Fitch Ratings has affirmed the Long-Term Issuer Default Ratings (IDRs) for ConocoPhillips (COP), ConocoPhillips Company and Polar Tankers, Inc. at 'A'/Stable.
In addition, Fitch has affirmed the long-term issue-level ratings at these entities, as well as at Burlington Resources at 'A'. Fitch has affirmed ConocoPhillips Company's Short-Term IDR and commercial paper (CP) programs at 'F1+'.
ConocoPhillips' ratings reflect its pro forma size and scale as one of the largest North American independent exploration and production (E&P) companies following the Concho Resources, Inc. (CXO) acquisition; diversified, low-cost portfolio with more than 23 billion barrels (bbl) of resource that can be developed at an average cost of supply of less than $30/boe; low debt balances; strong credit metrics; track record of defending the rating through corporate actions; and moderate maturity wall.
Ratings concerns including the impacts of the pandemic, which led the company to curtail 225,000boepd in 2Q20 and has the potential to cause oil prices and volumes to drop again over the next few quarters, and a shareholder-friendly distribution policy that targets returning 30% of cash flow from operations to shareholders.
KEY RATING DRIVERS
Credit Friendly Transaction: As contemplated, the $9.7 billion transaction is expected to be credit friendly, with elements including a stock-for-stock exchange between COP and CXO at a fixed exchange ratio representing a 15% premium for the acquisition, and conservative balance sheets maintained at both companies. As calculated by Fitch, at June 30,2020, COP's LTM debt/EBITDA leverage was 1.5x while CXO's was 1.3x.
Enhanced Permian Position: The acquisition will materially augment COP's low-cost inventory, adding about 200,000bopd of CXO's Permian oil production, along with 1.2 billion boe of proven (1p) reserves, and 550,000 net acres primarily across the Northern and Southern Delaware and Midland basins. The resource additions meet COP's acquisition criteria for low-cost assets that compete within its portfolio, given CXO's cost of supply in the low- to mid-$30/bbl range. On a combined basis, COP will have over 1.5 million net acres across its core four shale positions (Delaware, Midland, Eagle Ford and Bakken), which include 17,000 drilling locations at less than $40/bbl cost of supply.
Synergies: Synergies associated with the deal are moderate. The company has outlined $500 million in run rate synergies it expects to achieve, which includes $100 million from the elimination of duplicate G&A, $250 million from exploration related costs, and $150 million from streamlining corporate center and business unit support costs. Costs to achieve these synergies should be modest. As calculated by Fitch, these should increase the company's netbacks by just under $1.00/boe. Other operational synergies from the adoption of CXO's best practices may also result in gains but were not yet well defined.
Acquisition Increases Size and Scale: COP's ratings reflect the company's size and scale, which will be materially augmented by the acquisition of CXO. On a PF basis, COP's production will increase to around 1.5 million boepd PF from around 1.15 million boepd in 2020. Size is positive for E&P credit profiles, as larger companies tend to have more liquidity options in a downturn, including a bigger pool of assets from which to sell. However, the prospects for asset sales are limited in the current pandemic environment, given few transactions to date. Asset sales are also capped by the fact COP has aggressively sold assets down over the past several years. On a pro forma basis following the close of the deal, the company will be about the same size as it was in 2016.
Portfolio Diversification: COP's portfolio diversification is high. The company's asset base includes a fast-growing unconventional shale footprint (Delaware, Midland, Eagle Ford and Bakken), a sizable conventional footprint (Alaska, Norway, Indonesia and Malaysia), and low-cost brownfield mega-projects in the Canadian oil sands (Surmont), Australia (APLNG) and the Middle East (Qatargas 3). These projects anchor the company's lower decline rate, which reduces pressure to spend. Following the acquisition, the portfolio decline rate will edge up to 12%, and depending on how much capital CXO properties receive, may continue to rise, but should still be advantaged over faster declining pure shale peers. While much of the company's production is royalty based, Conoco has exposure to production sharing contracts (PSCs) in Asia, which provide a modest operational hedge in a downturn. The Canadian assets also have PSC-like benefits due to sliding scale royalty payments.
Distribution Focus: Fitch anticipates no change in the company's financial policies of rewarding shareholders post acquisition. In terms of financial priorities, the company seeks to first invest sustaining capital (about $5.1 billion jointly) and pay its base dividend, followed by maintaining the balance sheet, making additional shareholder distributions and, finally, depending on prices, grow volumes. COP continues to target paying out about 30% of CFO to its shareholders. From a credit perspective, Fitch considers the company's returns-focused strategy as largely positive, given the high-grading of the remaining portfolio and maintenance of low debt levels. However, Fitch recognizes there are some long-term risks associated with the strategy, including potential reductions in size and scale, and timing risk around distributions, particularly if made right before another downturn.
Equalization of Ratings: Under Fitch's Parent and Subsidiary Rating Linkage methodology, Fitch equalized the ratings between the parent ConocoPhillips and the subsidiary ConocoPhillips Company. The equalization was driven by the strong legal ties seen across Conoco's different subsidiaries, in particular, the extensive joint and several cross guarantees seen within the structure, with COP and ConocoPhillips Company cross-guaranteeing each other's debt, indicate strong linkage and support equalization of IDRs across the companies.
DERIVATION SUMMARY
On a PF basis following the transaction, COP will be the largest independent E&P company in North America at about 1.5 million boepd; it is well positioned versus investment-grade (IG) peers in the space. Geographic and basin diversification is above average compared with independent peers. The company has a property mix including positions in short-cycle unconventional shale (Eagle Ford, Bakken, Permian Delaware and Midland), medium-term conventional projects (Alaska, Malaysia and Indonesia), and low-decline mega projects (the Oil Sands and APLNG). These projects help anchor a decline rate that is well below peers' at around 12% (10% prior to the CXO acquisition). We expect the Permian Basin will be the fastest growing within the portfolio and may put some pressure on the decline rate over time but will remain below that of peers.
The CXO acquisition is expected to boost COP's inventory of low-cost resources (23 billion boe that can be developed at
CONOCOPHILLIPS 
