- Australia-based oil and gas exploration and production (E&P) company Karoon Energy Ltd. is planning to issue five-year senior secured second-lien notes of US$400 million. It will use the proceeds to diversify debt funding sources, lengthen its maturity profile, and repay the drawn amount (US$274 million as of Dec. 31, 2023) in its existing US$340 million reserve-based lending facility (RBL facility).
- Karoon benefits from the low-cost position of its 100%-owned Bauna project, located in the Santos Basin off the coast of Brazil, and its recently acquired 30% noncontrolling interest in the Who Dat asset, located in the Gulf of Mexico. However, the relatively small size of the company's reserves and production levels compared with rated global peers constrain the ratings.
- On April 23, 2024, S&P Global Ratings assigned its 'B' long-term issuer credit rating to Karoon and 'B+' long-term issue rating to the company's proposed senior secured second-lien notes. The '2' recovery rating on the notes indicates our expectation of substantial recovery (rounded estimate: 80%) in the event of a default.
- The stable rating outlook incorporates our view that Karoon will maintain its financial discipline as it seeks to increase production and reserves through asset enhancements, developments, and strategic asset acquisitions. Our base case incorporates a ratio of average funds from operations (FFO) to debt of more than 45% and a ratio of debt to EBITDA of below 2.0x over the next two years.
MELBOURNE (S&P Global Ratings) April 23, 2024--S&P Global Ratings today took the rating actions listed above.
Karoon's small scale and limited reserve life compared with peers weigh on our assessment of its business risk. We view the company's smaller proved reserve base and production level relative to peers, and its asset concentration, as limiting factors for the ratings. Karoon's asset portfolio consists of its 100%-owned Bauna project in the Santos Basin off the coast of Brazil, and its recently acquired 30% noncontrolling interest in the Who Dat asset in the Gulf of Mexico.
Karoon's proved reserves are about 58 million barrels of oil equivalent (mmboe) and annual production of 10.5 mmboe-12.5 mmboe projected in 2024. At current production levels, factoring in some inherent level of natural decline, this implies a reserve life of about five to six years, excluding unproved reserves. This is at the lower end of the range for 'B' rated peers such as Talos Energy Ltd., and EnQuest PLC. Accordingly, Karoon is exposed to a material risk of reserve depletion unless it can replenish its reserves via asset enhancements, developments, or asset acquisitions. We also note the operational risks related to offshore oil production, and asset retirement obligations, which elevate spending relative to onshore producers.
We expect Karoon to remain prudent in its approach to managing growth to augment its reserve base and maintain production.The short reserve life of the company's key asset, Bauna, means we expect Karoon will seek to replace these depleting reserves over the next few years. Accordingly, Karoon will likely pursue a combination of asset enhancements, developments, and strategic asset acquisitions. We believe the company will prefer mid-life producing assets, as it targets opportunities arising from the major oil and gas companies shedding smaller nonstrategic assets from time to time.
Karoon's low operating costs and ability to generate strong EBITDA margins will support its creditworthiness in the next one to two years. Our base case forecasts Karoon's average operating costs per barrel of about US$12.0 (US$15.4 at Bauna and US$5.7 at Who Dat) in 2024 and about US$13.4 (US$16.8 at Bauna and US$6.5 at Who Dat) in 2025. This compares favorably with similar rated peers such as Gran Tierra Energy Inc. (B/Stable/--), EnQuest PLC (B/Stable/--), 3R Petroleum Oleo e Gas S.A. (B+/Stable/--), and GeoPark Ltd. (B+/Stable/--).
We believe these lower production costs will be key for Karoon to maintain its strong EBITDA margins over the next two years or so. We expect group EBITDA margins to remain at 75%-78% in fiscal 2024 and 2025 (year ending Dec. 31). At these margins, our base case reflects an expectation the company will generate EBITDA of about US$685 million in 2024 and about US$650 million in 2025. Such earnings mean we expect the company to comfortably manage its capital spending requirements over the next few years. We project capital expenditure (capex) of US$175 million-US$200 million in 2024, decreasing to about US$120 million-US$130 million in fiscal 2025. We anticipate a debt-to-EBITDA ratio of about 1.4x and 1.3x and FFO-to-debt ratio of 60% and 55% in fiscal 2024 and 2025, respectively.
Liquidity and balance sheet strength should help Karoon pursue its growth strategy. Karoon is planning to launch a five-year senior secured second-lien debt issue of up to US$500 million. It envisages using the issue proceeds to diversify its debt funding sources, lengthen its maturity profile, and repay its drawings under the existing US$340 million RBL facility.
Following the planned issuance, the company's minimal near-term debt maturities, undrawn RBL facility, and cash of about US$670 million, will support the group's liquidity position. We believe the company will use this liquidity strength to increase production and reserves. Notwithstanding our expectation the company will undertake acquisitions to bolster scale, we do not expect the company's adjusted peak leverage to exceed about 2.5x before it uses operating cash flow to de-lever to below 2x.
The stable outlook reflects S&P Global Ratings' expectation that Karoon will continue to benefit from supportive crude oil prices, as it generates positive free operating cash flow (FOCF) and maintains daily production throughout 2024 and 2025. We forecast adjusted financial metrics averaging close to 55% for the FFO-to-debt ratio with a debt-to-EBITDA ratio of below 1.5x.
We also expect the company to maintain its reserve levels by continuing to invest in offshore producing assets.
We could lower our rating if we expected the debt-to-EBITDA ratio to exceed 3.0x and FFO-to-debt ratio to fall below 30% for a sustained period without a credible deleveraging path, or if liquidity deteriorated. This would most likely occur due to:
- A material deterioration in oil prices, resulting in lower EBITDA generation;
- Production falling significantly below our expectations due to operational interruptions or delays, or the company being unable to execute asset life extension initiatives;
- Reserves materially decreasing and the company being unable to sufficiently replace them; or
The company demonstrating a more aggressive acquisition or growth strategy, significantly increasing leverage and reducing free operating cash flow.
We could raise our rating on Karoon if the company is able to diversify its asset base and increase its production and reserve levels such that the risk of reserve depletion significantly diminishes. Factors supporting this would include the company maintaining its conservative balance sheet leverage, adequate liquidity, and financial discipline in the deployment of capital.
Environmental factors are a negative consideration in our credit rating analysis on Karoon's as the E&P industry contends with the energy transition and adoption of renewable energy sources. Over the long term, we believe falling demand for fossil fuels will lead to declining profitability and a more difficult financing environment, especially for smaller independent operators.
As an offshore producer in Brazil and the Gulf of Mexico, Karoon works with multiple regulatory bodies to ensure the company's compliance with environmental and safety standards. Karoon's Carbon Management Action Plan tries to balance oil production with the minimization and offsetting of its carbon footprint. Karoon seeks to invest in or develop quality projects to offset residual emissions to help it achieve its sustainability target of net zero by 2035 for Scope 1 and 2 greenhouse gas emissions.
We also note that social obligations can be material for oil and gas companies. This stems from risk management related to offshore operations such as the possible exposure to fatal accidents. There are inherent risks in operating oil rigs, which involve air and water transportation of personnel, among other activities, which could be life-threatening without proper care.
KAR Price at posting:
$1.97 Sentiment: Buy Disclosure: Held
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