March 14 - Overview -- U.S. oil and gas exploration and production (E&P) company Rosetta Resources is allocating a majority of its capital to oil-weighted drilling in the Eagle Ford. -- We are raising our corporate credit rating on Rosetta to 'B+' from 'B' and raising our issue-level rating on Rosetta's senior unsecured notes to 'BB-' from 'B+'. -- The stable outlook reflects our expectation that the company will improve its proved developed reserve base to above 40% of total reserves. Rating Action On March 14, 2012, Standard & Poor's Ratings Services raised its corporate credit rating on Houston-based Rosetta Resources Inc. (Rosetta) to 'B+' from 'B'. The outlook is stable. At the same time, we raised the senior unsecured rating to 'BB-' (one notch higher than the corporate credit rating) from 'B+'. The recovery rating remains '2', indicating our expectation of substantial (70% to 90%) recovery in the event of a payment default. Rationale The upgrade on Rosetta reflects our expectation that robust oil prices and its oil-weighted capital spending program in 2012 will benefit its proved developed reserve base. We anticipate that Rosetta will increase its proportion of proved developed reserves, which were small at about 36% of its 965 billion cubic feet equivalent (Bcfe) reserve base at year-end 2011. The company intends to allocate about 90% of its $640 million budget to the oil-rich Eagle Ford basin this year, and we think that this program is likely to improve its proved developed reserve base to above 40% of total proved reserves. We consider this level to be appropriate for the 'B+' rating category. The ratings on Rosetta reflect Standard & Poor's view of its relatively small proved reserve base relative to peers, its aggressive growth strategy, and its reliance on one location (Eagle Ford) for much of its future growth. Our ratings also reflect its exposure to robust crude oil prices and its healthy credit protection measures. We consider its business risk to be "weak" and its financial risk "aggressive" (as our criteria define these terms). The company is limited to the Eagle Ford for a majority of production and intends to spend a majority of its 2012 capital budget in the basin this year. While we view the Eagle Ford favorably because of its high condensate mix, Rosetta's aggressive capital spending program there means the company will become highly reliant on one basin for much of its future cash flows, which it uses to service debt and other obligations. We expect that this investment in the Eagle Ford will leave liquids (crude oil and natural gas liquids ) as a percentage of total production to be about 57% at the end of 2012 and 60% at the end of 2013 (in the fourth quarter, about 49% of production was tied to liquids). Rosetta has one of the lowest cost structures in its rating category, with cash costs as of Dec. 31, 2011, of about $1.91 per million cubic feet equivalent (Mcfe) and a levered breakeven cost inclusive of three-year all in finding and development (F&D) of slightly less than $3.50/Mcfe (similarly rated peers are typically about $3 or more and near $6 or more, respectively). The low cost structure has historically benefitted from the company's contiguous nature of positions in its basins, leading to somewhat lower development costs compared with its peers. Rosetta's rising oil and natural gas liquids (NGL) production out of the Eagle Ford will lead to higher lease operating expenses (LOE), in our estimation, but increasing, more profitable, condensate production should amply offset cost increases. As of Dec. 31, 2011, the company had about $282 million of adjusted debt (inclusive of operating lease commitments and asset retirement obligations). We expect leverage to be about 1x over the next year based on our price deck for natural gas of $3.00/Mcf in 2012 and $3.25/Mcf in 2013 and for oil of $80/barrel in 2012 and $70 thereafter, and assuming production growth of more than 40% in 2012 to approximately 230 million cubic feet equivalent per day (MMcfe/d) and more than 25% growth in 2013. As of Dec. 31, 2011, Rosetta had hedged about a third of our forecasted daily production in 2012 (including about 20% of its gas) and approximately 10% of forecasted 2013 production hedged (no hedges on gas production). Using these assumptions, we project EBITDA for full-year 2012 will be more than $500 million and that for 2013 it will total more than $600 million. We forecast funds from operations (FFO) in 2012 will total approximately $400 million and in 2013 will be more than $475 million. Rosetta has announced that, inclusive of growth capital, it will spend $640 million in 2012, with more than 90% targeted to the Eagle Ford. We are forecasting 2013 capital spending inclusive of growth spending at $600 million to $700 million. Coupled with our expectation that annual cash interest will total approximately $25 million, we project that Rosetta will outspend cash flows by more than $100 million in both 2012 and 2013. We believe that current liquidity is sufficient to cover this shortfall. Liquidity We consider Rosetta's liquidity to be "adequate", reflecting the following assumptions and expectations: -- As of Dec. 31, 2011, the company had $47 million of cash. In early 2012, its borrowing base availability was $245 million on its $325 million facility maturing May 10, 2016. -- We think Rosetta will spend $640 million in 2012 and nearly $700 million in 2013. At this level, we believe sources of liquidity will exceed uses by more than 1.2x over the next several years and that net sources of liquidity will remain positive even if EBITDA declines by more than 20%. -- We believe that Rosetta could absorb, without refinancing, a high-impact, low-probability event and view its relationship with banks as well-established and solid. -- The company has a maximum debt to EBITDAX (earnings before interest, taxes, depreciation, amortization, and exploration expenses) covenant of 4x. At our price assumption for natural gas and oil, we do not expect Rosetta to have any issues meeting these requirements over the next several years. Recovery analysis For the complete recovery analysis, please see our recovery report on Rosetta published Sept. 15, 2011, on RatingsDirect. Outlook The stable outlook reflects our view that Rosetta will continue to benefit from robust oil prices and that its capital spending program in the Eagle Ford will result in further development of its proved reserves. Given its increasing oil production, we foresee Rosetta maintaining credit protection measures that are strong for the current rating, with year-end leverage projected to be below 1x. We could lower the rating if Rosetta exceeds leverage of 4.5x, a level that would require an 84% decline based on annualized fourth quarter EBITDA. We consider this unlikely given Rosetta's exposure to oil prices. Related Criteria And Research -- Key Credit Factors: Global Criteria For Rating The Oil And Gas Exploration And Production Industry, Jan. 20, 2012 -- Revised Assumptions For Assigning Recovery Ratings To The Debt Of U.S. Oil And Gas Exploration And Production Industry, Sept. 30, 2010 Ratings List Upgraded; Outlook Stable To From Rosetta Resources Inc. Corporate Credit Rating B+/Stable/-- B/Positive/-- Senior Unsecured BB- B+ Recovery Rating 2 2 Complete ratings information is available to subscribers of RatingsDirect on the Global Credit Portal at www.globalcreditportal.com. All ratings affected by this rating action can be found on Standard & Poor's public Web site at www.standardandpoors.com. Use the Ratings search box located in the left column.