Harbour Energy : Fitch Assigns Harbour's USD500m Notes Final 'BB' Rating

Published: 2021-10-19 05:11:13 ET HBR.L

Fitch Ratings has assigned UK-listed Harbour Energy PLC's USD500 million senior unsecured notes due 2026 a final rating of 'BB' with a Recovery Rating of 'RR4'.

We rate the senior unsecured notes using a generic approach for 'BB' category issuers, which reflects the relative instrument ranking in the capital structure, in accordance with our Corporates Recovery Ratings and Instrument Ratings Criteria. While most of the company's debt will be represented by the secured reserve base landing (RBL), the company's leverage is low and it plans to focus on unsecured funding.

Harbour's 'BB' Long-term Issuer Default Rating (IDR) reflects (i) its increased scale of production following the completed acquisitions; (ii) low financial leverage and conservative financial and hedging policies; and (iii) a favourable tax position. At the same time, Harbour's 1P and 2P reserve life is lower than peers' (2P: seven years based on the 2020 pro-forma production), and its cost of production and decommissioning liabilities are high. We believe that Harbour should be able to maintain broadly stable production from the current asset base in the medium term. Its longer-term performance will depend on its ability to pursue M&A opportunities or transfer contingent resources (2C) into reserves.

Key Rating Drivers

Largest UKCS Player: After acquiring ConocoPhillips' UK assets in 2019 and Premier Oil plc in 2021, Harbour has become the largest UK Continental Shelf (UKCS) player by level of production. The company's current production (2021 proforma guidance: 185-195 thousand barrels of oil equivalent per day, kboe/d) is focused mainly on the UK (more than 90%) but well-diversified by hubs. Harbour operates over two-thirds of its production, which makes its capex fairly flexible; and its portfolio is well-balanced between liquids (around 55% of production) and natural gas (45%).

Low Reserve Life: Harbour's reserve life is lower than peers. In 2020, its 2P reserve life based on the pro-forma production stayed at seven years, lower than that of Aker BP ASA (BBB-/Stable, 11 years), Lundin Energy AB (BBB-/Stable, 11 years) and Neptune Energy Group Midco Limited (BB/Stable; 12 years). This is mitigated by Harbour's conservative leverage, which should allow for acquisitions, and substantial resources (2C), a significant share of which relates to assets in production or under development.

While Harbour should be able to maintain relatively stable production in the medium term from the current reserve base, its production potential over the longer term will depend on its ability to replenish reserves organically and through acquisitions.

High Costs, Low Taxes: Harbour's current cost position of USD16/boe is fairly high, albeit typical for UKCS, and could put the company at a disadvantage in a consistently low oil-price environment. This is mitigated by Harbour's favourable tax position with significant accumulated losses, which should largely shield it from taxes in the next five years. Overall, Harbour's Fitch-projected unit margins (funds from operations (FFO)/boe) are broadly comparable with its North Sea-focussed peers.

Conservative Financial Policies: Harbour targets maintaining net leverage (defined as net debt to EBITDAX) below 1.5x through the cycle. Our projected FFO net leverage below 2.0x over 2021-2024 is commensurate with the company's target, although we recognise that leverage could be affected by potential acquisitions. We assume dividends will be paid in 2022-2024 but note that the company is yet to formalise its dividend policy.

Moderate Capital Intensity: We assume Harbour's capital intensity to be moderate relative to peers at around USD10/boe produced over the forecast horizon, or around USD750 million per year (excluding decommissioning obligations). Harbour's focus is on small scale, short cycle capex with projects largely based on the current infrastructure, including infill drillings. Harbour operates around two-thirds of its production, which gives it a reasonably high degree of control over its capex budget.

Hedging Policies Positive: We view positively Harbour's hedging policy, which should protect its cash flows in case of a significant drop in oil and natural gas prices. We estimate that currently 36% of its liquids production and 57% of its natural gas production in 2022-23 are hedged at an average price of USD61/bbl and USD6.2/mcf, respectively (mainly using swaps). This is above Fitch's price deck used for the period.

Addressing Energy Transition Risks: We assume that at least in the next three to five years the impact of energy transition on oil and gas companies will be limited. However, over the long term, industry participants, and in particular pure upstream players, may be subject to more vigorous regulations, and their margins could be affected by carbon taxes and other regulatory measures. We view positively Harbour's target to become carbon neutral on the Scope 1&2 basis by 2035 through minimising emissions and investments in carbon offsets.

High Decommissioning Obligations: Harbour has an ESG Relevance Score of '4' for 'Exposure to Environmental Impacts' due to high decommissioning liabilities, which negatively affect the company's cash flows.

Harbour's pro-forma decommissioning liabilities at end-2020 were high at around USD4.5 billion (pre-tax, excluding a refund from Shell), or around USD8/boe per 2P reserves (Aker BP: USD3/boe; Ithaca Energy Ltd (B/Stable): USD6/boe). Most decommissioning-related cash outflows are long term and tax deductible. Fitch's approach is not to add decommissioning liabilities to debt, but to deduct them from projected operating cash flow as they are being incurred. We assume that over the forecast horizon Harbour's gross decommissioning expense will average around USD300 million per year on a pre-tax basis.

Derivation Summary

Harbour's level of production (pro-forma 2020: 234kboe/d) is comparable with that of Aker BP ASA (211kboe/d) and higher than that of Lundin (165kboe/d) and Neptune (165kboe/d). Its 2P reserve life is low relative to peers (seven years in 2020, compared to Neptune's 12 years and Aker BP and Lundin's 11 years) and counterbalanced by substantial 2C resources and low leverage (FFO net leverage below 2x in 2021-2024), allowing for acquisitions.

Key Assumptions

Brent price of USD63/bbl in 2021, USD55/bbl in 2022, and USD53/bbl in 2023 and 2024

TTF price of USD10/mcf in 2021, USD6/mcf in 2022, and USD5/mcf in 2023 and 2024

Production volumes averaging around 200 kboe/d through 2024

Capex (excluding decommissioning) averaging approximately USD750 million per year through 2024

Dividends paid out from 2022

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Material improvement in the business profile (e.g. much higher proved reserve life and lower production costs) while maintaining a conservative financial profile (FFO net leverage below 1.5x)

Factors that could, individually or collectively, lead to negative rating action/downgrade:

FFO net leverage consistently above 2.0x

Falling proved reserve life

Falling absolute level of reserves

Consistently negative FCF after dividends

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Strong Immediate Liquidity: Harbour's capital structure is dominated by a senior secured RBL facility maturing in 2027 with current availability of USD3.3 billion. Harbour's notes will be subordinated to the RBL and are meant to be mainly used to repay the USD400 million junior facility from Shell. Harbour's liquidity buffers are represented by the unutilised RBL portion (around USD700 million at 30 June 2021) and unrestricted cash (USD424 million). We view Harbour's immediate liquidity position as strong but it could be affected by RBL re-determinations and possible acquisitions.

ESG CONSIDERATIONS

Harbour has an ESG Relevance Score of '4' for 'Exposure to Environmental Impacts' due to high decommissioning obligations, which has a negative impact on the credit profile, and is relevant to the ratings in conjunction with other factors.

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg

Issuer Profile

Harbour is a medium-scale independent oil and gas producer with assets mainly in the UKCS.

Date of Relevant Committee

24 September 2021

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

Harbour Energy PLC

senior unsecured

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