Research Update: Hilcorp Downgraded To 'BB-' On Weak Credit Metrics, Ratings Remain On CreditWatch Negative On Proposed BP Acquisition April 7, 2020 Rating Action Overview - We expect U.S.-based exploration and production company Hilcorp Energy I L.P.'s credit measures will be below expectations for the rating through 2021, under our revised oil and gas price assumptions. - Moreover, we believe it will be challenging to recover the $500 million already spent on the pending BP transaction if it doesn't close. - We are lowering our issuer credit rating and unsecured debt ratings on Hilcorp to 'BB-' from 'BB+'. - Our ratings on Hilcorp remain on CreditWatch with negative implications as we believe the company will either have higher leverage or weak liquidity if the transaction closes as proposed. PRIMARY CREDIT ANALYST Sarah F Sherman, CFA New York + 1 (212) 438 3550 sarah.sherman @spglobal.com SECONDARY CONTACT Ben B Tsocanos New York (1) 212-438-5014 ben.tsocanos @spglobal.com Rating Action Rationale We estimate credit metrics 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), as well as the unlikely ability for Hilcorp to recover the $500 million previously paid for the BP transaction, we expect Hilcorp's funds from operations (FFO) to debt to fall to approximately 20% over the next two years. Nevertheless, the company is expected generate cash over the timeframe, particularly due to its substantial hedge position with approximately 85% of its oil hedged at a high $50 West Texas Intermediate (WTI) dollar price in 2020. Given the current capital markets environment, financing could be challenging for the proposed BP transaction. Given current capital market conditions and Hilcorp's $1.7 billion dollar facility--with $1.24 billion drawn at year-end 2019--we believe it will be challenging for the company to finance this transaction. Still, BP recently put out a press release stating it expected www.spglobal.com/ratingsdirect April 7, 2020 1 Research Update: Hilcorp Downgraded To 'BB-' On Weak Credit Metrics, Ratings Remain On CreditWatch Negative On Proposed BP Acquisition the transaction to close in 2020. Hilcorp has a strategic relationship with BP given its business model of acquiring developed, mature properties and then augmenting production through workovers and other well enhancements. We're keeping the rating on CreditWatch negative because we believe this transaction would most likely be a leveraging event. Hilcorp is cutting capex to below maintenance levels as it looks to become cash flow neutral. The company guided its capital expenditure (capex) program to the $275 million-$325 million range from prior year levels of $500 million as it looks to be pre-hedge cash flow neutral. Subsequently we expect pre-transaction production to modestly decline over the next two years. CreditWatch The CreditWatch negative reflects our view that we could lower the issuer credit rating on Hilcorp following the acquisition of BP's Alaska operations based on the likelihood of higher leverage. In resolving the CreditWatch, we will assess the effect of the acquisition on Hilcorp's liquidity and its plan to finance the transaction, as well as its production, reserves and operating and capital costs. We intend to resolve the CreditWatch when the transaction closes. Company Description Hilcorp is an exploration and production company with reserves focused in the Cook Inlet and North Slope in Alaska (32%), Louisiana (19%), Texas (25%), Wyoming (12%), and the Utica shale play in Ohio (12%). As of year-end 2019, the company had 903 million barrels of oil equivalent (boe), consisting of 36% oil, 57% natural gas, and 7% natural gas liquids, of which 32% was proved undeveloped. Year-end production declined slightly to 159 million boe per day. Our Base-Case Scenario - S&P Global Ratings' gas price assumptions are $2.0 per million British thermal unit (mmBtu) for the remainder of 2020, $2.25/mmBtu for 2021, and $2.5/mmBtu thereafter. - Our price assumptions for WTI are $25 per barrel (bbl) for the remainder of 2020, $45/bbl for 2021, and $50/bbl thereafter. - Capital spending of approximately $300 million over the next year. Based on these assumptions, we arrive at the following credit measures: - FFO to debt: approximately 20% over the next two years. - Positive free cash flow over the next two years. Liquidity We assess the company's liquidity as adequate. We expect liquidity sources will exceed uses by at least 1.2x for the 12 months beginning Dec. 31, 2019. In addition, we believe sources will exceed uses even if forecast EBITDA declines 15%. Principal liquidity sources: - Cash FFO of roughly $700 million-$750 million over the next 12 months. www.spglobal.com/ratingsdirect April 7, 2020 2 Research Update: Hilcorp Downgraded To 'BB-' On Weak Credit Metrics, Ratings Remain On CreditWatch Negative On Proposed BP Acquisition - $36 million of cash on hand as of Dec. 31, 2019. - As of Dec. 31, 2019, the company had approximately $725 million of availability with $1.7 billion in commitments and a $1.8 billion dollar borrowing base due January 2022. Principal liquidity uses: - Approximately $300 million in capex anticipated in 2020. Covenants As of Dec. 31, 2019, Hilcorp was in compliance with its debt-to-EBITDA covenant of 4.5x. We expect the company to remain in compliance over the next 12-18 months Issue Ratings - Recovery Analysis Key analytical factors - Our simulated default scenario contemplates a sustained period of low commodity prices, consistent with the conditions of past defaults in this sector. - We base our valuation on a company-provided PV-10 report, using year-end 2019 proven reserves evaluated at our recovery price deck assumptions of $50/bbl for WTI crude oil and $2.5/mmBtu for Henry Hub natural gas. - Our recovery analysis for Hilcorp also incorporates its $1.8 billion commitments on its senior secured reserve-based loan facility, which we assume will be fully drawn at default. Simulated default assumptions - Simulated year of default: 2025 - Jurisdiction (Rank A): The company is headquartered in the U.S. and most of its revenue/assets are located domestically. - We adjusted our gross enterprise value (EV) to account for restructuring administrative costs (estimated at about 5% of gross value). Simplified waterfall - Net EV (after 5% in administrative costs): $4.6 billion* - Secured first-lien debt: $1.76 billion - --Recovery expectations: Not applicable - Total value available to unsecured claims: $2.84 billion - Senior unsecured debt claims: $1.65 billion - --Recovery expectations: 50% to 70% (Rounded estimate: 65%)* www.spglobal.com/ratingsdirect April 7, 2020 3 Research Update: Hilcorp Downgraded To 'BB-' On Weak Credit Metrics, Ratings Remain On CreditWatch Negative On Proposed BP Acquisition All debt amounts include six months of prepetition interest. *This valuation does not include Hilcorp's natural gas contracts in Alaska. We generally cap recovery ratings on unsecured debt issued by corporate entities with issuer credit ratings of 'BB-' or higher at '3' (50%-70% recovery) to account for the greater risk of their recovery prospects. Ratings Score Snapshot Issuer credit rating: BB-/Watch Neg/-Business risk: Fair - Country risk: Very low - Industry risk: Intermediate - Competitive position: Fair Financial risk: Aggressive - Cash flow/leverage: Aggressive Anchor: bbModifiers - Diversification/portfolio effect: Neutral - Capital structure: Neutral - Financial policy: Neutral - Liquidity: Adequate - Management and governance: Satisfactory - Comparable rating analysis: Neutral Related Criteria - General Criteria: Group Rating Methodology, July 1, 2019 - Criteria Corporates General: Corporate Methodology: Ratios And Adjustments, April 1, 2019 - Criteria Corporates General: Recovery Rating Criteria For Speculative-Grade Corporate Issuers, Dec. 7, 2016 - Criteria Corporates General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate Issuers, Dec. 16, 2014 - Criteria Corporates General: Corporate Methodology, Nov. 19, 2013 - General Criteria: Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013 - General Criteria: Methodology: Industry Risk, Nov. 19, 2013 - General Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities, Nov. 13, 2012 - Criteria Corporates Industrials: Revised Assumptions For Assigning Recovery Ratings To The Debt Of Oil And Gas Exploration And Production Companies, Sept. 14, 2012 www.spglobal.com/ratingsdirect April 7, 2020 4 Research Update: Hilcorp Downgraded To 'BB-' On Weak Credit Metrics, Ratings Remain On CreditWatch Negative On Proposed BP Acquisition - General Criteria: Use Of CreditWatch And Outlooks, Sept. 14, 2009 Ratings List Downgraded To From Hilcorp Energy I L.P. Issuer Credit Rating BB-/Watch Neg BB+/Watch Neg Ratings Lowered; Recovery Ratings Unchanged To From Hilcorp Energy I L.P. Hilcorp Finance Co. Senior Unsecured Recovery Rating BB-/Watch Neg BB+/Watch Neg 3(65%) 3(65%) Certain terms used in this report, particularly certain adjectives used to express our view on rating relevant factors, have specific meanings ascribed to them in our criteria, and should therefore be read in conjunction with such criteria. Please see Ratings Criteria at www.standardandpoors.com for further information. Complete ratings information is available to subscribers of RatingsDirect at www.capitaliq.com. All ratings affected by this rating action can be found on S&P Global Ratings' public website at www.standardandpoors.com. 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