OREANDA-NEWS. Fitch Ratings has revised Repsol, S.A.'s and Repsol Oil and Gas Canada Inc.'s (ROGC, formerly Talisman Energy Inc.) Outlooks to Negative from Stable and affirmed their Long-term Issuer Default Ratings (IDR) at 'BBB' and 'BBB-', respectively. A full list of rating actions is below.

The revision of the Outlooks reflects our expectation that weak oil prices will result in Repsol's financial leverage being higher than we previously assumed. We now expect funds from operations (FFO) net leverage to total 3.6.x and 3.3x in 2016 and 2017, respectively, and to return to below 3.0x, our guidance for negative rating action, in 2018. We lowered our price deck in February 2016 and forecast Brent to average USD35 per barrel (bbl) in 2016, before gradually recovering to USD45/bbl in 2017, USD55/bbl in 2018 and USD65/bbl in the long term. The expectation for improved credit metrics is also conditional on successful implementation of management's plans aimed at improving financial performance and debt reduction including synergies from acquisition of Talisman, efficiency measures and disposal of assets.

Repsol's ratings are supported by the company's sound business diversification with a strong downstream segment and a larger and more geographically diversified upstream segment after the acquisition of Talisman. The ratings are constrained by high leverage relative to peers and uncertainty over the profitability of upstream production, mainly in North America and the North Sea.

Fitch views the strategic and operational ties between Repsol and ROGC as strong, but due to the lack of direct debt guarantees and cross default clauses in Repsol's debt documentation, we rate ROGC using a top-down approach, one notch below Repsol's rating.

KEY RATING DRIVERS
Response to More Difficult Market Conditions
Repsol's EBITDA excluding impairments and income on equity accounted associates increased by 44% yoy in 2015 due to the acquisition of ROGC closed in May 2015 and strong downstream performance. However, the acquisition coupled with lower oil prices pushed FFO net adjusted leverage to 4.4x in 2015 (proforma ratio including consolidation of ROGC for a full year totalled 4.0x) from 2.8x in 2014.

Repsol has responded to a more challenging macro backdrop and higher leverage, announcing a number of measures to strengthen its balance sheet. The company plans to decrease free cash flow after dividends breakeven to USD40/bbl in 2016 and 2017 (excluding disposals except sales of the piped LPG business) from USD60/bbl as stipulated in the strategic update announced in October 2015.

Capex in 2016 and 2017 will be by EUR1.8bn lower compared with earlier plans. Opex synergy effects and efficiency improvements are targeted at EUR0.8bn in 2016 increasing to EUR1.5bn in 2018. Repsol has already announced disposals valued at EUR1.5bn since the acquisition was announced and plans further asset sales to decrease leverage. We understand the company has a pool of assets, whose valuation is not related to oil, which supports its disposal plan.

We view positively Repsol's response to the more difficult macro environment and forecast the leverage metrics to improve to around 3.0x in 2018, commensurate with our guidance for the current rating. The Negative Outlook reflects the challenges related to the implementation of the capex and opex reduction programme as well as actual disposal proceeds. At the same time, we still believe management has significant flexibility in shaping the financial policy of the company, for example through further disposals of assets, whose value is not directly related to oil prices.

Upstream Under Pressure
Oil and gas reserves (excluding equity stakes) increased to 1.3 billion barrels of oil equivalent (boe) in 2015 from 0.6bn boe in 2014. The corresponding value including equity-accounted investees is 2.4bn boe in 2015 (1.5bn in 2014). Oil and gas output increased to 304 thousand of oil equivalent per day (mboepd) in 2015 (excluding production at equity accounted investees of 250mboepd) from 144mboepd a year earlier. Inorganic reserve replacement ratio was 500% and 159% excluding the impact of acquisitions. The company targets broadly stable oil and gas output of over 700mboepd in 2016 and 2017.

Repsol reduced the operating cost per barrel in 2015 to USD18.7/bbl from USD21.5/bbl in 2014 and plans to cut costs further to USD15.7bbl in 2016. Upstream EBITDA excluding JVs decreased 40% in 2015 to EUR.08.bn due to lower prices. Relatively high production costs per barrel compared with peers and a comparatively high percentage of production in higher cost regions such as the North Sea and the US constrain the ratings. Targeted synergies and efficiency improvement measures as well as full year consolidation of ROGC's assets should help Repsol protect profitability of the upstream segment in 2016 and 2017, when we expect Brent prices to average USD35/bbl and USD45/bbl.

Strong Downstream in 2015
Repsol's credit profile is supported by the strong downstream segment, which recorded EBITDA current cost of supplies of EUR3.8bn in 2015, a 70% increase yoy. We expect the refining margins to moderate from the exceptionally high levels seen in 2015. However, low oil prices driving down cost of oil consumption for own use, a stronger US dollar against the euro and low end-product prices supporting demand should help keep refining margins healthy.

Top-Down Approach to ROGC
ROGCs ratings are driven by the subsidiary's linkage with Repsol due to strong strategic and operational ties between the companies. At the same time, the lack of direct debt guarantees and hence strong legal ties are reflected in ROGC being rated one notch below Repsol via Fitch's top-down rating approach. In 2015 USD1.6bn of ROGC's bonds tender offer was financed with Repsol's funding, which served to decrease ROGC's gross external debt at end-2015 to USD2.2bn and underlines the ties between the companies. Fitch expects Repsol will further reinforce Talisman's near-term capitalisation and liquidity position, which will likely lead to rating alignment in the future.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Brent & WTI gradually recovering from USD35/bbl in 2015 to USD45/bbl in 2017, USD55/bbl in 2018 and USD65/bbl in the long term.
- NBP gas prices USD5/mcf in 2016, USD6/mcf in 2017, USD6.5/mcf in 2018 and USD7/mcf in 2019.
- Capex of EUR3.9bn in 2016, rising to EUR4.5bn in 2018.

RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to stabilisation of Outlook include:
- FFO adjusted net leverage trending towards 3x (2015:4.4x).
- FFO margin trending towards 10%.
- Capex at no more than 100% operating cash flow.

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- FFO adjusted net leverage above 3.0x and FFO fixed charge cover of 6x and below on a sustained basis.

LIQUIDITY
At 31 December 2015 Repsol had a cash position of EUR2.5bn and undrawn credit lines amounting to EUR6.3bn against short-term debt of EUR4.1bn (excluding a short-term loan from Repsol Sinopec Brasil JV of EUR2.9bn, which is also excluded from debt in our analysis of Repsol). Undrawn credit lines at end-2015 of EUR6.3bn included USD3.2bn bank loan at ROGC subject to financial covenants of debt to cash flow ratio of less than 3.5:1. As at 31 December 2015, this ratio was 1.4:1. In February 2016 Repsol signed long-term loans for EUR2bn, which further strengthened its liquidity.

FULL LIST OF RATING ACTIONS
Repsol S.A.
Long-term IDR affirmed at 'BBB'; Outlook revised to Negative from Stable
Senior unsecured debt affirmed at 'BBB'
Short-term IDR affirmed at 'F3'

Repsol International Finance
Senior unsecured debt affirmed at 'BBB'
Commercial paper affirmed at 'F3'
Hybrid capital instruments affirmed at 'BB+'

Repsol Oil and Gas Canada Inc.
Long-term IDR affirmed at 'BBB-'; Outlook revised to Negative from Stable
Senior unsecured debt affirmed at 'BBB-'
Short-term IDR affirmed at 'F3'
Commercial paper affirmed at 'F3'