OREANDA-NEWS. Fitch Ratings has assigned a 'BB+/RR1' rating to Unit Corporation's (Unit; NYSE: UNT) senior secured revolver. Fitch has also affirmed Unit's
Long-Term Issuer Default Rating (IDR) at 'B+'. The Rating Outlook is Negative.

The Negative Outlook reflects concerns around the declining production base, loss of operational momentum, and potential for further price-induced borrowing base reductions.

Approximately $928 million is debt is affected by today's rating action. A full list of rating actions follows at the end of this release.

In conjunction with the April borrowing base redetermination, Unit entered into a third amendment to grant the credit facility a security position. The company pledged 85% of its proved developed producing oil and gas properties as well as its 100% ownership interests in its midstream affiliate, Superior Pipeline Company LLC. Further, the borrowing base and commitment amounts were reduced to $475 million from a $550 million borrowing base and $500 million commitment. Fitch believes this helps alleviate near-term liquidity concerns; however, a persistently weak oil and gas pricing environment could put further pressure on the borrowing base. While the company's drilling rigs are not currently included in the borrowing base, Fitch believes they would provide minimal value.

The amendment also established a senior secured leverage ratio test of not more than 2.75x in effect through March 2019 and a total leverage covenant of not more than 4.00x beginning on June 30, 2019. Fitch believes there is additional headroom under the new covenants, alleviating prior leverage ratio covenant concerns.

Another consideration following the establishment of the secured facility is the capacity to issue additional debt, which could further subordinate the existing 2021 subordinated notes. While Fitch does not expect that UNT will need to issue incremental debt under Fitch's base case, the agency notes that there are no unsecured debt incurrence covenants that would prevent the company from doing so. An unsecured debt issuance could pressure the rating and recovery prospects for the senior subordinated notes.

KEY RATING DRIVERS

LOSS OF REVENUE DIVERSIFICATION

Unit has historically benefited from a modestly diversified business mix with approximately 30% of EBITDA coming from non-exploration and production (E&P) segments. Fitch expects the contract drilling segment and the midstream segment to contribute approximately 20% of a lower year-over-year EBITDA in 2016. Due to heightened recontracting risk and further rig fleet rationalization, the contract drilling segment is expected to represent the majority of the non-E&P EBITDA loss. The midstream segment benefits from its 68% fee based contract mix, but the remaining portion is at risk of lower volumes in 2016.

The E&P segment (about 63% of EBITDA) reported an almost 25% year-over-year decline in net proved reserves (1p) to 135 million barrels of oil equivalent (MMboe; 85% developed) for the year-ended 2015. A key driver of the decline was the impact of sharply lower prices on reserve calculations, with the largest reduction in proved undeveloped reserves. Production increased 9% in 2015 to 54.7 thousand boe per day (Mboepd; 45.3% liquids mix) resulting in a reserve life of nearly 7 years.

The contract drilling segment (about 27% of EBITDA) reported a modest increase in revenue per day to $20,950 mainly due to the placement of higher margin, new BOSS rigs into service during the first half of 2015. This was offset by the rapid decline in rig utilization from 63% in 2014 to 38% in 2015. At the end of 2014, Unit had 75 rigs operating, and as of Feb. 12, 2016, that number had dropped to 20. Fitch expects further rig rationalization to continue.

The midstream segment (about 10% of EBITDA) reported a revenue decline of 43% year over year mostly due to lower commodity prices. NGL volumes sold decreased as the company operated their processing facilities in full ethane rejection mode. Offsetting these declines, the company's gas gathering and processing volumes increased 11% and 13% over 2014; however, if oil and gas prices remain low the effect of further reductions in drilling activity could result in lower volumes.

Credit metrics weakened for the year ended 2015. The Fitch-calculated debt/EBITDA, debt/proved developed reserves (PD), and debt/flowing barrel were approximately 2.3x, $8.05/boe, and $16,946, respectively. Fitch notes that the upstream credit metrics allocate all outstanding debt to the E&P segment. Fitch expects these metrics to erode over the next few years as the impact of lower oil prices continues to strain metrics. Fitch's base case, assuming a West Texas Intermediate (WTI) price of $35, forecasts debt/EBITDA of 4.6x in 2016.

NEAR-TERM LIQUIDITY RISKS MITIGATED

As of Feb. 12, 2016, UNT had $262.9 million outstanding under its credit agreement (approximately $212.1 million available), down slightly from the $281 million outstanding at year end. The company sold approximately $37.4 million of non-core oil and gas properties since year end and has used the proceeds to pay down the borrowings under the credit agreement.

FORECASTED LEVERAGE METRICS WIDEN

Management's current leverage levels, in conjunction with the downsizing of the capital budget to be substantially in line with anticipated cash flows, reduce the need for additional debt. Fitch's base case, assuming a WTI price of $35, projects that Unit will be free cash flow (FCF) neutral. The Fitch base case results in debt/EBITDA of 4.6x in 2016. Debt/PD and debt per flowing barrel metrics are forecast to increase to approximately $8.53/boe, subject to any revisions, and $19,048, respectively. Fitch's base case WTI price forecast assumption of $45 in 2017 and $65 long-term suggests that the company may selectively increase drilling activity in 2017. In 2017, the Fitch base case considers that the company may be free cash flow positive given supportive pricing signals resulting in a debt/EBITDA of 3.6x.

HEDGES FORECAST TO PROVIDE SOME CASH FLOW UPLIFT

Unit utilizes a combination of swap and collared hedges to manage cash flows and support development funding. As of Feb. 12, 2016, the company's 2016 oil and gas hedges accounted for around 33% and 64%, respectively, of its estimated 2016 production. Hedges are estimated to provide about $22 million in additional uplift in 2016 but hedge coverage rolls off substantially in 2017.

LIMITED OTHER LIABILITIES

Unit does not have a defined benefit pension plan. Asset retirement obligations (AROs) were $98 million, as of Dec. 31, 2015, which was lower than the $101 million reported at year-end 2014. This was mainly due to a favorable revision of cost estimates associated with plugging wells based on actual costs over the preceding year. The company does not have any material additional liabilities.

KEY ASSUMPTIONS

--WTI oil that trends up from $35/barrel in 2016 to $45/barrel in 2017 and a long-term price of $65/barrel;
--Henry Hub gas that trends up from $2.25/mcf in 2016 to $2.50/mcf in 2017 and a long-term price of $3.25/mcf;
--Production decline of about 14% in 2016 with a 6% and 3% decline in 2017 and 2018, respectively;
--Drilling segment EBITDA is forecast to decline by over 90% in 2016 due to lower U.S. onshore activity with some BOSS rig margin offset;
--Midstream EBITDA shows more resiliency through downturn, but volumetric and commodity pricing exposure will pressure margins;
--Capital spending is forecast to be $153 million in 2016, consistent with guidance, followed by an operating cash flow outspend generally consistent with historical levels given supportive pricing signals;
--No additional asset divestiture proceeds are forecast given the challenged onshore drilling conditions

RATING SENSITIVITIES

Positive to 'BB-': Future developments that may, individually or collectively, lead to a positive rating action include:
--Increased size, scale, and diversification of Unit's E&P operations with some combination of the following metrics;
--Mid-cycle debt/EBITDA below 3.0x on a sustained basis;
--Mid-cycle debt/PD of $12.00/boe and/or debt/flowing barrel below $18,000 on a sustained basis;
--Favorable oil & gas services outlook and heightened rig utilization and day rates signal an improvement in asset quality and mix.

Future positive rating actions are unlikely without a material increase to the company's reserve base and production profile, in conjunction with improved leverage metrics. Management's budget suggests that the E&P operations will struggle to grow sufficiently over the near-term to help facilitate a positive rating action given the current weak pricing environment. Without an improvement in business diversification, production would need to trend towards 75 mboepd before a positive rating action.

The Negative Outlook could be revised should the company maintain liquidity while offsetting production declines.

Negative to 'B': Future developments that may, individually or collectively lead to a negative rating action include:
--Mid-cycle debt/EBITDA above 4.5x - 5.0x on a sustained basis;
--Mid-cycle debt/PD of $14.00/boe and/or debt/flowing barrel approaching $22,500 on a sustained basis;
--Reduction in size, scale and diversification or loss of operational momentum in key plays;
--Material reduction in available liquidity.

Future negative rating actions remain a possibility and will be closely linked to the company's ability to retain financial flexibility through the downcycle. Fitch understands, however, that the company's midstream assets, if sold, could generate considerable liquidity. These types of asset sales due have been executed by peers to improve financial flexibility. While a midstream asset sale is not contemplated in the rating, Fitch recognizes that embedded liquidity option value is present.

FULL LIST OF RATING ACTIONS

Fitch has taken the following actions:

Unit Corporation
--Long-term Issuer Default Rating affirmed at 'B+';
--Senior secured bank revolver assigned a new rating of 'BB+'; Recovery Rating 'RR1';
--Senior unsecured bank revolver rating withdrawn;
--Senior subordinated notes affirmed at 'BB-'; Recovery Rating 'RR3';

The Rating Outlook is Negative.