Fitch Rates Energy XXI Gulf Coast's Second Lien Issuance 'BB'

Fitch Ratings has assigned 'BB/RR1' ratings to Energy XXI Gulf Coast Inc.'s (EXXI GC) $1.25 billion second-lien notes. In addition, Fitch has downgraded EXXI GC's senior unsecured notes to 'B-/RR5'. A complete list of rating actions follows at the end of this release.

The Rating Outlook remains Negative.

Ratings for EXXI's second-lien notes are driven by strong recovery prospects and low first-lien debt levels relative to the collateral base. EXXI's second-lien issuance will increase cash on hand at EXXI GC to over $450 million, and EXXI's credit facility will be paid down with proceeds. Concurrently, EXXI's borrowing base will be reduced to $500 million from $1.5 billion. $124 million will be undrawn at closing, net of $226 million in letters of credit and $150 million drawn under the EPL sub-facility. While EPL is not currently a guarantor of the second lien notes, the majority of value on a PV-10 basis (approximately 72%) is housed at EXXI GC, leading to good coverage of EXXI GC first and second lien debt. In addition, at such time that the EPL notes are redeemed the EPL reserves will become part of the general collateral pool.

EXXI GC's senior unsecured notes were downgraded on lower recovery prospects, driven by higher levels of secured debt and lower 1P reserves at current strip prices.

KEY RATING DRIVERS

Positive trends in production volumes have been offset by the upheaval in global crude markets, leading to lower oil prices and subsequent challenges for EXXI in implementing its plan to de-lever following the acquisition of EPL.

The Negative Outlook is driven by uncertainties around the length and depth of the crude downturn, with several follow-on effects. These include the ability of the company to layer on hedges at meaningful levels in 2016, the potential for lower capex levels to impair production growth, and uncertainty around the size and timing of potential asset sales, including the Grand Isle Gathering System.

Fitch expects that leverage will be higher in FY15 and FY16, driven by lower oil price realizations. EXXI has monetized $102 million in hedge positions over the last eight months, and subsequently entered into hedge positions providing sub-$50/bbl price protection. While this has increased liquidity, the company remains vulnerable to continued cash burn if oil prices are sustained under $65/bbl. However, Fitch believes that higher forecasted leverage is offset in the near term by the company's enhanced liquidity position.

CREDIT CONCERNS

EXXI remains highly leveraged after the EPL acquisition, and management's intention to meaningfully deleverage with free cash flow will likely be delayed given current market conditions. While Fitch believes that current and projected credit metrics are appropriate for the rating category, headroom in the rating has effectively been eliminated. Additionally, while EXXI has hedges for approximately 70% and 40% of 2015 and 2016 production, calendar 2016 oil hedges are primarily collar positions with downside protection at around $52/bbl. Oil realizations of $50-65/bbl reduce negative cash flow impact but are not anticipated to generate positive free cash flow for EXXI. In its base case, Fitch anticipates that production volumes will be flat to modestly positive. To the extent that current volumes decline materially Fitch could take a negative credit action given limited overall headroom in the rating.

FREE CASH FLOW

Management expects to spend $680 million for capex in FY15. As much of this spending was front-loaded Fitch anticipates limited oil-price related changes to FY15 spending. However, given the company's ability to sustain production levels with lower capex levels by focusing on development activity, Fitch anticipates positive free cash flow along with modest debt reduction in a $70-75 WTI price environment. In a lower oil price environment, cash burn should be manageable in the near term given the company's improved liquidity position, though leverage metrics could be stressed.

LIQUIDITY

Pro forma for the second lien issuance, EXXI will have over $550 million in cash, inclusive of $101 million held at EXXI LTD, and $124 million available on the credit facility, leading to approximately $674 million in available liquidity. Fitch's base case forecasts that liquidity should be adequate to bridge funding gaps given Fitch's long term oil price assumption of $75/bbl, under which EXXI should generate positive free cash flow. Under more challenging conditions ($50/WTI), Fitch anticipates that liquidity will remain adequate in the near term. Potential cash burn rates at various crude prices are factored into the liquidity analysis and overall outlook.

CRUDE OIL SCENARIOS

Fitch ran a number of price scenarios to capture what EXXI might look like in a sustained downside oil case. In cases with prices sustained above $65/bbl free cash flow was neutral to slightly positive and liquidity concerns were not material. In a sustained downside case, and without meaningful hedge protection in calendar 2016, credit metrics could become challenged. However, the second lien issuance materially improves liquidity and provides additional time for the company to adjust capital spending levels and pursue operating cost efficiencies. Fitch will monitor the continuing developments in crude markets, improvements in operating costs, hedge positions, and liquidity in assessing EXXI credit quality.

KEY ASSUMPTIONS

--WTI oil prices of $50/bbl in 2015, increasing to $75/bbl in 2018;

--Capex reduced to $400 million per year to maintain production and 1P reserve levels;

--Flat production volumes in FY15 and FY16, increasing modestly in out years after response to higher oil prices;

--Successful sale of the Grand Isle Gathering System in FY15.

RATING SENSITIVITIES

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

--Inability to maintain liquidity of $400 million during the current downcycle;

--A material decline production levels that compounds the revenue effects of lower oil prices;

--Continued weak forward oil prices, leading to an inability to meaningfully hedge 2016 oil volumes.

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

--Sustained increases in overall production levels with positive free cash flow generation and subsequent debt reduction;

--Demonstrated commitment to lower debt levels leading to mid-cycle Debt/EBITDA below 3.5x;

--Upgrades are not considered probable in the near term given headwinds from lower crude prices, as well as limited capacity to pay down material amounts of debt.

Fitch has taken the following rating actions:

Energy XXI Gulf Coast Inc.

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

--Senior secured first lien revolver affirmed at 'BB/RR1';

--Senior secured second lien notes assigned 'BB/RR1';

--Senior unsecured notes downgraded to 'B-/RR5' from 'B/RR4'.

Energy XXI LTD

--IDR affirmed at 'B-';

--Convertible perpetual preferred affirmed at 'CCC/RR6';

--Convertible notes affirmed at 'CCC/RR6'.

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

Applicable Criteria & Related Research:

--'Fitch Oil and Gas Assumptions Summary' (Feb. 11, 2015);

--'Production Sharing Contracts; Countercyclicality Supports Debt in a Low Oil Price Environment' (Jan. 28, 2015);

--'E&P Borrowing Base Redeterminations: History Suggests Lenders May Go Easy in a Downturn' (Dec. 5, 2014);

--'Full Cycle Costs for North American E&P (Production Costs Moderate in 2013)' (July 30, 2014);

--'North American Energy Outlook and LNG' (July 16, 2014);

--'North American Exploration and Production Handbook' (July 16, 2014);

--'Corporate Rating Methodology Including Short-Term Ratings and Parent and Subsidiary Linkage' (May 28, 2014);

--'Global Impact of US Shale Oil - Rising Production Tempers World Prices' (Feb. 10, 2014).

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=980711

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