Frontera Energy Corp. Downgraded To 'B+' From 'BB-' On Sharply Lower Crude Oil Prices; Outlook Negative

  • The credit metrics of Canada-based oil and gas producer Frontera Energy Corp. will fall below our expectations for the next two years following our March 19, 2020, revision of oil and gas price assumptions.
  • Due to the company's exposure to lower crude oil prices and the current economic downturn, we expect Frontera to slash its output in its least-profitable wells, which could decrease production about 15% for 2020 compared with 2019. In addition, we expect the company to sharply reduce its planned capital expenditure (capex) spending and dividend payments to preserve its liquidity.
  • On March 27, 2020, S&P Global Ratings lowered its issuer credit and issue-level ratings on Frontera to 'B+' from 'BB-'.
  • The negative outlook reflects our uncertainty regarding the recovery in crude oil prices for the next 12-18 months, which could delay the overhaul of the company's operations and contract its EBITDA. In addition, we believe the economic downturn, as a result of COVID-19, could extend beyond our expectations, compromising the company's growth prospects. This would dent Frontera's leverage metrics, leading to debt to EBITDA of 2.0x-3.0x for 2020 and possibly above 3.0x in 2021.
MEXICO CITY (S&P Global Ratings) March 27, 2020--S&P Global Ratings today took the rating actions listed above.
The crash in oil prices will erode the company's credit metrics. Our latest revision to our crude oil and gas price assumptions reflects the price war between Saudi Arabia and Russia as well as a likely massive drop in demand due to COVID-19. The revised price deck includes an average annual price assumption for Brent crude oil of $30 per barrel (versus $40/bbl) for 2020 and $50/bbl (versus $50/bbl) for 2021 (see "S&P Global Ratings Cuts WTI And Brent Crude Oil Price Assumptions Amid Continued Near-Term Pressure" published March 19, 2020). We expect this to weaken Frontera's credit metrics, leading to debt to EBITDA close to 3.0X, funds from operations (FFO) to debt of 20%-30%, and free operating cash flow (FOCF) to debt below 5%. These metrics deviate substantially from our previous expectations.
An expected shift in Frontera´s operating strategy could delay its growth prospects and rise in EBITDA. While the company's profitability largely depends on oil prices, we believe that the current economic turndown would also erode Frontera's growth prospects and cause its volume sales to drop about 15% in 2020, a trend that could extend into 2021. We expect the company to reduce production to 20.5 million barrels of oil equivalent (mboe) for 2020 and to 15.9 mboe in 2021, mostly due to cuts in exploratory and non-core well drilling activities. Even though Frontera is likely to decrease some operating costs, such as in transportation and production, it would still generate EBITDA in 2020 that's about half the total in 2019.
In our view, the uncertainty over the duration of these market conditions could prevent a recovery in Frontera's operations in the upcoming months. We believe that even though its contraction measures would preserve the company's liquidity, the lower expansion and production investments could curtail the revamp in operations in the future.
Frontera's hedging strategy and lower capex should ease the impact of a lower price deck on cash flows, while we continue assessing its liquidity as adequate. As of Feb. 29, 2020, Frontera managed to hedge approximately 43% of total production for this year through multiple financial instruments at a strike price between $48.5 and $55.0 per barrel. As of this report's date, we don't expect any hedging strategy for 2021. Moreover, we expect the company to cut approximately 50% of its capex, by slashing expansion investments and drilling activities in response to grim market conditions. Finally, the company ties its dividend payments to quarterly oil prices, for which, if the price falls below $60, we do not expect any dividend payments. We expect this strategy to partly compensate for wide cash loses during 2020 because we also estimate EBITDA will shrink about 50%.
The negative outlook reflects our expectation that the current economic downturn and a possible delay in crude oil price recovery could impair Frontera's EBITDA for the next 12-18 months, leading to debt to EBITDA above 3x.
We could lower the ratings in the next 12-18 months if Frontera's operations continue drifting from our expectations, leading to debt to EBITDA above 3x and FFO to debt below 30%. This could occur if Frontera's production deviates significantly from our current projections, or if oil prices remain below our current price deck for a sustained period and the company is unable to reduce costs, resulting in lower EBITDA.
We could revise the outlook to stable in the next 12-18 months if Frontera is able to absorb the economic downturn and recover its production, while maintaining average debt to EBITDA below 3x and FFO to debt above 30%.
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