DBRS Morningstar Confirms Ratings on Obsidian Energy Ltd. at B (high), Stable Trends

DBRS Limited (DBRS Morningstar) confirmed the Issuer Rating and the Senior Unsecured Notes (the Senior Notes) rating of Obsidian Energy Ltd. (Obsidian or the Company) at B (high). DBRS Morningstar also has a recovery rating of RR4 on the Senior Notes. All trends are Stable. The Company’s ratings are supported by its (1) higher netbacks from its oil-weighted production mix; (2) relatively lower decline rates, providing the Company with the ability to flex capital expenditures (capex) in a volatile price environment; (3) relatively stronger reserve metrics; and (4) relatively stronger financial risk profile, which, under DBRS Morningstar’s base case commodity price assumptions, provides an uplift to the rating. Obsidian’s rating is constrained by its size (2023 production guidance of 32,750 barrels of oil equivalent per day (boe/d)), relatively higher operating costs, and some exposure to heavy-light price differentials and relatively higher asset retirement obligations.

Obsidian’s operating performance in 2022 was largely in line with DBRS Morningstar's expectations. Production was marginally lower than the Company's guidance because of cold weather in December. The Company had a successful development program focused on the Cardium and Peace River areas and was able to increase its proved reserves and replace more than 200% of its annual production in 2022. While the Company experienced inflationary pressure on operating and capital costs, the impact was offset by stronger commodity prices. Obsidian generated healthy netbacks, and its recycle ratios were well over 4.0 times (x) in 2022. Production in Q1 2023 was higher compared with Q1 2022 because of its continued development program; however, DBRS Morningstar notes that the Company had to shut in some production in May 2023 because of wildfires. However, all the production is now back online, and the impact of the shut in on annual production (approximately 500 boe/d) is not expected to be material.

Stronger crude oil and natural gas prices in 2022 allowed the Company to generate a material free cash flow (FCF; cash flow after capex and dividends) surplus in 2022, which was primarily used to repay debt. As a result, the Company's key credit metrics have seen a material improvement. The Company also increased the size of its Senior Secured Credit facility (Credit Facility) to $240.0 million from $175.0 million, which has improved its liquidity position.

Based on DBRS Morningstar’s base case commodity price assumptions and the Company’s annual production and capex guidance, we expect the Company to generate a modest FCF surplus in 2023. DBRS Morningstar notes that the Company intends to hedge up to 50% of its near-term production if prices remain constructive. DBRS Morningstar expects the Company to use part of the surplus to reduce borrowings as it progresses toward its net debt target of $225.0 million. DBRS Morningstar expects the Company’s financial risk profile to be strong and provide an uplift to the overall ratings under its base case commodity price assumptions, thereby supporting the Stable trends. DBRS Morningstar expects the Company will maintain its lease-adjusted debt-to-cash flow ratio below 2.0x over the forecast horizon.

A rating upgrade would require a material improvement in the Company’s size as measured by production. Given the support provided by the Company’s financial risk profile to the overall rating, a material deterioration in Obsidian’s lease-adjusted debt-to-cash flow ratio, which could be caused by significantly lower oil prices or a material deterioration in liquidity, could trigger a negative rating action.

ENVIRONMENTAL, SOCIAL, GOVERNANCE (ESG) CONSIDERATIONS

Environmental Factors
DBRS Morningstar considered carbon and greenhouse gas costs as a relevant environmental factor. This factor is relevant because compliance with ever-increasing environmental regulations and standards limits the growth potential and adds costs for all oil and gas companies, including Obsidian.

There were no Social/Governance factor(s) that had a significant or relevant effect on the credit analysis.

A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework can be found in the DBRS Morningstar Criteria: Approach to Environmental, Social, and Governance Risk Factors in Credit Ratings at https://www.dbrsmorningstar.com/research/416784 (July 4, 2023).

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

DBRS Morningstar applied the following principal methodologies:
-- Global Methodology for Rating Companies in the Oil and Gas and Oilfield Services Industries (August 31, 2022), https://www.dbrsmorningstar.com/research/402196

-- DBRS Morningstar Global Criteria: Recovery Ratings for Non-Investment-Grade Corporate Issuers (September 1, 2022), https://www.dbrsmorningstar.com/research/402218

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

A description of how DBRS Morningstar analyzes corporate finance transactions and how the methodologies are collectively applied can be found at: https://www.dbrsmorningstar.com/research/397223.

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@dbrsmorningstar.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.

DBRS Morningstar had access to the accounts, managements, 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. DBRS Morningstar trends and credit ratings are under regular surveillance.

DBRS Morningstar will publish a full report shortly that will provide additional analytical detail on this rating action. If you are interested in receiving this report, contact us at info@dbrsmorningstar.com.

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

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