Fitch Ratings has revised Harbour Energy PLC's Outlook to Negative from Stable, while affirming its Long-Term Issuer Default Rating (IDR) at 'BB' and senior unsecured rating at 'BB'.

The Recovery Rating is 'RR4'.

The Outlook revision reflects Harbour's reduced oil and gas reserves in 2022, resulting in a weak 2P reserve life of six years, and our expectation that without acquisitions and material reserves additions Harbour's production may decline in the next four years.

The rating, however, is supported by Harbour's very low leverage as it has significantly reduced its gross debt in 2022-1H23, which should allow for acquisitions, and by a pipeline of new projects and prospects of organic reserves additions. Despite decreasing production and recently increased UK hydrocarbon taxes, we expect Harbour to generate healthy pre-dividend free cash flow (FCF) at least in 2023-2025.

Key Rating Drivers

Low Reserve Life: Harbour's reserve life is lower than peers', which puts its rating under pressure. Its 2P reserve life (based on projected 2023 production and end-2022 reserves) amounted to six years, lower than Aker BP ASA's (BBB/Stable) nine years and Neptune Energy Group Midco Limited's (BB+/Rating Watch Positive) 11 years. Harbour's absolute level of 2P reserves decreased to 410 million barrels of oil equivalent (MMboe) in 2022 from 488 MMboe in 2021 as its reserves additions in 2022 were low.

Organic Opportunities: Harbour has significant 2C resources (455MMboe), some of which may be translated into 2P in the next four years. In particular, some reserves could be added through development of Zama (Mexico), Tuna (Indonesia), Timpan (Indonesia) and infill drilling across the UK and others. However, such additions are not certain.

Low Leverage: Harbour's low reserves are partly counterbalanced by its very low debt levels. It sharply reduced its gross debt in 2022-1H23, which we expect to result in low EBITDA net leverage (0.1x in 2023) and for the next four years, assuming no acquisitions and moderate dividend payments. We do not rule out acquisitions, which were Harbour's main source of reserve additions in the past.

Declining Production in UK: Harbour expects its production to decline to 185-195 thousand barrels of oil equivalent per day (kboe/d) in 2023, from 208 kboe/d in 2022, due mostly to a natural production decline as many of the company's fields are mature. Harbour's production is focused mainly on the UK (more than 90%), but we expect the weight of international projects in its production portfolio to increase.

EPL Tax Burden Manageable: The UK government's introduction of the energy profit levy (EPL) is credit-negative for Harbour but is overall manageable, given fairly high oil and gas prices. Our rating case estimates Harbour's tax charge to average around USD800 million p.a. in 2023-2025 (or around 35% of EBITDA). However, the lack of clarity about future evolution of UK taxes reduce Harbour's longer-term cash flow visibility.

Material Decommissioning Obligations: Harbour's decommissioning liabilities at end-2022 were high at around USD4.1 billion (pre-tax, discounted at a risk-free rate in line with IFRS), or around USD10/boe per 2P reserves. Most decommissioning-related cash outflows are long-term and are partially tax-deductible. Fitch's approach is not to add decommissioning liabilities to debt, but to deduct them from projected funds flow from operations (FFO) as they are being incurred. We assume that over the forecast horizon Harbour's gross decommissioning expense will average around USD250 million per year on a pre-tax basis.

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. Harbour's target is to become carbon neutral on the Scope 1&2 basis by 2035 through minimising emissions and investments in carbon offsets.

Derivation Summary

Harbour's level of production (1H23: 196kboe/d) is slightly higher than that of Neptune (140kboe/d) and Energean (145kboe/d), and significantly lower than that of Aker BP (467kboe/d). Its 2P reserve life is low relative to peers' (six years, versus Neptune's 11 years and Aker BP's nine years) and counterbalanced by substantial 2C resources and low leverage, allowing for acquisitions.

Key Assumptions

Brent oil price: USD80/bbl in 2023, USD75/bbl in 2024, USD70/bbl in 2025, USD65/bbl in 2026, USD60/bbl in 2027

Title transfer facility (TTF) gas price: USD13/mcf in 2023, USD10/mcf in 2024-2025, USD5/mcf in 2026-2027

Production volumes declining by around 10% p.a. in 2023-2027

Capex (including decommissioning and exploration) averaging approximately USD800 million across 2023-2027

RATING SENSITIVITIES

Factors That Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade:

The rating is on Negative Outlook, therefore, we do not expect positive rating action at least in the short term. However, stabilised production profile with an improved reserve life (organically or through acquisitions) while maintaining a conservative financial profile would lead to Outlook stabilisation.

Material improvement in the business profile while maintaining a conservative financial profile (e.g. EBITDA net leverage below 1.2x) would be positive for the rating

Factors That Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade:

Inability to stabilise reserves position (eg 2P reserve life remaining at or falling below six years, falling absolute level of reserves) and production levels

EBITDA net leverage consistently above 1.7x

Consistently negative FCF after dividends

Liquidity and Debt Structure

RBL Cut, Strong Immediate Liquidity: In June 2023, Harbour's reserve-based loan (RBL) availability was reduced to USD1.1 billion, from USD2.7 billion, reflecting the EPL introduction and lower reserves. However, Harbour's immediate liquidity remains strong as its RBL was fully unutilised at end-July 2023, and its only material maturity (the USD500 million bond) is in 2026.

Senior Unsecured Bond: Harbour's USD500 million senior unsecured notes (BB/RR4) are rated in line with the IDR, using a generic approach for 'BB' category issuers. This reflects the instrument ranking in the company's capital structure, in accordance with our Corporates Recovery Ratings and Instrument Ratings Criteria.

Issuer Profile

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

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.

ESG Considerations

Harbour Energy PLC has an ESG Relevance Score of '4' for Waste & Hazardous Materials Management; Ecological Impacts due to high decommissioning obligations, which has a negative impact on the credit profile, and is relevant to the rating in conjunction with other factors.

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' 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. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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