DBRS Confirms the Senior Unsecured Long-Term Debt Rating of Canadian Oil Sands at BBB, Stable

DBRS has today confirmed the Senior Unsecured Long-Term Debt rating of Canadian Oil Sands Limited (COS or the Company) at BBB with a Stable trend. The rating confirmation reflects the Company’s strong asset base in Alberta’s oil sands, with its equity interest (36.74%) in Syncrude Canada Limited (Syncrude), one of the largest oil sands mining projects in Canada; good growth prospects; and a strong financial profile. Key challenges are its reliance on a single oil sands mining project, significant exposure to crude oil, rising cost inflation pressure and potential balance-sheet pressure from planned major capital investments.

The Company’s operating performance is highly sensitive to crude oil price movements given its 100% oil-weighted operations with unhedged production. Strong earnings from high oil prices have ultimately improved credit metrics sharply over the past two years, particularly debt-to-cash flow and interest coverage ratios. Leverage improved only modestly as strong operating cash flow was mainly used to support higher dividend payments and capital investments. The rating confirmation is based on DBRS’s expectation that the Company will maintain adequate credit metrics within the rating category by funding its growth plans and dividends, mostly through internally generated cash flow or a prudent mix of debt and equity.

COS benefits from well-defined long-life reserves and relatively low maintenance capex over time. Higher project capex is expected from 2011 to 2014 ($600 million to $700 million per annum, in addition to sustaining capex at the $300 million level) as a result of several major projects, including Syncrude emissions reduction ($600 million), Mildred Lake mine train replacement ($1.3 billion), Aurora North mine train relocation ($300 million), and Aurora North tailings management ($300 million). The Company intends to fund these major capital projects with internally generated cash flow.

Based on strong crude oil prices, operating cash flow is expected to be approximately $1.9 billion in 2011, which is expected to be sufficient to cover estimated capex of $900 million and dividends of $500 million (based on distributions paid to date). Cash surplus could be used to pay down debt or pay higher dividend payments. As a result, credit metrics should remain strong in the foreseeable future.

The Company maintains sufficient liquidity through its $1.64 billion of credit facilities ($1.565 billion undrawn as of June 30, 2011), with no long-term debt maturities until 2013. Debt-refinancing risk is manageable over the next five years. In addition, at the end of 2010, the Company was able to successfully increase tax pools to approximately $2 billion, which is expected to fully shelter taxable income for one to two years, depending largely on oil prices.

COS’s operating performance should benefit from Syncrude’s production growth plan in the medium to long term. Syncrude plans to increase its production capacity by 50,000 barrels per day (b/d) (18,000 b/d to COS) to 400,000 b/d (147,000 b/d to COS) by 2017 by debottlenecking the existing capacity and further increasing production capacity by 150,000 b/d (55,000 b/d to COS) by 2020 by opening undeveloped leases. These projects require the unanimous consent of all joint-venture partners, including COS.

There are other limiting factors that are considered manageable. Operations are based solely in Alberta, which adds to concentration risk. COS has high operating leverage as a large portion of its total operating costs are fixed, with remaining costs tied mainly to volatile natural gas prices. There are potential operating challenges associated with running complex cokers as unplanned outages may occur, the risk of which is partially mitigated by the benefits of having three cokers (as opposed to one), as well as the experienced operations team under a ten-year services agreement with Imperial Oil Limited and Exxon Mobil Corporation.

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.

This rating did not include issuer participation and is based solely on publicly available information.