Devon Energy Corp. Outlook Revised To Negative On Weaker Credit Measures; 'BBB-' Ratings Affirmed

  • We recently lowered our crude oil and natural gas price deck assumptions, including WTI crude oil to $25/bbl and Henry Hub natural gas to $2.00/mmBtu for the remainder of the year.
  • As a result, we expect independent oil and gas exploration and production company Devon Energy Corp.'s cash flow/leverage measures to weaken in 2020, remaining close to our downgrade trigger for at least the next two years.
  • We are affirming our 'BBB-' issuer credit rating, revising the outlook to negative from stable, and affirming the unsecured debt ratings on Devon Energy. We are also affirming our 'A-3' short-term and commercial paper (CP) ratings.
  • Our negative outlook reflects the potential for a downgrade if we expected FFO/debt to fall below 30% for a sustained period. This would most likely occur if realized oil and natural gas prices remain weak and the company did not take further steps to reduce capital spending.
NEW YORK (S&P Global Ratings) March 27, 2020-- S&P Global Ratings today took the rating actions listed above.
We estimate cash flow/leverage measures will be weak for the rating over the next two years.  Based on our revised oil and natural gas price deck assumptions (see "S&P Global Ratings Cuts WTI And Brent Crude Oil Price Assumptions Amid Continued Near-Term Pressure," published March 19, 2020), we now expect Devon's funds from operations (FFO) to debt to fall to the 30% to 35% range in 2020 and 2021, from about 45% in 2019. The company has more than 75% of its crude oil and nearly 40% of natural gas production hedged in 2020, limiting the cash flow impact of lower prices; however, most of these hedges roll off in 2021. Although the company should have positive cash flow this year, including expected asset sale proceeds, we estimate negative discretionary cash flow in 2021. We have assumed the company does not execute any additional share repurchases over the next two years.
The company has reduced its 2020 capital budget by nearly 30%, but we believe additional cuts will be needed if commodity prices remain weak to maintain appropriate leverage.  The company has already announced a $500 million (~30%) reduction to 2020 capital expenditures (capex)--primarily in the Anadarko and Powder River basins)--which we estimate will largely limit production in 2021. We estimate production in 2020 will increase by about 2% on a pro forma basis to 325,000-330,000 barrels of oil equivalent per day (boe/day), followed by a 5% to 10% decline in 2021. However, if commodity prices remain weaker for longer than we currently anticipate, additional capex cuts would likely be needed to maintain leverage appropriate for the rating.
The negative outlook reflects Devon's weak credit measures over the next two years, despite the company taking initial steps to lower capital spending and reduce share repurchases. We estimate FFO/debt will fall to the 30% to 35% range in 2020 from about 45% last year, due largely to the sharp decline in oil and natural gas prices. Although we assume in our base case that the Barnett shale asset sale closes as expected by mid-year, we estimate that leverage on a three year average basis would remain above our downgrade trigger even if the sale is not completed.
The negative outlook reflects the potential for a downgrade if we expected FFO/debt to fall below 30% for a sustained period, which would most likely occur if oil or natural gas prices averaged below our current price assumptions and the company did not take further steps to reduce capital spending.
We could revise the outlook to stable if FFO/debt approached 45% for a sustained period. This would most likely occur if commodity prices rise more quickly than our current expectations and the company continued to exercise capital discipline.
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