Fitch Places GeoPark on Rating Watch Negative
KEY RATING DRIVERS
The rating action reflects incorporation of Fitch's new price deck expectations for West Texas Intermediate (WTI) prices of USD50/bbl in 2015 and 2016. Fitch believes the company has sufficient liquidity to withstand this level of prices in the short-term if it is able to maintain expected production of at least 23,000 barrels of oil equivalent per day (BOED). If the company is unable to maintain its cost base at levels seen in the third quarter while increasing production and minimizing its cash burn rates, the company could face a negative rating action. If current prices are sustained beyond 2016 and/or prices decline significantly below USD50/bbl in the near term, the company's credit profile could also be further harmed.
Lower Oil Price Assumptions: The Rating Watch Negative reflects the negative pressure on GeoPark's credit profile due to expectations for sustained low oil prices in 2015 and 2016. Since June 2014, WTI spot prices have declined by nearly 60%, which has negatively impacted the global oil & gas industry throughout its value chain. In December 2014, Fitch revised the sector outlook for Latin American Oil & Gas to Negative from Stable. The revision was due to expectations that pressure from lower crude prices should continue to negatively affect equity prices and credit spreads for integrated, exploration and production (E&P), and drilling and service companies.
In November 2015, Fitch cut the oil and gas price assumptions it uses when rating energy sector companies, reflecting the continued imbalance between oil supply and demand, as well as expectation that marginal costs will further decline in the medium term. Fitch pushed back its expected timing for a recovery in oil prices, now assuming that WTI prices will average USD50/bbl in both 2015 and 2016, with a slight increase to USD60/bbl in 2017. Previously, Fitch was expecting average WTI prices of USD60/bbl in 2016. Incorporating the new pricing assumptions into Fitch's GeoPark projections, Fitch believes the company's liquidity and credit profile could face incremental pressure in 2016, if it is unable to maintain the increased production seen by the company at the start of the fourth quarter. According to the company's latest earnings release, current 4Q production is approximately 23,000 BOED (up 20% versus 3Q15 production of 19,244 BOED). Fitch's Base Case projects 2016 production average of 23,000 BOED.
Financial Metrics to Remain Pressured Short-term: Until 2015, GeoPark's credit metrics had been improving in recent years as a result of the company's growth strategy. In 2014, the leverage ratio, as measured by total debt/EBITDA, was 1.7x, down from 2.1x in 2013-2012 and 2.6x in 2011. Given expectations of an average oil price of USD50/bbl, Fitch is forecasting EBITDA of approximately USD70 million/year for 2015. This would mean that the company's total debt/EBITDA would spike to approximately 5x for the year. If production of 23,500 BOED is maintained throughout 2016, Fitch would expect consolidated EBITDA to increase to the USD120 million level, which would mean leverage would meaningfully decline to the 3x level.
Debt on a reserve basis should remain high, though stable, as Fitch estimates that total debt/total proved reserves stands close to USD8.5/BOE. This does represent an improvement versus USD18.0/BOE in 2013. On a proved and developed reserves basis the company's debt per barrel stands high at USD26/BOE, which could rise further if the company is not able to add proved reserve levels as it moves to preserve cash. Given recent discoveries in Colombia, the company's reserves could increase for the year, despite a possible eventual reserve adjustment due to lower global oil prices.
Metrics Above Incurrence Covenant Limits: At expected leverage levels of 5x and EBITDA coverage levels of 3x, the company would record financial leverage metrics well above its international bond's debt covenant requirements for 2015. The covenant requirements are as follows: consolidated debt to consolidated EBITDA ratio not higher than 2.5x for the remaining life of the notes, and consolidated EBITDA to consolidated interest expenses over 3.5x. This is an incurrence covenant, that would prevent the company from raising additional debt, though the bond's covenants do have exceptions for lines of credit or working capital facilities up to 8% of total assets (approximately USD80 million). The company has been above the covenant limits since the second quarter of 2015, and based on Fitch's base case forecast would remain above this level during 2016 as well, with improvement below these levels by 2017.
RATING SENSITIVITIES
Negative: Future developments that could, individually or collectively, lead to negative rating actions in the short-term:
--Production does not meet Fitch's expectations for 23,000 BOED;
--The company is not able to maintain its operating costs at the level seen in 3Q15, which could lead to a higher level of cash burn;
--Prices decline significantly below the USD50/bbl level leading to significant harm to the company's credit profile and liquidity.
Long-term, if current depressed oil prices are maintained beyond 2016 and/or average WTI prices decline significantly this could lead to significant harm to the company's credit profile. If current low oil prices persist beyond 2016, the company would remain above its incurrence covenant limitations, thereby pressuring the company's ability to raise additional indebtedness in the face of cash needs. Finally, if leverage does not rapidly decline when/if global oil prices recover, this could lead to a negative rating action.
Positive: A positive rating action is currently not envisaged. If the company maintains production/cost controls at the forecast levels, this could translate to GeoPark's ratings being affirmed. A sustained recovery of oil prices to USD60/bbl or more would help to improve the company's credit profile and eliminate the company's Rating Watch Negative.
Long-term, drivers for a positive rating action or Outlook include increased diversification of the company's production profile, and consistent growth in both production and reserves while improving financial metrics. A substantial reduction in the debt/proved-reserves ratio would also be viewed favorably.
LIQUIDITY AND DEBT STRUCTURE
Stretched, Though Sufficient, Cash Cushion: The company is rightly focusing on cash preservation during this period of relatively low oil prices. GeoPark has reported negative annual FCF over the past eight years, mainly as a result of its aggressive growth strategy, though improvements had been seen as recently as 2014, when the company reported almost breakeven cash flow (FCF of -USD7 million).
Prior to the oil price decline, GeoPark was on pace to record positive FCF by 2016. Incorporating the company's capex and opex cut-backs in 2015, Fitch is still projecting that the company will generate negative FCF in 2015-2016, achieving positive FCF in 2017 as the price of oil rises.
The company has sufficient liquidity to meet its short-term debt obligations, as GeoPark reported cash on hand as of September 2015 of USD90 million, which is 3x its short-term debt obligations. Interest expense for the company's USD300 million international bond and USD70 million Itau loan, should total USD25-USD30 million in 2016. Despite GeoPark's aggressive capex program and corresponding cash burn, the company's liquidity was helped by the 2014 IPO which raised USD95 million in cash. Furthermore, the Brazilian acquisition, which closed in 1Q14, was FCF accretive in the first year, and the company has been helped by recent discoveries in Colombia. Incorporating expectations of USD50/bbl WTI prices in 2016, Fitch is projecting that the company will end 2016 with USD75 million in cash on hand. This is contingent on maintaining current 4Q production throughout 2016, otherwise EBITDA generation and cash burn will be more negative and could lead to a negative rating action.
KEY ASSUMPTIONS
--Average realized oil price calculated as a 20% discount of Fitch's price deck assumptions for WTI price of oil of USD50/bbl in 2015 and 2016;
--Long-term WTI price assumed to increase to USD70/bbl by 2019;
--2016 production of 23,000 BOED;
--Capital expenditures to remain in the USD60 million/year level in 2015 and 2016;
--Leverage defined as total debt/EBITDA in the 4.0x-5.0x level during 2015, declining to the 3x level in 2016.
FULL LIST OF RATING ACTIONS
Fitch has assigned an 'RR4' Recovery Rating to the company's USD300 million senior unsecured notes due 2020. Fitch has placed the following ratings for GeoPark on Rating Watch Negative:
--Foreign and local currency IDRs 'B';
--International senior unsecured debt rating 'B/RR4'.
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