News Column

Fitch Assigns 'B/RR4' to Energy XXI's Issuance; Outlook Stable

May 12, 2014

CHICAGO--(BUSINESS WIRE)-- Fitch Ratings has assigned a 'B/RR4' to Energy XXI Gulf Coast's issuance of senior unsecured 2024 notes. The notes are jointly and severally guaranteed by EXXI Gulf Coast's existing subsidiaries, certain future material domestic restricted subsidiaries, and by EXXI Bermuda.

Proceeds will be used to repay revolver borrowings and to fund a portion of the cash consideration of the pending EPL acquisition. If the EPL acquisition is not consummated, proceeds will go to general corporate purposes.

Fitch currently rates EXXI as follows:

Energy XXI (Bermuda)

--Issuer Default Rating (IDR) 'B-';

--Convertible perpetual preferred 'CCC/RR6';

--Convertible notes 'CCC/RR6'.

Energy XXI Gulf Coast (Delaware)

--IDR 'B';

--Senior secured revolver 'BB/RR1';

--Senior unsecured notes 'B/RR4'.

KEY RATINGS DRIVERS

EPL ACQUISITION

In March, Energy XXI announced it would acquire EPL for total consideration of $2.3 billion, including the assumption of existing EPL debt. Following completion of the deal, EXXI will be the largest publicly traded pure-play company in the Gulf of Mexico (GoM), with production of approximately 65,000 barrels of oil equivalent per day (boepd), versus approximately 44,000 boepd today. The combined company's output mix is expected to be 70% oil, while its proven (1p) reserve base will increase from 171 MMboe to 243 MMboe. The combined company will operate 10 of the largest oil fields in the Gulf of Mexico shelf. EPL's asset profile is very similar to EXXI's, and should allow for meaningful cost savings synergies.

The deal will also significantly increase EXXI's leverage on a pro forma basis. As calculated by Fitch, pro forma debt/boe 1p reserves will increase above $14, debt/boe PD will rise above $23, and debt/flowing barrel will rise above $53,000/barrel. This compares to levels of just $8.36/boe, $13.64/boe, and approximately $35,000/barrel at June 30, 2013.

Energy XXI's ratings are supported by the company's growing scale and robust organic drilling program; high exposure to liquids, composed mostly of higher-value black oil linked to waterborne grade pricing; historically strong production economics and cash generation; operator status on a majority of its properties; and the short-term cash flow protections of its hedging position.

Ratings issues for bondholders include higher leverage; the company's status as a small offshore GoM producer; lack of basin diversification; the relatively flat production outlook over the next few years; increasing structural subordination at EXXI Bermuda; and exposure to the riskier ultra-deep shelf exploration program.

INCREASE IN 2013 RESERVES

EXXI reported a large (50%) increase in audited proven (1p) reserves at June 30, 2013, resulting in a 2013 reserve replacement ratio of 393% on an organic basis, and 475% on an all-in basis, as calculated by Fitch. Total 1p reserves climbed to 179 MMboe from 119 MMboe the year prior, comprised primarily of extensions and discoveries (62 MMboe), and to a lesser degree acquisitions (13 MMboe). A significant driver of the increase was the company's horizontal drilling program in the GoM, which consists of short laterals (less than 1000 feet) drilled in EXXI's mature offshore properties. Fitch would note that there is a sizable backlog of such drilling opportunities across EXXI's portfolio.

INCREASED SUBORDINATION AT EXXI BERMUDA

The notching between the IDRs of EXXI Gulf Coast and EXXI Bermuda is driven by recognition of the significant legal separations between the stronger EXXI Gulf Coast subsidiary (which houses most of the corporation's assets and cash flows) and the weaker EXXI Bermuda parent (which depends on distributions from EXXI Gulf Coast), as well as increased leverage at the Bermuda parent level.

Fitch would note that despite reasonably strong operational ties, the legal separations between EXXI Gulf Coast and Bermuda are significant and include restrictions on dividend payments from Gulf Coast to the parent; a lack of guarantees from the subsidiary up to the parent; and separate legal jurisdictions (Bermuda vs. the U.S.).

LIMITED ULTRA-DEEP SHELF COMMITMENT

EXXI has participated in eight ultra-deep shelf wells to date with participation levels of 9%-20%. The company seeks to limit its total exposure to these projects to less than 10% of expected cash flow in any one year, and EXXI's strategy has been to fund this higher risk exploration drilling with lower risk drilling prospects across the rest of its portfolio.

LIQUIDITY

EXXI's liquidity was good at Dec. 31, 2013, and included availability on its main revolver of approximately $710 million, or 65.3% after borrowings of $152.3 million and letters of credit of $225.3 million. The revolver, which expires in April 2018, is secured by a borrowing base linked to at least 85% of the company's proven properties. Similar to other borrowing-based revolvers, the base periodically resizes in line with the underlying value of the collateral.

Key revolver covenants include maximum leverage of 3.5x; minimum interest coverage of 3.0x; and a minimum current ratio of 1.0x, as well as change of control provisions and restricted payments. The company had ample headroom on all covenants at Dec. 31, 2013. Restrictions on dividends from EXXI Gulf Coast to its Bermuda parent were recently loosened to include $350 million per year, subject to liquidity and minimum cumulative consolidated net income tests. EXXI's other maturities are light, with the no major bonds maturities due over the next three years.

RECOVERY RATING

Fitch's Recovery Rating (RR) of '1' on EXXI's secured revolving credit facility indicates outstanding recovery prospects (91%-100%) for holders of this debt. The revolver is secured by at least 85% of the total value of proven reserves of the company and its subsidiaries. The RR for EXXI's senior unsecured notes of '4' indicates average recovery prospects for holders of these issues, while the RR of EXXI's junior securities of '6' indicates poor recovery prospects for these securities.

OTHER LIABILITIES

EXXI's other liabilities are manageable. The company's Asset Retirement Obligation (ARO) was approximately $307.1 million at year-end (YE) 2013. EXXI has provided a guarantee to its 20% joint venture M21k for the payment of that company's ARO and other minor liabilities ($1.8 million) in exchange for a $6.3 million payment from M21k. EXXI hedges a significant portion of its expected output using a range of instruments, including swaps, collars, 3-way collars, and puts.

RATINGS SENSITIVITIES

Positive: Future developments that may lead to positive rating actions include:

--Increased size, scale and portfolio diversification, accompanied by sustained improvement in debt/boe metrics;

--A demonstrated managerial commitment to lower debt levels.

Negative: Future developments that could lead to negative rating action include:

--Additional increase in debt/boe metrics from current levels;

--A change in philosophy on the use of balance sheet;

--A major operational issue such as sustained difficulty in integrating the new acquisition or a well blowout;

--A sustained collapse in oil prices without other adjustments to capex.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Relevant Research:

--'Corporate Rating Methodology Including Short-Term Ratings and Parent and Subsidiary Linkage' (Aug. 5, 2013);

--Parent and Subsidiary Rating Linkage: Fitch's Approach to Rating Entities Within a Corporate Group Structure, (Aug. 5, 2013);

--Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis (Dec. 13, 2012);

--Cash Flow Trends in the U.S. Energy Sector--Shareholder Activism Having an Impact (Feb. 4, 2014);

--Scenario Analysis: Lifting the U.S. Crude Export Ban (Jan. 27, 2014);

--Investor FAQs--Recent Questions on E&P, Refining, and Drilling and Services Sectors (Aug. 12, 2013);

--Energy Handbook--Upstream Oil & Gas (June 28, 2013).

Applicable Criteria and Related Research:

Corporate Rating Methodology: Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715139

Parent and Subsidiary Rating Linkage Fitch's Approach to Rating Entities within a Corporate Group Structure

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=714476

Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=726863

Cash Flow Trends in the U.S. Energy Sector (Shareholder Activism Having an Impact)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=733556

Scenario Analysis: Lifting the Crude Export Ban (Overall Credit Impact Limited but Varies by Industry)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=732055

Investor FAQs: Recent Questions on the E&P, Refining, and Drilling and Services Sectors

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=715859

Energy Handbook - Upstream Oil & Gas

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=706481

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=829703

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH WEBSITE.



Fitch Ratings

Primary Analyst

Mark C. Sadeghian, CFA, +1 312-368-2090

Senior Director

Fitch Ratings, Inc.

70 W. Madison Street

Chicago, IL 60602

or

Secondary Analyst

Dino Kritikos, +1 312-368-3150

Director

or

Committee Chairperson:

Sean T. Sexton, CFA, +1 312-368-3130

Managing Director

or

Media Relations:

Brian Bertsch, +1 212-908-0549

brian.bertsch@fitchratings.com

Source: Fitch Ratings


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