DBRS Upgrades Imperial Oil to R-1 (high) and Confirms AA (high)

DBRS has today upgraded the Commercial Paper (CP) rating of Imperial Oil Limited (Imperial or the Company) to R-1 (high) from R-1 (middle) in line with the usual expectation for an AA (high) rated entity; the Company’s CP limit has been increased to $2 billion from $1 billion. Imperial’s Unsecured Debentures rating is confirmed at AA (high). The trends are Stable. The CP program is supported by a recently established credit facility, reducing Imperial’s reliance on cash balances for liquidity as experienced in the past. The Company also retains a $5 billion long-term facility arranged with an affiliate of ExxonMobil Corporation (XOM). Furthermore, the rating actions reflect Imperial’s continued financial/operational excellence, growth prospects and strong ownership/sponsorship by XOM.

The Company has reaffirmed its substantial growth phase for the next decade, planning to invest $35 billion to $40 billion for the period with an aim to raise oil sands production by 40% by 2014 and to double volumes by 2020. The former should be achievable underpinned by Imperial’s largest project, the Kearl oil sands project (Kearl - 71/29 split with XOM)) with Phase 1 currently under construction for start-up scheduled for late 2012 (about 65% complete at May 31, 2011). The project’s design capacity of 110,000 b/d (78,000 b/d net to Imperial) is close to one-third of 2010 volumes. Phase 2 plus debottlenecking/expansion is expected to reach 345,000 b/d, representing near 85% of 2010 production.

During its growth phase, Imperial’s balance sheet leverage will rise, potentially to over 20% by mid-decade as estimated by the Company (albeit from a very low levered position), which is still consistent with the current credit ratings. While the project economics remain unchanged and compare favourably with peer projects, the reconfigured two-phased Kearl development plans (from three phases) would result in a higher cost estimate for Phase 1 (about $7.7 billion net to Imperial). DBRS estimates that the remaining $3 billion to $4 billion spending by year-end 2012 is manageable, and should be largely funded by internal cash flow, supplemented by drawdowns on the $5 billion long-term inter-company facility mentioned above. The Company also has a CP program with the increased limit of $2 billion as mentioned above. As a result, capital markets requirements are unlikely as seen in previous growth periods.

DBRS believes Imperial has sufficient financial strength enhanced by its low cost structure to support the accelerated project and other more modest expansions, while keeping credit metrics within the current rating categories. The accelerated growth plan would likely lessen the cost pressures over the next few years, when many oil sands projects could have resumed (for instance, Suncor Energy Inc.’s Voyageur and Fort Hills projects), given the robust crude oil pricing environment. A $4 billion to $4.5 billion capex program is planned in 2011 ($3.8 billion in 2010), potentially at equivalent levels in 2012. Most of the spending (over 90%) is directed at upstream, primarily in Kearl Phase 1, and to a lesser extent at Syncrude Canada Limited (Syncrude-25% interest) projects (for tailing management and mine trains relocation/replacement) and Nabiye at Cold Lake.

Given the substantial investments planned at an average annual level of $3.5 billion to $4 billion over the next ten years, cost overruns and project delays are potential concerns as seen in other mega oil sands projects. However, unlike its peers, Kearl’s mine plan excludes onsite bitumen upgrading, which typically accounts for more than half of the project costs and can be the most problematic in initial operating periods. Imperial also benefits from its experience through Syncrude, where it provides management services on a ten-year contract. Other challenges, although considered manageable, include the Company’s increasing exposure to heavy/light crude oil pricing differentials (Differentials), which have recently widened due to third party pipeline outages. DBRS expects the Differentials to remain in the 15% to 20% range in the near to medium term, partly mitigating the Company’s significant heavy oil component, should pipeline availability to the Gulf Coast materialize (primarily TransCanada Corporation’s Keystone XL crude oil pipeline). Refineries therein are better equipped to handle heavier crude.

In the near term, incremental volume growth is expected from Cold Lake and Syncrude (the latter estimated at 3% in 2011) as a result of improved plant reliability and reduced planned maintenance, which should offset natural field declines, as seen in 2010 and Q1 2011. Syncrude Stage 3 expansion (29% of production in Q1 2011 versus 25% in 2009) has achieved improved reliability, despite previous operational issues. It is expected to gradually reach its productive capacity of 350,000 b/d (86% reached in Q1 2011). Cold Lake heavy oil (100% owned), the largest in-situ development in Canada, remains Imperial’s key operation (47% of production for the last three years). The Company is advancing the design and development of the Nabiye expansion (+30,000 b/d), which could raise total production by 10% from current levels when completed in 2015.

Long-term opportunities are underpinned by Mackenzie Delta natural gas (Mackenzie), expected beyond the middle of the decade, with regulatory approval received in March 2011, although the fiscal framework and land claim issues have yet to be resolved. Additional exploratory acreage acquired in the Beaufort Sea on a 50/50 basis with XOM is further affirmation of the Company’s commitment in the Far North, where the proposed Mackenzie pipeline would provide a key transportation link to the marketplace should natural gas developments be pursued. Unconventional shale gas developments through Horn River, where Imperial and XOM have acquired additional acreage, present another avenue for growth over time.

On the operational front, the substantial proved reserves booked for Kearl (sanctioned in 2009) and additions at Cold Lake have elevated Imperial to one of the highest capital-efficiency operators in the industry, measured in terms of reserve recycle ratio (5.7 times in 2010). Including oil sands, it also has the longest reserve life (including oil sands) of 28.5 years and the lowest reserve replacement cost among its peers ($5.92/boe on a three-year average basis in 2010), reversing previous rising trends as resources were accumulated.

Notes:
All figures are in Canadian dollars unless otherwise noted.

The applicable methodology is Rating Oil and Gas Companies, which can be found on our website under Methodologies.