DBRS Confirms Talisman Energy Inc. at BBB (high), Stable Trend

DBRS has today confirmed the Unsecured Debentures & Medium-Term Notes rating for Talisman Energy Inc. (Talisman or the Company) at BBB (high) with a Stable trend, reflective of its stable financial profile which is more comparable with its peers than prior periods helped by substantial divestitures since 2006, and progress made on the operational front, particularly on meeting production growth targets and a gradual reduction in reserve replacement costs. However, the latter cost remains relatively high with low reserve life. Further improvements are expected as production ramp-up at unconventional shale gas (Shale) in Pennsylvania Marcellus, and recently in the liquids-rich Eagle Ford (Texas) is achieved, likely in 2011/2012. Substantial capital investments in Shale in North America (N. America) since 2008 (estimated close to $4.6 billion) as an integral part of (new) management’s repositioning strategies, while successful, have impacted the capital cost base, near term, and will likely not be free cash flow positive for a couple of years. The recent joint venture arrangements in Shale with Sasol and Statoil, outlined in more detail below should accelerate growth and alleviate in part substantial capex during Talisman’s growth phase. However, continued cash flow shortfalls are likely, near term, with an increase in balance sheet leverage, although still within the parameters of the current credit rating.

Debt-to-capital will likely remain below the low end of the Company’s guidance range of 35% to 45% (30% at March 31, 2011 (Mar./11)) and debt-to-cash flow below 2.0 times (x – similar to LTM level of 1.6x estimated by DBRS), respectively, helped by hedges covering about 75% of H2 2011 planned volumes and estimated 10% to date of 2012 volumes. The Company maintains sufficient liquidity with about $4 billion of available credit facilities and cash balances of $860 million at June 30 2011, with no material debt maturities until 2019. The Company’s Q1 2011 operating results were negatively affected by the recent tax increase in the United Kingdom (UK – from 50% to 62%) which also resulted in asset impairments and higher deferred income taxes therein, as well as non-cash risk management charges. The Q2 2011 operating results are in line with expectations with slightly weakened credit metrics as result of land purchases in a potentially liquids-rich Duvernay (Alberta) shale play.

The Company has continued to manage its balance sheet and to re-invest in growth assets in the North Sea (N. Sea) and in Southeast Asia (SE Asia), which have generated the highest returns among its operating regions. N. Sea remains a strong cash flow contributor to augment developments in Shale, which have a longer life and lower operating cost base than conventional gas, SE Asia is self-funding and remains a growth region beyond 2011. The Company’s recently shifted focus to Eagle Ford and conventional oil should enhance its gas-weighted N. American operation, given the continued low gas prices. Shale will remain a growth vehicle, likely representing about half of the region’s gas volumes in 2011 as seen in H1 2011 from a minimal position in 2009, or about 20% of total volumes, going forward.

The recently closed 50/50 joint venture arrangements with Sasol Ltd. (Sasol JV - totaling $2.1 billion) in Montney Shale (Talisman as operator) have provided about $520 million upfront payments with the remainder of $1.6 billion to fund about 87% of future capex. Sasol is a large integrated energy and chemicals company with worldwide operations. The Eagle Ford 50/50 joint venture with Statoil S.A. (Statoil JV), closed in late 2010, facilitated certain asset monetization and the consummation of a $1.3 billion land acquisition (100%) in the liquid-rich area of the region.

Based on the July 2011 guidance of WTI of $95/b and Nymex of $4/mcf, the Company expects to slightly fall short of its 5% to 10% production growth targets in 2011 (average gross volumes of about 435,000 boe/d or 4% over 2010 levels) due primarily to the delayed commissioning of the Yme field (Norway) to mid 2012 and a slight delay at Eagle Ford. The key growth drivers include shale volumes in Marcellus and Eagle Ford (average 375 mmcf and 55 mmcf/d, respectively), incremental output from the recently acquired Colombia operation and start-up in Indonesia and the UK. These factors together with developments in Montney and SE Asia should also support similar growth targets to 2015. Total production increased 13% in Q1 2011 versus Q1 2010, or up 10% for H1 2011 (up 6% in 2010) from continuing operations.

Going forward, the Company’s product mix would likely be more liquids-weighted compared with 45%/55% in oil/gas in Q1 2011, benefitting from the favourable crude oil prices expected in the near to medium term. The 2011 volume growth is supported by capex of $4 billion to $4.5 billion, split 83%/17% for development/exploration. The share of Shale spending, while still considerable (34% versus 41% in 2010), has been reduced, with increased spending in conventional oil and SE Asia (20% versus 14%)

However, reserve replacement cost (three-year average of $35.65/boe versus $40.33/boe in 2008) remains high among its peers, albeit improved from 2008 when the strategic repositioning programs commenced. Similarly, reserve life of about 8.9 years (9.3 years in 2008) remains below the industry average, although this was impacted by substantial non-core divestitures. Further improvements are expected, over time, as development projects reach design capacities, particularly in Shale. The Colombia purchase (see separate press release of August 3, 2010) closed in early 2011, while adding a new growth region, including Peru (ultimate production of about 50,000 boe/d over the next four to five years versus about 12,000 boe/d expected in 2011), has raised the Company’s political risk exposure slightly. This risk is considered manageable and in line with the Company’s corporate strategy to expand its presence in South America (S. America), principally Colombia (rated BBB (low)) and Peru (rated BBB (low)). Ecopetrol S.A. (ECP), its 51% joint venture partner and the operator, is a leading oil and gas company in Colombia and is majority owned by the government. It is also a partner with Talisman in several blocks in Colombia and Peru.

The Company’s ability to continue to successfully develop Shale in N. America and longer-life reserves in SE Asia remains crucial to its commitment to generating a more predictable production and reserve profile and a lower-cost structure in the near to medium term. Overall stable credit metrics and more sustainable production are expected in 2011, also as previously estimated by DBRS. Currently, about three-quarters of the Company’s production and proved reserves are located within Organization for Economic Cooperation and Development (OECD) countries, with over 40% in N. America.

Note:
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.