Hilcorp Energy I, L.P. -- Moody's downgrades Hilcorp's CFR to Ba2; unsecured notes to Ba3

Rating Action: Moody's downgrades Hilcorp's CFR to Ba2; unsecured notes to Ba3

Global Credit Research - 25 Aug 2020

New York, August 25, 2020 -- Moody's Investors Service, ("Moody's") downgraded Hilcorp Energy I, L.P.'s (HEI) Corporate Family Rating (CFR) to Ba2 from Ba1, its senior unsecured notes to Ba3 from Ba2 and its Probability of Default Rating to Ba2-PD from Ba1-PD. The outlook is stable. This rating action concludes the review initiated on August 28, 2019 following HEI's announcement that Hilcorp Alaska, LLC, its wholly owned subsidiary, had agreed to acquire BP p.l.c.'s (BP, A1 negative) assets in Alaska.

Effective June 30, HEI closed on its $5.5 billion acquisition of BP's entire Alaskan upstream and midstream asset base, including BP Exploration (Alaska) Inc., that owns all of BP's upstream oil and gas interests in Alaska. The acquisition gives HEI a 26.4% interest in the prolific Prudhoe Bay field, which it will operate. The 50% of the Milne Point producing asset not presently owned by HEI was contributed to HEI at closing, while the remainder of the upstream asset package is held in a separately capitalized 100% owned unrestricted HEI subsidiary (the "UnSub"). The BP Alaska midstream assets will be closed in a separate transaction at Harvest Midstream I, L.P. (Ba3 stable) for $100 million in the second half of 2020.

"The acquisition of BP's Alaskan upstream assets will materially expand the scale of Hilcorp's production and reserves, and should generate ample free cash flow for debt reduction," commented Andrew Brooks, Moody's Vice President, "While the acquisition is essentially wholly debt financed adding considerably to consolidated HEI debt levels, the use of an unrestricted subsidiary to hold all but the Milne Point upstream assets largely insulates HEI from the financing and debt servicing obligations of the acquired assets."

Downgrades:

..Issuer: Hilcorp Energy I, L.P.

.... Probability of Default Rating, Downgraded to Ba2-PD from Ba1-PD

.... Corporate Family Rating, Downgraded to Ba2 from Ba1

....Senior Unsecured Notes, Downgraded to Ba3 (LGD5) from Ba2 (LGD5)

Outlook Actions:

..Issuer: Hilcorp Energy I, L.P.

....Outlook, Changed To Stable From Rating Under Review

RATINGS RATIONALE

The acquisition of BP's assets will more than double HEI's Alaskan production to around 120,000 barrels of oil equivalent (Boe) per day. The acquired production, which is all oil, is expected to average over 70,000 Boe per day, while HEI's total pro forma production across its portfolio will increase to about 230,000 Boe per day. HEI has consistently employed a strategy of acquiring older, mature, long-lived properties, including in Alaska's Cook Inlet and North Slope regions, with a base level of production, creating value by minimizing declining well performance and reducing costs. Moody's expects HEI to extend this strategy to the newly acquired Alaskan assets as well.

A key structural component of the purchase and sale transaction is the establishment of UnSub to hold all but the Milne Point Alaskan assets acquired by HEI, and the provision of seller-financing by BP to fund this element of the acquisition on a non-recourse basis to HEI. An approximate $2.1 billion five-year note will be extended by BP payable at 8% after year-one, together with a one-year $700 million cash sharing obligation. A $1.6 billion contingent earnout provision, which is payable from 50% of UnSub's net cash flow is subject to the realization of eight-quarters of Alaska North Slope (ANS) crude pricing of at least $50 per barrel, and on the basis of a quarterly ANS average of at least $50 per barrel. There is no termination date to the earn out. The components of the UnSub financing are secured only by the assets of UnSub, with anticipated free cash flow directed to the repayment of UnSub debt. HEI has no financial guarantees or contractual obligations in support of UnSub's debts or liabilities. Any distributions from UnSub to HEI, which are expected to be modest if any, are required to repay HEI debt. Moody's projects that there will be significant free cash flow from the acquired Alaskan assets at both HEI and UnSub enabling HEI to maintain stand-alone leverage consistent with its targeted 2.5x debt/EBITDA level, and with UnSub approaching 2.5x debt/EBITDA by 2023.

HEI will capitalize an independently evaluated fair market valuation of the UnSub's financing obligations as liabilities on its balance sheet in accordance with GAAP, which Moody's will include in HEI's consolidated debt aggregate. As such, the absolute amount of HEI consolidated debt will approximately double from its $2.65 billion June 30 total. Moody's expects that debt will increase to the equivalent of around $21,000 per Boe of production from about $18,000 per Boe prior to the acquisition. Retained cash flow (RCF) to debt is expected to remain in the mid-20% area.

The rapid spread of the coronavirus outbreak, deteriorating global economic outlook, low oil prices, and high asset price volatility have created an unprecedented credit shock across a range of sectors and regions. We regard the coronavirus outbreak as a social risk under our ESG framework, given the substantial implications for public health and safety. HEI's exposure to oil prices leaves it vulnerable to shifts in market demand and sentiment in these unprecedented operating conditions.

From a governance perspective, company founder, Mr. Jeffery Hildebrand, owns the vast majority of HEI's limited partner interests and holds the 1% general partnership interest through Hilcorp Energy Company, which manages HEI's oil and gas operations. The singular control Mr. Hildebrand wields over the Hilcorp enterprises is also considered in HEI's credit profile. However, HEI has prospered under Mr. Hildebrand's control and leadership, while limiting its use of excessive debt financing.

Moody's expects HEI's liquidity position to remain good into 2021. At June 30, however, HEI's cash and marketable securities balance had declined to $9 million from its year-end total of $260 million, HEI having used $209 million of the amount to close on the 50% interest in Milne Point acquired from BP. HEI's $1.7 billion secured borrowing base revolving credit facility was utilized in the amount of $1.055 billion at June 30, and is scheduled to mature in November 2022. HEI paid $500 million to BP in two instalments in 2019, both installments borrowed under its revolving credit facility. UnSub has no credit facility. Moody's expects HEI and the UnSub to be substantially free cash flow positive, using cash flow for debt repayment.

The Ba3 rating on HEI's senior unsecured notes reflects their subordinate position to the company's $1.7 billion secured borrowing base revolving credit's priority claim to the company's assets. The size of the senior secured claims relative to HEI's outstanding senior unsecured notes results in the notes being rated one notch below the Ba2 CFR.

The stable outlook reflects HEI's low risk exploitation strategy, and Moody's expectation that the company will be able to generate its forecasted free cash flow for debt reduction.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS

A rating upgrade could be considered if HEI reduces consolidated debt to average daily production below $18,000 per Boe and increase RCF to debt above 30%. Moody's would further expect that HEI's future growth strategy not materially deviate from its historic focus on the acquisition of mature, longer-lived assets whose potential avail themselves to future exploitation upside. A downgrade is possible should HEI's debt increase above $25,000 per Boe of average daily production, should RCF to debt drop below 20% or should debt levels further increase to fund acquisitions or distributions.

Hilcorp Energy I, L.P. is a private limited partnership headquartered in Houston, Texas. The company's primary producing assets are located in Alaska, Texas, Louisiana and the Utica Shale.

The principal methodology used in these ratings was Independent Exploration and Production Industry published in May 2017 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1056808. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

REGULATORY DISCLOSURES

For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

These ratings are solicited. Please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website www.moodys.com.

Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.

Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.

At least one ESG consideration was material to the credit rating action(s) announced and described above.

The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on www.moodys.com.3437130

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Andrew Brooks VP - Senior Credit Officer Corporate Finance Group Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Steven Wood MD - Corporate Finance Corporate Finance Group JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653 Releasing Office: Moody's Investors Service, Inc. 250 Greenwich Street New York, NY 10007 U.S.A. JOURNALISTS: 1 212 553 0376 Client Service: 1 212 553 1653

© 2020 Moody's Corporation, Moody's Investors Service, Inc., Moody's Analytics, Inc. and/or their licensors and affiliates (collectively, "MOODY'S"). All rights reserved.

CREDIT RATINGS ISSUED BY MOODY'S INVESTORS SERVICE, INC. AND/OR ITS CREDIT RATINGS AFFILIATES ARE MOODY'S CURRENT OPINIONS OF THE RELATIVE FUTURE CREDIT RISK OF ENTITIES, CREDIT COMMITMENTS, OR DEBT OR DEBT-LIKE SECURITIES, AND MATERIALS, PRODUCTS, SERVICES AND INFORMATION PUBLISHED BY MOODY'S (COLLECTIVELY, "PUBLICATIONS") MAY INCLUDE SUCH CURRENT OPINIONS. MOODY'S INVESTORS SERVICE DEFINES CREDIT RISK AS THE RISK THAT AN ENTITY MAY NOT MEET ITS CONTRACTUAL FINANCIAL OBLIGATIONS AS THEY COME DUE AND ANY ESTIMATED FINANCIAL LOSS IN THE EVENT OF DEFAULT OR IMPAIRMENT. SEE MOODY'S RATING SYMBOLS AND DEFINITIONS PUBLICATION FOR INFORMATION ON THE TYPES OF CONTRACTUAL FINANCIAL OBLIGATIONS ADDRESSED BY MOODY'S INVESTORS SERVICE CREDIT RATINGS. CREDIT RATINGS DO NOT ADDRESS ANY OTHER RISK, INCLUDING BUT NOT LIMITED TO: LIQUIDITY RISK, MARKET VALUE RISK, OR PRICE VOLATILITY. CREDIT RATINGS, NON-CREDIT ASSESSMENTS ("ASSESSMENTS"), AND OTHER OPINIONS INCLUDED IN MOODY'S PUBLICATIONS ARE NOT STATEMENTS OF CURRENT OR HISTORICAL FACT. MOODY'S PUBLICATIONS MAY ALSO INCLUDE QUANTITATIVE MODEL-BASED ESTIMATES OF CREDIT RISK AND RELATED OPINIONS OR COMMENTARY PUBLISHED BY MOODY'S ANALYTICS, INC. AND/OR ITS AFFILIATES. MOODY'S CREDIT RATINGS, ASSESSMENTS, OTHER OPINIONS AND PUBLICATIONS DO NOT CONSTITUTE OR PROVIDE INVESTMENT OR FINANCIAL ADVICE, AND MOODY'S CREDIT RATINGS, ASSESSMENTS, OTHER OPINIONS AND PUBLICATIONS ARE NOT AND DO NOT PROVIDE RECOMMENDATIONS TO PURCHASE, SELL, OR HOLD PARTICULAR SECURITIES. MOODY'S CREDIT RATINGS, ASSESSMENTS, OTHER OPINIONS AND PUBLICATIONS DO NOT COMMENT ON THE SUITABILITY OF AN INVESTMENT FOR ANY PARTICULAR INVESTOR. MOODY'S ISSUES ITS CREDIT RATINGS, ASSESSMENTS AND OTHER OPINIONS AND PUBLISHES ITS PUBLICATIONS WITH THE EXPECTATION AND UNDERSTANDING THAT EACH INVESTOR WILL, WITH DUE CARE, MAKE ITS OWN STUDY AND EVALUATION OF EACH SECURITY THAT IS UNDER CONSIDERATION FOR PURCHASE, HOLDING, OR SALE.

MOODY'S CREDIT RATINGS,ASSESSMENTS, OTHER OPINIONS, AND PUBLICATIONS ARE NOT INTENDED FOR USE BY RETAIL INVESTORS AND IT WOULD BE RECKLESS AND INAPPROPRIATE FOR RETAIL INVESTORS TO USE MOODY'S CREDIT RATINGS, ASSESSMENTS, OTHER OPINIONS OR PUBLICATIONS WHEN MAKING AN INVESTMENT DECISION. IF IN DOUBT YOU SHOULD CONTACT YOUR FINANCIAL OR OTHER PROFESSIONAL ADVISER.

ALL INFORMATION CONTAINED HEREIN IS PROTECTED BY LAW, INCLUDING BUT NOT LIMITED TO, COPYRIGHT LAW, AND NONE OF SUCH INFORMATION MAY BE COPIED OR OTHERWISE REPRODUCED, REPACKAGED, FURTHER TRANSMITTED, TRANSFERRED, DISSEMINATED, REDISTRIBUTED OR RESOLD, OR STORED FOR SUBSEQUENT USE FOR ANY SUCH PURPOSE, IN WHOLE OR IN PART, IN ANY FORM OR MANNER OR BY ANY MEANS WHATSOEVER, BY ANY PERSON WITHOUT MOODY'S PRIOR WRITTEN CONSENT.

MOODY'S CREDIT RATINGS,ASSESSMENTS, OTHER OPINIONS AND PUBLICATIONS ARE NOT INTENDED FOR USE BY ANY PERSON AS A BENCHMARK AS THAT TERM IS DEFINED FOR REGULATORY PURPOSES AND MUST NOT BE USED IN ANY WAY THAT COULD RESULT IN THEM BEING CONSIDERED A BENCHMARK.

All information contained herein is obtained by MOODY'S from sources believed by it to be accurate and reliable. Because of the possibility of human or mechanical error as well as other factors, however, all information contained herein is provided "AS IS" without warranty of any kind. MOODY'S adopts all necessary measures so that the information it uses in assigning a credit rating is of sufficient quality and from sources MOODY'S considers to be reliable including, when appropriate, independent third-party sources. However, MOODY'S is not an auditor and cannot in every instance independently verify or validate information received in the rating process or in preparing its Publications.

To the extent permitted by law, MOODY'S and its directors, officers, employees, agents, representatives, licensors and suppliers disclaim liability to any person or entity for any indirect, special, consequential, or incidental losses or damages whatsoever arising from or in connection with the information contained herein or the use of or inability to use any such information, even if MOODY'S or any of its directors, officers, employees, agents, representatives, licensors or suppliers is advised in advance of the possibility of such losses or damages, including but not limited to: (a) any loss of present or prospective profits or (b) any loss or damage arising where the relevant financial instrument is not the subject of a particular credit rating assigned by MOODY'S.

To the extent permitted by law, MOODY'S and its directors, officers, employees, agents, representatives, licensors and suppliers disclaim liability for any direct or compensatory losses or damages caused to any person or entity, including but not limited to by any negligence (but excluding fraud, willful misconduct or any other type of liability that, for the avoidance of doubt, by law cannot be excluded) on the part of, or any contingency within or beyond the control of, MOODY'S or any of its directors, officers, employees, agents, representatives, licensors or suppliers, arising from or in connection with the information contained herein or the use of or inability to use any such information.

NO WARRANTY, EXPRESS OR IMPLIED, AS TO THE ACCURACY, TIMELINESS, COMPLETENESS, MERCHANTABILITY OR FITNESS FOR ANY PARTICULAR PURPOSE OF ANY CREDIT RATING, ASSESSMENT, OTHER OPINION OR INFORMATION IS GIVEN OR MADE BY MOODY'S IN ANY FORM OR MANNER WHATSOEVER.

Moody's Investors Service, Inc., a wholly-owned credit rating agency subsidiary of Moody's Corporation ("MCO"), hereby discloses that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by Moody's Investors Service, Inc. have, prior to assignment of any credit rating, agreed to pay to Moody's Investors Service, Inc. for credit ratings opinions and services rendered by it fees ranging from $1,000 to approximately $2,700,000. MCO and Moody's investors Service also maintain policies and procedures to address the independence of Moody's Investors Service credit ratings and credit rating processes. Information regarding certain affiliations that may exist between directors of MCO and rated entities, and between entities who hold credit ratings from Moody's Investors Service and have also publicly reported to the SEC an ownership interest in MCO of more than 5%, is posted annually at www.moodys.com under the heading "Investor Relations — Corporate Governance — Director and Shareholder Affiliation Policy."

Additional terms for Australia only: Any publication into Australia of this document is pursuant to the Australian Financial Services License of MOODY'S affiliate, Moody's Investors Service Pty Limited ABN 61 003 399 657AFSL 336969 and/or Moody's Analytics Australia Pty Ltd ABN 94 105 136 972 AFSL 383569 (as applicable). This document is intended to be provided only to "wholesale clients" within the meaning of section 761G of the Corporations Act 2001. By continuing to access this document from within Australia, you represent to MOODY'S that you are, or are accessing the document as a representative of, a "wholesale client" and that neither you nor the entity you represent will directly or indirectly disseminate this document or its contents to "retail clients" within the meaning of section 761G of the Corporations Act 2001. MOODY'S credit rating is an opinion as to the creditworthiness of a debt obligation of the issuer, not on the equity securities of the issuer or any form of security that is available to retail investors.

Additional terms for Japan only: Moody's Japan K.K. ("MJKK") is a wholly-owned credit rating agency subsidiary of Moody's Group Japan G.K., which is wholly-owned by Moody's Overseas Holdings Inc., a wholly-owned subsidiary of MCO. Moody's SF Japan K.K. ("MSFJ") is a wholly-owned credit rating agency subsidiary of MJKK. MSFJ is not a Nationally Recognized Statistical Rating Organization ("NRSRO"). Therefore, credit ratings assigned by MSFJ are Non-NRSRO Credit Ratings. Non-NRSRO Credit Ratings are assigned by an entity that is not a NRSRO and, consequently, the rated obligation will not qualify for certain types of treatment under U.S. laws. MJKK and MSFJ are credit rating agencies registered with the Japan Financial Services Agency and their registration numbers are FSA Commissioner (Ratings) No. 2 and 3 respectively.

MJKK or MSFJ (as applicable) hereby disclose that most issuers of debt securities (including corporate and municipal bonds, debentures, notes and commercial paper) and preferred stock rated by MJKK or MSFJ (as applicable) have, prior to assignment of any credit rating, agreed to pay to MJKK or MSFJ (as applicable) for credit ratings opinions and services rendered by it fees ranging from JPY125,000 to approximately JPY250,000,000.

MJKK and MSFJ also maintain policies and procedures to address Japanese regulatory requirements.

​​​​​​​​