Fitch Ratings has downgraded the Long-Term Issuer Default Ratings (IDRs) of Ovintiv Inc. (OVV), Ovintiv Canada ULC and Ovintiv Exploration Inc. to 'BB+' from 'BBB-', OVV and Ovintiv Exploration's senior unsecured ratings to 'BB+'/ 'RR4' from 'BBB-', and has maintained the Negative Outlook.
Fitch has also downgraded the Short-Term IDRs and CP ratings of Ovintiv Inc. and Ovintiv Canada ULC to 'B' from 'F3'.
The main drivers for the downgrade include Ovintiv's above average refinancing risk ($1.25 billion in notes due by Jan 2022, with another $1.25 billion drawn on the revolver); the risk that revolver borrowings could rise further if low oil prices limit the attractiveness of tapping the bond market in the near term; improving, but still below average netbacks, and lower expected production growth over the next few years given capex reductions. Fitch also recently lowered its long-term oil price deck. The Negative Outlook also reflects concerns about refinancing risk.
These considerations are somewhat offset by Ovintiv's progress in reducing its cost structure through efficiency gains; large post-acquisition size as an independent exploration and production (E&P); basin and geographic diversification; near-term improvements in natural gas and NGLs pricing; and good near-term hedge protection.
KEY RATING DRIVERS
Above Average Refinancing Risk: OVV's refinancing risk is above average versus peers, given the combination of its maturity wall and existing revolver draws. At June 30, 2020 OVV's maturity wall included $1.25 billion in notes, split between $590 million in 3.9% notes due Nov 2021, and $660 million in 5.75% notes due Jan 2022, as well as a revolver balance of $1.25 billion. Total revolver utilization was around 31% on the company's $4.0 billion in unsecured revolver capacity (matures July 2024). Fitch anticipates borrowings could rise to the degree low oil prices keep the company's spreads elevated and limit the attractiveness of tapping the bond market in the near term.
Debt Repayment Plan: OVV plans to allocate excess cash flow to lower debt over the next six quarters. Fitch notes the amount of de-leveraging is highly dependent on underlying commodity prices, with pricing at or below strip levels likely to slow the program. At the end of Q2, OVV's total debt increased by $392 million versus YE 2019, rising to just under $7.4 billion. The main drivers of the increase include timing effects of capex reductions, unfavorable shifts in working capital linked to the pandemic, severance costs, and remediation spending for Deep Panuke. Working capital draws should largely reverse.
Sensitivity to Lower Prices: OVV's cash flows and credit metrics are relatively sensitive to lower hydrocarbon prices given its below average netbacks. Oil has recovered from April lows but has seen renewed weakness recently given still high global inventories and a stalling recovery in transport fuel demand. Fitch recently lowered its 2022 and long-term price assumptions for WTI in part to reflect the risks of a more drawn out recovery (see 'Fitch Ratings Cuts its Long-Term Oil Price Assumptions', published Sept 08, 2020). Changes include reductions in the base WTI oil price for 2022 from $50/bbl to $47/bbl, and the long-term price from $52/bbl to $50/bbl. In contrast to oil, natural gas has seen some support, as lower oil production is expected to result in less associated gas from shale plays, and a corresponding tightening in supply balances.
Margin Improvement: Offsetting these considerations somewhat, OVV's margins and unit economics continue to improve as it drives well cost efficiencies and focuses on its highest value liquids. Well costs across the company's three core plays are down 15% vs. 2019 as it moves from a 23 rig program (Q1) to a seven rig program for the remainder of the year. OVV raised its guidance for cash cost savings to over $200 million in 2020, which it expects to achieve through lower operating expenses, reduced transportation and processing costs, and G&A reductions.
Scale and Diversification: Ovintiv operates in seven basins, with production concentrated in its three core plays: the Permian, Montney, and Anadarko Basins. Remaining non-core production is largely in the Bakken, Eagle Ford and Duvernay. Fitch expects non-core assets will be retained in the near term, given a challenging asset sales market, but believes these are candidates for future disposals in the event market conditions become more favorable. Fitch views OVV's scaled multi-basin model favorably, given it mitigates against single-basin regulatory risk, and allows companies to still reach their production guidance by shifting capital in the event issues pop up in one basin.
Track Record of Defending the Rating: OVV has historically defended the rating in previous downturns, with actions including deep capex and dividend cuts, asset sales, significant gross debt reduction and equity raises (approximately $2.2 billion in 2015 and 2016 combined). If the current downturn worsens, Fitch thinks the company is likely to cut capex first.
Parent Subsidiary Linkage Reflects Integration: Fitch has equalized the IDRs between parent Ovintiv Inc. and subsidiaries Ovintiv Canada ULC, and Ovintiv Exploration Inc. This equalization is based on strong legal ties among the entities. This includes Ovintiv's explicit assumption of all legacy Encana debt as the new obligor. It is also based on the extensive cross guarantees put into place following the redomiciling which make unsecured debt pari passu.
DERIVATION SUMMARY
At 537,000 boepd (Q2), OVV is above average in size when compared with peers including Hess (BBB-/Stable), Noble (BBB/RWP), Marathon Oil (BBB-/Stable), Apache (BB+/Stable), and Murphy (BB+/Negative). Geographic and basin diversification is above average for the peer group, and includes the company's three core growth plays (Permian, Anadarko and Montney) as well as several other base production plays. However, cash netbacks remain below average versus diversified E&P peers, due to the company's high exposure to natural gas (48% of production at Q2) and NGLs. As calculated by Fitch, at June 30, 2020, OVV's unhedged netbacks averaged -$2.6/boe, versus $5.5/boe for APA, $2.1/boe for MUR, $2.0/boe for MRO, and -$3.0/boe for HES. OVV's maturity wall and revolver utilization are also somewhat larger than peers. No parent/subsidiary, country ceiling or operating environment considerations constrain the rating.
KEY ASSUMPTIONS
Fitch's Key Assumptions Within Our Rating Case for the Issuer
Base Case WTI oil price of $38 in 2020; $42 in 2021; $47 in 2022; and $50 in 2023 and the long term;
Base Case Henry Hub natural gas prices of $2.10/mcf in 2020; and $2.45/mcf across the remainder of the forecast;
Capex of $1.8 billion in 2020, declining to $1.5 billion in 2021, before rising thereafter in line with a rising price deck;
Production of 531,000 boepd in 2020, 511,000 boepd in 2021, 498,000 boepd in 2022, and 518,000 boepd in 2023 with declines concentrated in natural gas and lower value NGLs;
No asset sales assumed.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Material gross debt reduction, accompanied by consistently positive FCF and rising margins;
Mid-cycle debt/EBITDA below 2.7x;
Mid-cycle FFO leverage below 2.7x.
The Negative Outlook could be resolved to the degree the company shows a trend of improvement in FCF generation and related refinancing and liquidity issues.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
Inability to maintain adequate liquidity while addressing upcoming maturities;
Mid-cycle debt/EBITDA above 3.3x;
Mid-cycle FFO leverage above 3.3x;
Trend of additional gross debt increases.
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
Adequate Liquidity: OVV's liquidity is adequate but revolver utilization is higher than most E&P peers. At June 30, 2020, the company had $1.25 billion drawn on its $4.0 billion in revolver capacity, or around 31% utilization, which includes the repurchase of existing senior notes ($137 million in par value at a $22 million discount). The company also had $137 million in Letters of credit (LOCs) issued against its uncommitted lines at June 30, 2020. OVV's revolver capacity is split between a $2.5 billion unsecured revolver at Ovintiv Inc. and a separate $1.5 billion revolver held at Ovintiv Canada ULC, both of which mature in July 2024. Following note repurchase activity, maturities over the next few years include $590 million in 3.9% notes due Nov 2021, and a $660 million 5.75% Jan 2022 note.
Financial Covenants: OVV's covenants are light, with the main financial covenant a 60% maximum consolidated debt/capitalization ratio on its unsecured credit facilities. The facility covenant excludes nonrecourse debt, the Bow Office lease, and allows for the add-back of approximately $7.7 billion in impairments originally taken when the Canadian company converted to GAAP accounting in 2011. Other features include a negative pledge, restrictions on changes in the nature of the business (unless the successor entity is investment grade), and restrictions on the ability to issue debt from non-guarantor material subsidiaries (maximum of 17.5% of consolidated tangible assets). As of June 30, 2020, the company had ample headroom on this covenant with an actual ratio of 35%, versus 28% at YE 2019.
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
The highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or to the way in which they are being managed by the entity(ies). For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.
RATING ACTIONS
ENTITY/DEBT RATING RECOVERY PRIOR
Ovintiv Canada ULC LT IDR BB+ Downgrade BBB-
ST IDR B Downgrade F3
senior unsecured
ST B Downgrade F3
Ovintiv Exploration Inc. LT IDR BB+ Downgrade BBB-
senior unsecured
LT BB+ Downgrade RR4 BBB-
Ovintiv Inc. LT IDR BB+ Downgrade BBB-
ST IDR B Downgrade F3
senior unsecured
LT BB+ Downgrade RR4 BBB-
senior unsecured
ST B Downgrade F3
VIEW ADDITIONAL RATING DETAILS
Additional information is available on www.fitchratings.com
OVINTIV INC. 
