CHICAGO–(BUSINESS WIRE)–Fitch Ratings has downgraded Energy XXI LTD’s (NYSE: EXXI) and Energy XXI Gulf Coast, Inc.’s (EGC) long-term Issuer Default Rating (IDR) to ‘C’ following the non-payment of interest due Feb. 16 on EPL Oil & Gas’ (EPL) unsecured notes due 2018. EPL is a wholly-owned subsidiary of EGC. Fitch believes that EXXI’s capital structure is unsustainable at our current oil & natural gas price deck, and that the potential for debt exchanges or restructuring will be elevated over the next six months.
A full list of rating actions follows this release.
KEY RATING DRIVERS
ENTRY INTO GRACE PERIOD
The downgrade to ‘C’ is driven by EXXI’s election to enter a 30-day grace period on the EPL notes through non-payment of $8.8 million in interest due Feb. 16. While EXXI has the financial capacity to make the payment, the election to defer payment indicates that negotiations with creditors could lead to either a distressed debt exchange or bankruptcy. In addition to the $8.8 million in interest, EXXI has $80 million in interest due on March 17 related to the company’s $1.45 billion in second-lien notes.
DEBT REPURCHASES NOT SUFFICIENTLY DELEVERAGING
Since June 30, 2015, EXXI has repurchased debt in the open market, using $232.3 million in cash to repurchase $1.71 billion in aggregate principal. Pro forma for debt repurchases subsequent to Dec. 31, 2015, EXXI’s consolidated cash is estimated at $306 million ($348 million as of Dec. 31 less $19 million in subsequent bond repurchases). Pro forma annual interest expense is estimated at $248 million, leading to limited near term financial flexibility absent a rapid rebound in oil prices or additional debt reduction. Through debt repurchases, the company has lowered total debt to $2.8 billion at Feb. 15, 2016 from $4.6 billion at June 30, 2015. Despite these actions, Fitch believes that the current debt load remains unsustainable at our current price deck.
RESERVES LOWER ON PRICE, DEVELOPMENT DEFERRAL
At Dec. 31, 2015, EXXI’s total proved reserves were 107.9 MMBOE, down from 183.5 MMBOE as of June 30, 2015. Due to expectations for lower capital spending, EXXI has reclassified essentially all proved undeveloped reserves out of the proved category, as they are not currently expected to be drilled within the next five years. Fitch expects the company to focus on lower cost recompletions and low-risk development activity, but anticipates that 2016 production will decline at current spending levels. Production in the quarter ending Dec. 31 was 54.5 thousand barrels of oil equivalent (mboe)/d, down 7.4% from 58.9 mboe/d for the quarter ending Sept. 30, 2015.
UPDATED RECOVERY ANALYSIS
EXXI Gulf Coast recoveries are estimated as outstanding (‘RR1’ – 100%) at the first-lien secured level, superior (‘RR2’ – 75%) at the second-lien secured level, and poor (‘RR6’ – 0%) at the unsecured level. The current 0% estimated senior unsecured recovery contrasts to a 13% estimated recovery for unsecured creditors cited in the last review. EXXI LTD’s convertible notes and preferred stock are structurally subordinated to the assets at EXXI Gulf Coast, and receive no recovery value in our analysis (‘RR6’ – 0%).
Lower recovery estimates are driven by reduced value estimates for oil and gas reserves, with our lower oil and gas price deck having the largest impact. Recovery values are based on estimated liquidation values of proved (1P) reserves. EXXI disclosed updated 1P reserve totals as of Dec. 31, 2015, which were used in the recovery analysis, in their quarterly filing released on Feb. 16. Fitch begins with a standard value of $12.50/boe for an average producer based on our long-term price deck ($65/bbl oil, $3.25/mcf natural gas). Fitch makes adjustments for location and quality, oil & gas mix, as well as adjustments related to changes in our oil and gas price deck (last updated Jan. 19, 2016).
KEY ASSUMPTIONS
Fitch’s key assumptions within the rating case for Energy XXI include:
–Base Case WTI oil prices of $45/bbl in 2016, $55/bbl in 2017, and $60 in 2018;
–Base Case Henry Hub natural gas prices of $2.50/mcf in 2016, $2.75/mcf in 2017, and $3.00/mcf in 2018;
–Capex of $150 million in 2016;
–High single digit production declines;
–Stress Case WTI oil prices of $35/bbl in 2016, $40/bbl in 2017, and $42 in 2018;
–Stress Case Henry Hub natural gas prices of $2.25/mcf in 2016, $2.50/mcf in 2017, and $2.75/mcf in 2018;
RATING SENSITIVITIES
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
–Failure to pay debt service within grace periods and or bankruptcy filing would result in a downgrade of the IDR to ‘D’.
–A distressed debt exchange would result in a downgrade of the IDR to ‘RD’.
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
–Payment of interest in accordance with debt agreements.
–Better visibility on a sustainable deleveraging plan.
–An increase in oil and natural gas prices leading to positive free cash flow (FCF) generation.
No upgrades are currently contemplated given weakening credit metrics, lower liquidity following open market debt repurchases, and significant headwinds from lower oil and natural gas prices.
LIQUIDITY
Overall liquidity and financial flexibility are limited and are currently limited to cash on hand. As a result of the non-payment of interest due Feb. 16, EGC is restricted from drawing on the first-lien credit facility, lowering overall liquidity by approximately $122 million while the grace period restrictions are in effect.
Pro forma for debt repurchases subsequent to Dec. 31, 2015, EXXI’s consolidated cash is estimated at $306 million relative to approximately $248 million in annual interest expense. While debt repurchases have lowered overall debt balances, they have also lowered overall liquidity needed to service remaining debt, increasing the need to address the capital structure with stakeholders. At our current base case, Fitch expects EXXI to be FCF negative in 2016, increasing the call on available liquidity.
Pro forma for recent repurchases, scheduled debt maturities over the next five years are estimated at $423 million in 2017, $614 million in 2018, $101 million in 2019, and $1.45 billion in 2020.
FULL LIST OF RATING ACTIONS
Fitch has downgraded the following ratings:
Energy XXI Gulf Coast Inc.
–Long-term Issuer Default Rating (IDR) to ‘C’ from ‘CCC’;
–Senior secured first lien revolver to ‘CCC/RR1’ from ‘B/RR1’;
–Senior secured second lien notes to ‘CCC-/RR2’ from ‘B/RR1’;
–Senior unsecured notes to ‘C/RR6’ from ‘CCC-/RR5’.
Energy XXI LTD
–Long-term IDR to ‘C’ from ‘CCC’;
–Convertible notes to ‘C/RR6’ from ‘CC/RR6’;
–Convertible perpetual preferred to ‘C/RR6’ from ‘CC/RR6’.
Additional information is available at ‘www.fitchratings.com’.
Applicable Criteria
Corporate Rating Methodology – Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362
Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers (pub. 07 Dec 2015)
https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=873504
Additional Disclosures
Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=999691
Solicitation Status
https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=999691
Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31
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