DBRS Assigns Provisional Ratings of B (low) to Southern Pacific Resource Corp., Trends Stable

DBRS has today assigned a provisional Issuer Rating of B (low) with a Stable trend to Southern Pacific Resource Corp. (STP or the Company). DBRS has also assigned a provisional rating of B (low) with a Stable trend and a provisional recovery rating of RR4 to STP’s proposed Senior Secured Second Lien Notes (the Notes). The Notes, estimated at up to $300 million, are structurally subordinated to the Company’s secured first-lien $30 million bank facility and rank ahead of the $172.5 million convertible debentures.

STP’s cash flow generation capability will be largely driven by its successful production ramp-up at the STP-McKay oil sands steam-assisted gravity drainage (SAGD) project Phase 1 (STP-McKay), with a bitumen processing design capacity of 12,000 barrels per day (bbl/d). Production should grow to the permitted capacity by late 2013 or early 2014 if there are no material operational challenges. Successful ramp-up of production at STP-McKay could have positive implications for the ratings. Based on DBRS estimates, STP would generate positive cash flow once STP-McKay produces at over 80% of design capacity (assuming West Texas Intermediate (WTI) oil prices remain above $80 per barrel). As STP-McKay is still in the early stage of production ramp-up (approximately 1,200 bbl/d in December 2012), reservoir quality and production reliability have yet to be proven. Material delays in production ramp-up, particularly in a significantly lower oil pricing environment, would have negative implications for the assigned ratings. The ratings also factor in the Company’s limited access to pipeline infrastructure. STP has mitigated this by entering into a five-year agreement for rail transportation to the U.S. Gulf Coast, securing access for all projected STP-McKay production and not being subject to the significant level of volatility recently experienced with heavy oil pricing in Canada. However, the use of truck and rail is considerably more expensive than pipelines, and netbacks are highly sensitive to Brent pricing fluctuations.

STP’s financial and liquidity profiles have remained weak relative to its DBRS-rated peers. Weak cash flow coupled with significant capital spending has resulted in material free cash flow deficits and has pressured the balance sheet. As the Company continues to pursue elevated levels of capex (e.g., STP-McKay Phase 1 Expansion and Phase 2 projects), free cash flow deficits are expected to continue and require external funding.

Key challenges facing the Company include the following, which are discussed in detail in the Rating Considerations Details section of the report: (1) weak financial and liquidity profiles, (2) limited proven track record, (3) high up-front capital spending commitments and cost overrun risk associated with oil sands project expansion, (4) reliance on a single project and (5) limited access to pipeline capacity.

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

The related regulatory disclosures pursuant to the National Instrument 25-101 Designated Rating Organizations are hereby incorporated by reference and can be found by clicking on the link to the right under Related Research or by contacting us at info@dbrs.com.

The applicable methodology is Rating Oil and Gas Companies (April 2011), which can be found on our website under Methodologies.