August 21, 2012 / 4:42 PM / 5 years ago

TEXT-S&P raises Energy XXI (Bermuda) to 'B+'

Overview
     -- U.S. oil and gas exploration and production company Energy XXI 
(Bermuda) Ltd. reported strong financial and operational performance
for its fiscal year ended June 30. 
     -- We are raising our corporate credit rating to 'B+' from 'B'. Our 'B' 
senior unsecured debt ratings remain unchanged. We revised our recovery rating 
on the senior unsecured debt to '5' from '4'. 
     -- The stable outlook reflects our expectation that EXXI will maintain 
above-average financial and operational performance over the next 12 to 18 
months. Debt leverage should remain about 1.5x and reserve replacement 80% to 
90%.

Rating Action
On Aug. 21, 2012, Standard & Poor's Ratings Services raised its corporate 
credit rating on Bermuda-based exploration and production company Energy XXI 
(Bermuda) Ltd. (EXXI) to 'B+' from 'B'. The outlook is stable.

At the same time we revised our recovery rating on the company's senior 
unsecured debt to '5', indicating expectations for modest (10% to 30%) 
recovery in the event of a payment default, from '4'. The 'B' senior unsecured 
debt ratings remain unchanged. 

Rationale
The upgrade reflects our expectation that EXXI will maintain its solid 
operating performance, including minimum reserve replacement of about 85% or 
better, a proved developed reserve life of about five years, and above-average 
profitability. For its fiscal year ended June 30, the company replaced nearly 
120% of production and ended the year with a proved developed reserve life of 
about five years. We view these as above-average measures relative to its 
peers in the Gulf of Mexico and Gulf Coast regions. We expect EXXI's 
profitability, about $34 per boe for 2012, to remain strong for the rating. 

The revision of the recovery rating reflects a decrease in estimated recovery 
prospects following an analysis of June 30, 2012 reserves. Reserves were 
evaluated using our recovery price assumptions, $45 crude oil and $4 natural 
gas, as well as current cost levels. Largely as a result of increased 
operating costs versus year-ago levels, the estimated value of EXXI's reserves 
materially declined, and the estimated recovery on unsecured debt fell below 
30%.

The ratings on Energy XXI (Bermuda) Ltd. reflect our assessment of its "weak" 
business risk, "aggressive" financial risk, and "strong" liquidity profiles. 
The company's moderate reserve size, focus on the difficult Gulf of Mexico 
region that requires high reinvestment to maintain production and reserve 
levels, and an elevated cost structure limit the benefits of its above-average 
profitability. Rating factors also include the company's improved liquidity 
and cash flows, near-term free cash flow generation and expectations for a 
focus on maintaining low debt leverage.

We expect financial measures to remain strong for the rating, buffering the 
higher operational risk of the Gulf of Mexico region. We expect debt leverage 
to remain 1.5x or less and funds from operations (FFO) to debt to exceed 60% 
over the next 18 months. These expectations reflect our oil and natural gas 
price assumptions of $85 per barrel WTI crude oil and $2.50 per mmBtu natural 
gas for the remainder of 2012, and $80 per barrel WTI and $3.00 natural gas in 
2013. Both price assumptions have been adjusted for regional price 
differentials. In particular, EXXI's oil production benefits from positive 
price differentials, which we have assumed to be $10 over the next 12 months. 
For fiscal 2013, we expect EBITDA of about $1 billion and FFO of about $800 
million. Finally, interest coverage should remain strong at over 10x, and EXXI 
should continue to generate positive free cash flow during fiscal 2013 at 
projected capital spending of $700 million. 

We expect EXXI's strong operating performance to continue in 2013. One of the 
key factors in the rating upgrade is our expectation that EXXI will replace a 
significant portion of production through the drillbit, about 120% in 2012. 
Although internal reserve replacement may not always exceed 100%, we do not 
expect EXXI to be dependent on acquisitions for reserve replacement, although 
material growth will likely depend on mergers and acquisitions. Another 
support for the rating is EXXI's favorable proved reserve life of 7.5 years, 
five years on a proved developed basis, which we consider above average for 
offshore reserves. This provides EXXI a longer period of time to replace 
reserves and production versus peers with shorter reserve lives, who require 
consistently high reserve replacement in a region with typically lower rates 
of drilling success.

However, EXXI's high breakeven costs of about $50 per barrel, including 
three-year average finding and development costs, are a concern given the 
volatility of crude oil prices. Nevertheless, they are currently offset by its 
exposure to favorable crude oil prices over the next 18 months.

EXXI has a mid-sized reserve base of 120 mmboe (71% crude oil and 68% proved 
developed) located in the Gulf of Mexico. We assign a higher risk profile to 
the Gulf region due to its typically higher risk drilling, steep production 
declines, and risk of well damage and/or operational disruptions due to 
hurricanes. As a result, we generally require Gulf-focused companies to have 
stronger liquidity and financial measures than their onshore peers. EXXI 
exhibits both of these. Nevertheless, the company's lack of scale and limited 
asset diversity relative to much larger companies operating in the Gulf will 
continue to be a constraint on ratings. The potential success of its 
ultra-deep exploration with McMoRan Exploration Co. has not been factored into 
ratings.

Liquidity
We view EXXI's liquidity as strong. As of July 31, 2012, EXXI had about $500 
million of availability on its senior secured credit facility due December 
2014 ($750 million borrowing base and about $225 million letters of credit 
outstanding). In addition, the company had about $117 million of cash on hand 
as of June 30, 2012. Our assessment of EXXI's liquidity profile also 
incorporates the following expectations and assumptions:

     -- EXXI should generate positive free operating cash flow in 2013.
     -- Near-term cash flows will benefit from the positive differential for 
LLS versus WTI crude oils.
     -- No meaningful, near-term debt maturities.
     -- Financial covenant compliance should be met, including debt leverage 
of under 3.5x and interest coverage of greater than 3x.

A further benefit to liquidity is that Energy XXI does not have to post 
letters of credit related to its hedging program, which would limit 
availability under the facility. Nevertheless, EXXI's liquidity remains 
susceptible to its adjustable borrowing base, which is a concern if crude oil 
prices retreat to lower levels.

Recovery analysis
For the recovery analysis, see Standard & Poor's  on Energy XXI to be 
published following this report on RatingsDirect. 

Outlook
The stable outlook reflects our expectation that EXXI will maintain 
above-average financial and operational performance over the next 12 to 18 
months. Debt leverage should remain about 1.5x and reserve replacement 80% to 
90%.

We could lower ratings if debt leverage exceeds 3x for a prolonged period, or 
if we assess liquidity as less than adequate. We believe this could occur due 
to an extended period of low commodity prices such as crude oil below $60.00 
per barrel and natural gas below $2.00 per mcfe, which would lower cash flows 
and result in increased borrowing to fund capital spending to maintain 
production levels. Alternatively, a prolonged operational disruption from a 
hurricane could weaken liquidity. Finally, if the proved developed reserve 
life falls below four years, likely due to poor reserve replacement, we could 
lower ratings.

We currently do not expect to raise ratings over the next 12 months. An 
upgrade would require EXXI to increase reserves to over 200 mmboe while 
maintaining debt leverage below 3x. Given its concentration in the Gulf of 
Mexico, we would also need EXXI to maintain at least a five-year proved 
developed reserve life and increase its geographic diversification within the 
Gulf. 

Related Criteria And Research
     -- Key Credit Factors: Global Criteria For Rating The Oil And Gas 
Exploration And Production Industry, Jan. 20, 2012
     -- Standard & Poor's Raises Its U. S. Natural Gas Price Assumptions; Oil 
Price Assumptions Are Unchanged, July 24, 2012 
     -- Liquidity Descriptors For Global Corporate Issuers, Sept. 28, 2011 
     -- Credit FAQ: Why Standard & Poor's Revised Its Assumptions For Recovery 
Analysis On Exploration And Production Companies, Nov. 3, 2010 
     -- Assumptions: Revised Assumptions For Assigning Recovery Ratings To The 
Debt Of U.S. Oil And Gas Exploration And Production Companies, Sept. 30, 2010

Ratings List
Upgraded; Outlook Stable
                                    To             From
Energy XXI (Bermuda) Ltd.
 Corporate Credit Rating            B+/Stable/--   B/Positive/--

Ratings Affirmed; Recovery Rating Revised
Energy XXI Gulf Coast Inc.
Senior Unsecured                    B              B
   Recovery Rating                  5              4

Our Standards:The Thomson Reuters Trust Principles.
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