Fitch Ratings has downgraded Energy XXI's ratings as
follows:
Energy XXI Gulf Coast Inc.
--Long-term Issuer Default Rating (IDR) to 'CCC' from 'B';
--Senior secured first lien revolver to 'B/RR1' from
'BB/RR1';
--Senior secured second lien notes to 'B/RR1' from 'BB/RR1';
--Senior unsecured notes to 'CCC-/RR5' from 'B-/RR5'.
Energy XXI LTD
--Long-term IDR to 'CCC' from 'B-';
--Convertible notes to 'CC/RR6' from 'CCC/RR6';
--Convertible perpetual preferred to 'CC/RR6' from
'CCC/RR6'.
KEY RATING DRIVERS
Key drivers for the downgrade are: in Fitch's view, inadequate
hedge coverage for calendar 2016; higher interest costs per unit
which have increased estimated EXXI cash breakevens; weaker cash
flow forecasts and credit metrics following changes to Fitch's oil
& natural gas price decks; and heightened refinancing risk for
near term maturities, including the company's $750 million 9.25%
2017 notes.
DECREASED FORWARD HEDGE COVER
A key factor in Fitch's previous rating commentary was that
maintenance of the rating was contingent on the company's ability
to lock in 2016 production at economic prices. This has not
materialized to date, and weakness in the forward curve could
continue to limit the opportunity for the company to hedge at
meaningful levels in the near term.
After monetizing in-the-money hedges for approximately $102
million in proceeds over the nine months ending March 31, 2015,
EXXI currently has 14 mbbl/d of calendar 2016 oil production
volumes hedged (approximately 18% of oil volumes assuming flat
production), with downside protection via WTI puts at $51.43/bbl.
As of June 30, 2014, EXXI had approximately 65% of next 12 months
oil production economically hedged, provided a higher degree of
certainty around near term cash flow. The current hedge book
generates very little cash flow protection at Fitch's base case
price deck and highlights the potential for increased volatility in
cash flow measures in the near term.
Fitch estimates total fiscal year (FY) 2016 hedge contribution
of $30 million, or approximately 6% of FYE16 EBITDA including
hedges. This is primarily due to the contribution from
approximately 6.5 mbbl/d of collars with floors at $75/bbl and
$80/bbl for WTI and LLS, respectively, in the balance of calendar
2015 (EXXI fiscal year end is June 30).
HIGHER UNIT COSTS FOLLOWING SECOND LIEN ISSUANCE
At Fitch's base case oil price EXXI is set up for significantly
lower cash netbacks per barrel driven by lower revenues and higher
interest costs per unit of production. Based on updated
projections, Fitch estimates that the full-cycle cash breakeven for
EXXI has increased to approximately $75/bbl, from $65/bbl in
December 2014, driven largely by the higher interest costs from the
second-lien financing in March 2015. Increases in interest costs
are modestly offset by expected decreases in service costs. Taken
together, these estimates decrease our degree of confidence in the
ability of the company to economically produce its reserve base in
the near term.
EXXI Gulf Coast's issuance of $1.45 billion of 11% second-lien
notes will add approximately $160 million per year in interest
payments. Assuming production is roughly flat at 59 thousand
barrels of oil equivalent (mboe) per day in FY2016 (last nine
months average is 58.8 mboe per day), this leads to interest costs
of $18.4/boe, up substantially from $8.5/boe as of FY14.
NEAR TERM LIQUIDITY ADEQUATE
EXXI executed several liquidity-enhancing transactions in the
first half of 2015. In June, EXXI entered into an agreement to sell
its Grand Isle offshore oil gathering system to CorEnergy
Infrastructure Trust for $245 million. On July 1, the company
announced the sale of its East Bay field for $21 million to a
private buyer. As previously stated, in March, the company sold
$1.45 billion of second lien notes at an 11% coupon. Pro forma for
these transactions, total liquidity is estimated at between $900
million and $1 billion, including $125 million available on the
first-lien revolving credit facility.
While Fitch believes near term liquidity will be adequate,
particularly in a lower capex environment, recent changes to our
price deck, an elevated leverage forecast, and higher interest
burden from the second-lien notes (72% of expected base case 2016FY
EBITDA) have introduced longer term concerns about the viability of
the capital structure.
UPDATED RECOVERY ANALYSIS
EXXI Gulf Coast recoveries are estimated as outstanding
('RR1'--100%) at the first and second-lien secured level but below
average ('RR5'--13%) at the unsecured level. Recoveries at the
senior unsecured level have declined since the last review, driven
partially by the upsized issuance of $1.45 billion second-lien
secured debt given their priority status over the unsecured notes.
The current 13% estimated recovery contrasts to a 25% estimated
recovery for unsecured creditors cited in the last review. EXXI LTD
debt and preferred stock is structurally subordinated to the assets
at EXXI Gulf Coast, and receives no recovery value in our analysis
('RR6' --0%).
Lower recovery estimates are also influenced by reduced value
estimates for oil and gas reserves. Recovery values are based on
estimated liquidation values of proved (1P) reserves. Fitch begins
with a standard value of $12.50/boe for an average producer based
on our long term price deck ($70/bbl oil, $3.75/mcf natural gas).
Fitch makes adjustments for location and quality, oil & gas
mix, as well as adjustments related to the recent decline in
commodity prices.
REVISED FINANCIAL COVENANTS
Under EXXI's amended first-lien credit agreement, EXXI Gulf
Coast is required to maintain first-lien net leverage of below
1.25x and a maximum secured net leverage ratio of no more than
3.75x. Fitch does not expect these financial covenants to restrict
the company's financial flexibility in the near term, given base
case EBITDA projections and the company's significant cash balances
following asset sales and second-lien financing.
However, the amended agreement includes a clause whereby
first-lien debt accelerates to a date 210 days prior to the
maturity of EXXI Gulf Coast's $750 million in notes due December
2017. Further capital market access and refinancing opportunities
for EXXI could be limited and on more punitive terms.
KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer
include:
--WTI oil prices of $50/bbl in 2015, $60/bbl in 2016, increasing
to $70/bbl in 2018;
--Lower service costs in FY16 driven by contract renegotiations
and other cost savings;
--No additional hedge positions beyond the values reported on
June 10, 2015.
RATING SENSITIVITIES
Negative: Future developments that may lead to negative rating
actions include:
--An inability to successfully refinance senior notes due
2017;
--A material decline in production that compounds the revenue
effects of lower oil and gas prices;
--Failure to maintain liquidity of $200 million during the
current downcycle;
--Continued weak forward oil prices, leading to an inability to
meaningfully hedge 2016 oil volumes.
Positive: Future developments that may lead to positive rating
actions include:
--Improvements in full-cycle cost structure through lower lease
operating expenses, FD&A, or other cost reductions;
--Positive free cash flow generation and subsequent debt
reduction;
--Meaningful amounts of hedging leading to greater visibility on
near term cash flow.
Additional information is available on www.fitchratings.com
Applicable Criteria
Corporate Rating Methodology - Including Short-Term Ratings and
Parent and Subsidiary Linkage (pub. 28 May 2014)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393
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Fitch RatingsPrimary AnalystBrad BellAssociate Director, U.S.
Oil & Gas+1-312-368-3149Fitch Ratings, Inc.70 W Madison
StreetChicago, IL 60602orSecondary AnalystMark C. Sadeghian,
CFASenior Director+1-312-368-2090orCommittee ChairpersonShalini
MahajanManaging Director+1-212-908-0351orMedia Relations:Alyssa
Castelli, +1 212-908-0540alyssa.castelli@fitchratings.com