DBRS Limited (DBRS Morningstar) downgraded Ovintiv Inc.’s (Ovintiv or the Company) Issuer Rating and Unsecured Senior Notes rating to BBB (low) from BBB and removed the ratings from Under Review with Negative Implications. Both trends are Negative. On March 26, 2020, DBRS Morningstar had placed Ovintiv’s ratings Under Review with Negative Implications in response to the extreme price declines and heightened volatility in crude oil markets largely caused by the rapid spread of the Coronavirus Disease (COVID-19) and the concurrent crude oil-price war between OPEC (led by Saudi Arabia) and Russia. Subsequently, DBRS Morningstar revised its commodity price assumptions to factor in (1) the impact of the coronavirus on crude oil demand as lockdowns ease, (2) the significant buildup in global oil inventories, and (3) the impact of production cuts recently implemented by OPEC Plus. The downgrade follows DBRS Morningstar’s expectation that the Company’s key credit metrics will remain below the threshold for a BBB rating over the next three years under the revised commodity price assumptions (see DBRS Morningstar’s May 15, 2020, commentary “As Coronavirus Lockdowns Ease, DBRS Morningstar Resets Outlook for Oil and Natural Gas Prices”). While DBRS Morningstar expects the Company to operate mostly within cash flow over the forecast period (2020–22), the Negative trends reflect the dependence of the key credit metrics on higher commodity prices, especially in 2022, to support the current ratings.
Ovintiv’s current ratings are supported by the Company’s business risk profile, which is underpinned by its (1) large production base (Q1 2020: 571,000 barrels of oil equivalent per day (boe/d)) with higher-margin liquids production; (2) diversified asset base with a nearly equal mix of liquids and natural gas production from three core areas of operation (the Permian Basin in Texas, the Montney Formation in Northeast British Columbia and Northwest Alberta, and the Anadarko Basin in Oklahoma); (3) improved capital and operating efficiencies, which has reduced its overall cost structure; and (4) prudent financial risk management policy with a majority of near-term production protected by commodity hedges. The Company has completed the integration with Newfield Exploration Company with operating and capital costs trending lower post-completion of the acquisition. While the Company’s corporate decline rates are relatively higher, necessitating a greater level of capital investment to sustain production rates, DBRS Morningstar notes that the Company’s focus on lowering capital costs and economies of scale in its core areas of operation have allowed it to reduce its three-year average reserve-replacement cost (including acquisitions but not divestitures) to $3.14/boe in 2019 from $5.03/boe in F2018. While the Company’s business risk profile remains strong, DBRS Morningstar notes that persistently lower crude oil prices and the resultant reduction in capex could negatively affect the Company’s production and reserve attributes, leading to a weakening of the business risk profile.
As a result of the recent severe decline in crude oil prices, the Company’s key credit metrics have been under significant pressure and, at current oil price levels, are well below the BBB range. In response, the Company has reduced its budgeted capex in Q2 2020 by $500.0 million; shut in higher-cost production of 65,000 boe/d; and initiated operating-cost-reduction measures, which are expected to yield cash savings of $200.0 million in 2020. Ovintiv also expects to reduce well drilling and completion costs in its three core areas of operations by 20% in Q2 2020 and beyond, relative to 2019. The Company has also hedged (as at April 30, 2020) approximately 94% and 75%, respectively, of its expected crude and condensate and natural gas production for the remainder of the year. DBRS Morningstar expects that the hedges, along with lower capex, should allow the Company to remain largely free cash flow (FCF; cash flow after capex and dividends) neutral in 2020 and 2021 despite a material reduction in operating cash flow because of expected lower crude oil prices. While debt levels are forecast to remain relatively flat, DBRS Morningstar expects key credit metrics under its base-case commodity price assumptions to weaken in 2020 and 2021 with the lease-adjusted debt-to-cash flow ratio in the 5.0 times (x) to 5.5x range (F2019: 2.7x). The key credit metrics are expected to improve in 2022 (lease-adjusted debt-to-cash flow at or around 3.0x) as earnings and operating cash flow increase because of higher commodity price assumptions and the Company uses FCF surpluses to reduce debt. However, the improvement in credit metrics is not sufficient to support the previous BBB ratings, leading to a downgrade.
DBRS Morningstar believes the Company has sufficient liquidity to navigate the current downturn. As at March 31, 2020, the Company had $3.2 billion available under its committed credit facilities, which mature in July 2024. The Company has debt maturities totalling $1.25 billion over the next four years (in November 2021 and January 2022). Given the expectation that the Company will operate mostly within cash flow, DBRS Morningstar expects available liquidity under the credit facilities to be sufficient to repay the debt maturities in the event they are not refinanced. DBRS Morningstar also expects the Company to remain in compliance with the applicable covenant on the credit facilities, including debt-to-adjusted capitalization of less than 60% (28% as at March 31, 2020).
In assessing the Company’s credit risk profile, DBRS Morningstar’s approach is to rate through the cycle and give due weight to projected credit metrics when DBRS Morningstar anticipates a return to a more normalized operating and pricing environment. While market dynamics are improving, there is still uncertainty as the outlook for demand remains fluid. The Negative trends reflect the risk that the recovery in commodity prices may fall short of DBRS Morningstar’s base-case price assumptions and the Company’s overall financial risk profile may not support the current ratings. DBRS Morningstar may change the trends to Stable if the demand/supply dynamics in the crude oil markets continue to improve, leading to greater confidence that commodity prices and, consequently, the Company’s key credit metrics will improve in line with DBRS Morningstar’s base-case assumptions. Conversely, commodity prices and key credit metrics below expectations or a material increase in debt could lead to a negative rating action.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.
All figures are in U.S. dollars unless otherwise noted.
The principal methodologies are Rating Companies in the Oil and Gas and Oilfield Services Industries (August 23, 2019); DBRS Morningstar Criteria: Rating Corporate Holding Companies and Parent/Subsidiary Rating Relationships (November 25, 2019); and DBRS Morningstar Criteria: Guarantees and Other Forms of Support(January 22, 2020), which can be found on dbrsmorningstar.com under Methodologies & Criteria.
For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.
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The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.
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