 40,000 barrels of oil equivalent per day (boe/d) in 2025. The Company's operating and transportation expenses together in 2024 were slightly below the Company's annual guidance. Inflationary pressure on ARC's operating and capital costs also moderated in 2024, and a successful development program resulted in an improvement in the Company's reserve-related metrics relative to 2023. The Company further improved market access by entering into a long-term liquefaction tolling services agreement with Cedar LNG Partners LP to deliver natural gas for liquefaction. In addition, ARC also entered into a nonbinding agreement to sell the liquefied natural gas to an investment-grade counterparty. Including the previously announced marketing arrangements, approximately 29% of the Company's production will have access to global markets once all the contracts are on line. Despite lower commodity prices, comparable capital expenditures (capex), and higher dividend payments relative to 2023, ARC generated a free cash flow (FCF; cash flow after capex and dividends) surplus in 2024. ARC directed the FCF surplus primarily to shareholder distributions.

For 2025, ARC has budgeted capex of $1.6 billion to $1.7 billion, which is lower than the $1.85 billion spent in 2024 because of the completion of Attachie Phase I. ARC's budgeted production in 2025 between 380,000 boe/d and 395,000 boe/d and liquid contribution to overall production is higher than that of 2024 because of the contribution from Attachie Phase 1. Consequently, Morningstar DBRS expects ARC's FCF surplus in 2025 (approximately $1.0 billion) to increase materially relative to 2024 ($234 million) despite lower base-case commodity price assumptions. Morningstar DBRS expects the Company to direct the surplus entirely toward 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 the Company's business risk profile. Such an upgrade would likely occur if production increased to 450 mboe/d while a lease-adjusted debt-to-cash flow ratio at around 1.0 x was maintained. 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 2025 to be higher compared with 2024 as the impact of lower crude oil price assumptions is more than offset by higher production and higher liquids contribution. 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 material FCF surplus in 2025 and 2026. The Company is likely to prioritize shareholder distributions and/or growth initiatives given that it has achieved its stated leverage target. Morningstar DBRS considers the Company's liquidity profile to be adequate. The Company has $450 million of Senior Notes maturing in March 2026, and we expect the Company to refinance the Senior Notes prior to maturity or shortly thereafter. Morningstar DBRS expects the Company to maintain adequate availability under its committed revolving credit facility to repay the Senior Notes if required.

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
ESG Considerations had a relevant effect on the credit analysis.

Environmental (E) Factors

The following Environmental factors had a relevant effect on the credit analysis: 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 the 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.

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) https://dbrs.morningstar.com/research/437781.

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

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

(B) Weighting of FRA Factors
In the analysis of ARC, 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 ARC, 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, 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 (February 3, 2024; https://dbrs.morningstar.com/research/447186) 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 Criteria: Approach to ESG Factors in Credit Ratings (August 13, 2024)
https://dbrs.morningstar.com/research/437781
-- Morningstar DBRS Global Corporate Criteria (February 3, 2025)
https://dbrs.morningstar.com/research/447186

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

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