Morningstar DBRS Confirms Tourmaline Oil Corp. at BBB (high), Stable Trends

DBRS Limited (Morningstar DBRS) confirmed Tourmaline Oil Corp.'s (Tourmaline or the Company) Issuer Rating and Senior Unsecured Notes rating at BBB (high).

KEY CREDIT RATING CONSIDERATIONS
Tourmaline's earnings and cash flow were lower in Q1 2024 compared with Q1 2023 because of significantly lower natural gas prices. However, this was partially offset by an increase in production resulting from the acquisition of Bonavista Energy Corporation (the Acquisition) completed in November 2023. Tourmaline's earnings and cash flows are highly sensitive to natural gas prices with operating cash flow (OCF) changing by $74 million for a USD 0.10/thousand cubic feet (mcf) change in the New York Mercantile Exchange (NYMEX) Henry Hub spot natural gas price. Natural gas markets have been soft, resulting in lower benchmark prices. While Morningstar DBRS expects the natural gas supply/demand balance to gradually tighten in 2024 as low prices discourage new production¿which is already happening¿and, simultaneously, incentivize new demand through 2024, prices are likely to remain lower over the medium term. Consequently, Morningstar DBRS reduced its full-year 2024 NYMEX natural gas price estimates to $2.50/mcf from $3.50/mcf and the 2025 NYMEX gas price to $3.25/mcf from $3.50/mcf. However, the impact of lower natural gas price assumptions on Tourmaline's financial risk profile is mitigated by the Company's access to premium markets, which results in Tourmaline realizing premium-to-benchmark prices on its production, and hedges covering approximately 28% and 21% of its natural gas production for the balance of 2024 and 2025, respectively. Tourmaline also reduced its capital expenditure (capex) to $2.13 billion in 2024 from the previously announced $2.35 billion in response to weaker natural gas prices.

Tourmaline's operating performance continues to be in line with Morningstar DBRS' expectations. While inflationary pressures increased the Company's operating and capital costs modestly, the Company continues to have one of the lowest cost structures among its peers. The Company was able to replace 110% of its annual production in 2023 through its development program and replaced 254% of its production after factoring in acquisitions. The Company announced that it had entered into two new marketing agreements, which will increase its exposure to higher priced international markets. It has also partnered with other Canadian producers to advance liquefied natural gas (LNG) exports from Western Canada.

Despite lower realized crude oil and natural gas prices, Tourmaline was able to generate a free cash flow surplus (FCF; cash flow after capex and common base dividends) in 2023 and Q1 2024. Tourmaline used the surplus mainly for shareholder distributions in the form of special dividends, with a modest amount directed toward debt repayment. While gross debt at Q1 2024 was higher than YE2022 because of the Acquisition, Tourmaline's financial risk profile and key credit metrics remain strongly supportive of the rating.

CREDIT RATING DRIVERS
Given Tourmaline's strong financial risk profile, a positive rating action would require a material mprovement in the Company's business risk profile. While unlikely, a sustained material deterioration in the Company's financial risk profile (debt-to-cash flow ratio consistently above 1.50 times (x)) could lead to a negative rating action.

EARNINGS OUTLOOK
Tourmaline is aiming for average 2024 production volumes of 580 thousand barrels of oil equivalent per day (mboe/d) to 590 mboe/d, which represents an approximate 12% increase over 2023. Based on Morningstar DBRS' price assumptions¿the average of the West Texas Intermediate price (2024: USD 75/barrel (bbl), 2025: USD 60/bbl), AECO spot natural gas price (2024: $2.00/mcf, 2025: $2.75/mcf), and NYMEX Henry Hub spot natural gas price (2024: USD 2.50/mcf, 2024: USD 3.25/mcf)¿earnings in 2024 will likely be lower compared with those of 2023. While modest inflationary pressure on costs is expected to persist through the year, Morningstar DBRS does not expect it to have a material impact on earnings.

FINANCIAL OUTLOOK
Based on Morningstar DBRS' base-case price assumptions, Morningstar DBRS' expects OCF in 2024 to be lower compared with that of 2023. Nevertheless, Morningstar DBRS expects Tourmaline to generate an FCF surplus. Morningstar DBRS expects the Company to direct most of the FCF surplus toward shareholder returns and/or growth initiatives with a modest amount directed toward debt repayment. For the last 12 months ended March 31, 2024, Tourmaline's lease-adjusted EBIT interest coverage, lease-adjusted debt-to-cash flow, and lease-adjusted debt-to-capital ratios were all within the AA range. Morningstar DBRS expects Tourmaline to maintain a strong financial risk profile with lease-adjusted debt-to-cash flow ratio at or less than 1.0x. The Company's financial risk profile is stronger compared with its business risk profile and is expected to continue to support the ratings even if crude oil and natural gas prices trend below Morningstar DBRS' base-case assumptions, underscoring Tourmaline's financial flexibility.

CREDIT RATING RATIONALE
Tourmaline's ratings are underpinned by its (1) size (production of 592,077 boe/d in Q1 2024), (2) highly integrated and efficient operations geared to natural gas resource play development in Western Canada, (3) successful track record of low-cost reserve additions, and (4) strong financial risk profile. Tourmaline's ratings are constrained by its high exposure to lower-priced North American natural gas, asset concentration in Western Canada, and lower proved developed reserve life index.

ENVIRONMENTAL, SOCIAL, AND GOVERNANCE CONSIDERATIONS
Environmental (E) Factors
The following Environmental factors had a relevant effect on the credit analysis: Morningstar DBRS considers the impact of both physical and transition risks associated with climate change with the transition risk deemed to be more substantial. Morningstar DBRS considered carbon and greenhouse gas (GHG) costs as a relevant environmental factor for Tourmaline. This factor is relevant because ever-increasing environmental regulations in Canada targeting the reduction of GHG emissions will likely limit the growth potential and add costs for all oil and gas companies in Canada, including Tourmaline.

Social (S) Factors
There were no Social factors that had a relevant or significant effect on the credit analysis.

Governance (G) Factors
There were no Governance factors that had a relevant or significant effect on the credit analysis.

A description of how Morningstar DBRS considers ESG factors within the Morningstar DBRS analytical framework can be found in the Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024), https://dbrs.morningstar.com/research/427030.

BUSINESS RISK ASSESSMENT (BRA) AND FINANCIAL RISK ASSESSMENT (FRA)

(A) Weighting of BRA Factors
In the analysis of Tourmaline, the BRA factors are considered in the order of importance contemplated in the methodology.

(B) Weighting of FRA Factors
In the analysis of Tourmaline, the FRA factors are considered in the order of importance contemplated in the methodology.

(C) Weighting of the BRA and the FRA
In the analysis of Tourmaline, the BRA carries greater weight than the FRA.

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

Morningstar DBRS applied the following principal methodology:

Global Methodology for Rating Companies in the Oil and Gas and Oilfield Services Industries (April 15, 2024), https://dbrs.morningstar.com/research/431177.

Morningstar DBRS credit ratings may use one or more sections of the Morningstar DBRS Global Corporate Criteria (April 15, 2024), https://dbrs.morningstar.com/research/431186, which covers, for example, topics such as holding companies and parent/subsidiary relationships, guarantees, recovery, and common adjustments to financial ratios.

The following methodology has also been applied:

Morningstar DBRS Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings (January 23, 2024), https://dbrs.morningstar.com/research/427030.

The credit rating methodologies used in the analysis of this transaction can be found at: https://dbrs.morningstar.com/about/methodologies.

A description of how Morningstar DBRS analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://dbrs.morningstar.com/research/431153.

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 under Related Documents or by contacting us at info-DBRS@morningstar.com.

The credit rating was initiated at the request of the rated entity.

The rated entity or its related entities did participate in the credit rating process for this credit rating action.

Morningstar DBRS had access to the accounts, management and other relevant internal documents of the rated entity or its related entities in connection with this credit rating action.

This is a solicited credit rating.

The conditions that lead to the assignment of a Negative or Positive trend are generally resolved within a 12-month period. Morningstar DBRS trends and credit ratings are under regular surveillance.

Information regarding Morningstar DBRS credit ratings, including definitions, policies, and methodologies, is available on dbrs.morningstar.com or contact us at info-DBRS@morningstar.com.

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