Fitch Ratings has upgraded Marathon Oil Corporation’s (MRO) Issuer Default Rating (IDR) and associated ratings to ‘BBB+’ from ‘BBB’, and affirmed the company’s short-term IDR and commercial paper (CP) ratings at ‘F2’. The Outlook has been revised to Stable from Positive.
Approximately $6.46 billion of debt is affected by today’s rating action.
Upgrade to ‘BBB+
The upgrade was driven by MRO’s robust operational and financial performance over the last several quarters, which in turn has been driven by strong growth and efficiency gains in its liquids shale plays, resulting in debt/boe metrics that are strong for the rating category and compare favorably to a number of higher-rated peers. At March 31, 2014, Marathon’s debt boe/1p reserves declined to $3.04 from $3.42/boe; its debt/boe proved developed (PD) reserves declined to $4.27/boe from $4.77/boe; and its debt/flowing barrel stood at $14,156/bbl.
Marathon has a sizable, multi-year inventory of drilling opportunities in the shale plays which provides good visibility on future production and reserve growth and increases confidence that it will be able to sustain its positive momentum going forward.
Key Ratings Drivers
Marathon’s ratings are supported by its reasonably diverse upstream portfolio; high and growing exposure to liquids in the upstream (72% of production and 79% of reserves in 2013, up from 71% and 77% in 2012); strong cash generation (full-cycle 2013 netbacks as calculated by Fitch of $31.21/boe, one of the strongest among oil-heavy peers); robust liquidity; and track record of defending the rating through asset sales and capex cuts.
These are balanced by the company’s historically lackluster output growth (less than 2% on average from 2007-2011), and selective upstream execution issues that the company has experienced in the past. However, Fitch believes the strong performance in the shale plays, and the fact that these lower risk plays are set to make up a growing percentage of MRO’s overall portfolio, compensates for the risk of misses elsewhere in the portfolio on a forward-looking basis.
Marathon’s 2013 upstream metrics were solid. Total proven reserves rose to approximately 2.17 billion boe from 2.02 billion boe the year prior. PD reserves were 71% of totals but included a large number of reserves associated with the AOSP project in Canada. The company had a strong Reserve Replacement Ratio (RRR) of +185% on an organic basis, and +181% on an all-in basis. This resulted in very low 1-year F&D (finding & development cost) of just $15.81/boe, and 3-year FD&A (finding, development & acquisition costs) of just $19.29/boe. Sources of reserve gains were mostly operating additions and revisions.
As calculated by Fitch, Marathon’s 2013 R/P ratio edged up to 12.3 years from 11.8 years in 2012. Unit economics were very strong. Full-cycle netbacks rose to $31.21/barrel. The company’s strong netbacks stem from its high and growing liquids production, which gives it better cash flow relative to gas-heavy peers, as well as increased efficiency in shale plays, which lowered unit costs.
North Sea Asset Sale
In early June, Marathon announced it had entered an agreement to sell its Norwegian North Sea assets to Det norske oljeselskap ASA for $2.7 billion ($2.1 billion net proceeds) with the effective date of the transaction Jan. 1, 2014. Marathon retained its UK North Sea assets after failing to receive an acceptable offer. While the sale of the North Sea asset will have an impact on debt/flowing barrel, its impact on debt/boe metrics should be minor given that it has relatively small proven reserves associated with it (<5% of totals). Fitch does not anticipate the company will need to borrow to fund its capex program or dividend following the sale, given its current cash balances and the improving free cash flow (FCF) profile for the rest of its portfolio. Fitch also expects the company’s Asset Retirement Obligation (ARO) liabilities to improve significantly following the sale, as just under half of Marathon’s total $2.1 billion in AROs were associated with the North Sea properties.
Outperformance in Shales
Marathon has significantly exceeded previous production guidance for the Eagle Ford – earlier given as 80,000 boepd by 2016 and now reset to approximately 140,000 boepd by 2017. Higher well productivity and sharp drops in well completion times have been key drivers of gains in shale play. In first quarter 2014 (1Q’14), production averaged 96,000 boepd, a 33% increase over year ago averages. On a forward-looking basis, further gains are expected in the Eagle Ford as pad drilling increases, and spacing between wells, continues to fall. MRO’s other shale plays have also performed well, including legacy Bakken/Three Forks positions, as well as South Central Oklahoma Oil Province (SCOOP). Total production across the company’s three onshore shale plays rose to 154,000 boepd in 1Q’14, a 26% increase from levels seen a year ago.
Recent Financial Performance
Marathon’s latest 12-month (LTM) credit metrics for the period ending March 31, 2014 were strong. As calculated by Fitch, EBITDA stood at $7.94 billion, while debt edged down to $6.6 billion, resulting in LTM debt/EBITDA of just 0.81x, while EBITDA/gross interest expense stood at 28.1x. The combination of strong reserve additions, strong production growth, and moderate debt reductions combined to produce debt/boe metrics that are strong for the rating category. As calculated by Fitch, Marathon had debt/boe proven reserves of $3.04/boe, debt/boe PD reserves of $4.27/boe, and debt/flowing barrel of $13,625. LTM FCF improved significantly from -$1.41 billion at YE 2012 to $249 million for the LTM period. Under Fitch’s base case assumptions including the North Sea asset sale, the company will be FCF negative in 2014 and 2015, but will not need to borrow to fund capex over this period.
Marathon’s liquidity at the end of the first quarter was good, and included cash of $1.964 billion, and full availability on the company’s $2.5 billion unsecured revolver (recently renewed, now due 2019), which is also used to backstop the company’s commercial paper program. The main covenant on the revolver is a 65% debt-to-cap ratio, which the company had significant headroom on at March 31, 2014. The revolver also contains a negative pledge and change of control provisions. Other covenants across Marathon’s debt structure include restrictions on asset sales, sale-leasebacks, and mergers. Near-term debt maturities include $51 million due in 2014, $1.068 billion due 2015 and nothing due 2016.
Marathon’s other liabilities are manageable. The company’s ARO rose to $2.1 billion from $1.78 billion at YE 2012, and was primarily linked to environmental remediation of existing upstream platforms. The pension deficit at year-end 2013 for U.S. plans declined to $318 million versus $516 million the year before, but was manageable when scaled to underlying cash flows. Total pension contributions for 2014 across all plans are expected to be $77 million, of which MRO had contributed $20 million at the end of 1Q’14.
No upgrades are anticipated in the near term beyond the ‘BBB+’ level. However, future developments that could lead to positive rating actions include:
- Sustained lower debt levels, accompanied by increased size, scale, and diversification in plays, as well as continued solid upstream operational performance.
Future developments that could lead to negative rating action include:
- Inability to execute on stated growth targets in key plays or major negative reserve revision;
- A large leveraging transaction or asset sale which resulted in sustained debt/boe metrics significantly above current levels. This might include the sale of AOSP or Equatorial Guinea, depending on the size of the stake sold;
- A sustained period of low oil prices without offsetting adjustments in spending;
- Significant debt-funded shareholder-friendly actions.
Fitch has upgraded Marathon’s ratings as follows with a Stable Outlook:
- IDR to ‘BBB+’ from ‘BBB’;
- Senior unsecured revolver and notes to ‘BBB+’ from ‘BBB’;
- Industrial revenue bonds to ‘BBB+’ from ‘BBB’.
Fitch has affirmed the following, with a Stable Outlook:
- Commercial paper at ‘F2’;
- Short-Term IDR at ‘F2.’
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