Fitch Ratings has affirmed BlackBrush Oil and Gas, L.P.'s and BBOG Holdings LLC's Long-Term Issuer Default Ratings (IDRs) at 'CCC+'.

In addition, Fitch has affirmed BlackBrush's first-lien term loan at 'CCC+'/'RR4'.

BlackBrush's ratings reflect its small scale, reduced operating momentum in 2021, working interest on its core Karnes county acreage and limited access to capital. After a material decline in production in 2021, resulting from sub maintenance capex investment, Fitch expects BlackBrush to regain this lost production during 2022, and be in a position to generate neutral to positive FCF under modest production growth investment through the latter half of Fitch's forecast.

Key Rating Drivers

Regaining Production Growth in 2022: With a material decline in production in 2021 to below 5Mboepd, Fitch expects BlackBrush to regain this lost production in 2022, and to generate approximately $15 million-$25 million FCF annually under a modest growth drilling program through the latter half of Fitch's forecast. While the loss of operational momentum in 2021 affected BlackBrush's production, BlackBrush's production scale would have to increase materially for it to decrease the company's relative vulnerability to operational or market shocks.

High, But Manageable Leverage: In September 2020, BlackBrush's out of court restructuring resulted in former lenders receiving a $75 million first lien term loan due in 2025 plus 2% PIK interest, as well as, preferred equity with $225 million plus 1% PIK interest with a mandatory redemption in 2026, and 70% of the company's common equity. Management and Ares retained the remaining 30% equity interest.

This restructuring extended the company's first maturity to 2025, and initially re-sized the first lien term loan to approximately 1.0x PDP reserves, which has since improved to well under 1.0x. Under Fitch's Hybrids Treatment and Notching Criteria, BlackBrush's preferred equity receives 0% equity credit, which results in Fitch forecast leverage at YE 2021 of 9x.

Refinancing Risk: BlackBrush benefits from a capital structure that does not include financial maintenance covenants, requires less than $5 million annually in cash interest payments to service due to the debts PIK features, and the current alignment of debt and equity holder interests with BlackBrush debt currently owned by pre-restructuring debt holders. Despite no near-term refinancing risk, Fitch would like to see the company to demonstrate access to capital, and position itself to refinance its term loan and preferred shares upon maturity to reduce medium-term refinancing risks.

Limited Financial Flexibility: BlackBrush does not operate with a revolving credit facility, which in the absence of access to other external funding sources, greatly reduces the company's financial flexibility. Fitch expects BlackBrush to continue to explore other sources of financing (e.g. forward PDP sales, Drill Co agreements, non-core divestitures, etc.) to provide capital to develop its Karnes county Eagle Ford play acreage, and to a lesser extent, accelerate the development of South Texas Syndicate (STS), as well as, Frio and La Salle assets. Further development of these assets would help de-risk the company's asset profile and grow the company's reserve base, which was a relatively small 55 million proved boe at YE 2020.

Asset Base Restricts Operational Flexibility: BlackBrush's asset base consists of approximately 255,000 gross acres in the Eagle Ford and Austin Chalk plays in Texas and Louisiana. BlackBrush core development acreage is located in Karnes (1,341 net acres), Frio/La Salle (26,430 net acres) counties, as well as the STS area of La Salle and McMullen counties (41,010 net acres).

BlackBrush's development program targets their Karnes county assets, where low working interest and primarily non-op positions limit management's discretion on development pacing. This is partially offset by increased operating activity at STS, driven by higher gas prices. BlackBrush's more prospective Chittim, East Texas, and Louisiana assets may offer the company some option value, but entail increased execution risk as these plays are largely undeveloped.

Unhedged Production: BlackBrush does not have any oil hedges in place after 2021, and its open gas hedges expire in 1Q22. Unhedged volumes in 2022 provide upside to strong oil and gas prices, but no certainty on future cash flows. BlackBrush's current hedge position, particularly given it doesn't have a revolving facility to draw down should a weaker oil and gas environment affect its ability to meet its operating capital needs, adds cash flow risk to its credit profile.

Derivation Summary

BlackBrush's production of approximately 5Mboepd (72% liquids) at 3Q21, is materially lower than Eagle Ford operating peers Ranger Oil Corp (B-/Stable) and SM Energy (B/Stable) at 38Mboepd (91% liquids) inclusive of the Lonestar acquisition that closed in October, and 155.8Mboepd (66% liquids) respectively. It is also materially smaller than 'B-'/Outlook Stable rated Great Western Petroleum, which operates in the more highly regulated state of Colorado.

BlackBrush's Fitch calculated unhedged cash netbacks of $24.0/boe at 3Q21 have improved materially through 2021 in line with the strong commodity pricing environment. This compares to $41.3/boe, $39.4/boe and $32.6/boe for peers Ranger Oil, SM Energy and Great Western, respectively. Each of these peers has greater financial flexibility than BlackBrush, with access to revolving credit facilities and demonstrated ability during 2021 to access public debt capital markets.

BlackBrush's leverage at approximately 9x at fiscal 2021 is materially higher than the peers above; however, leverage is expected to decrease towards approximately 4x in 2022 as production and EBITDA improve, which were affected by sub maintenance capital investments made in 2020 when the company prioritized liquidity preservation.

Key Assumptions

WTI prices of $68.00/bbl in 2021, $67.00/bbl in 2022, $57.00/bbl in 2023 and $50.00/bbl thereafter;

Henry Hub prices of $3.80/mcf in 2021, $3.25/mcf in 2022, $2.75/mcf in 2023 and $2.50/mcf thereafter;

Majority of capex allocated to Karnes county assets, production in 2022 increases toward 8Mboepd and grows at single digit percent annually through the remainder of Fitch's forecast period;

Increasing gross debt resulting from the PIK features of the company's first lien term loan and preferred stock (0% equity credit);

Working capital in 2021 benefits from certain large capex expenses being paid in 2022;

Liquids mix relatively stable through the forecast period.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Material improvement in ability to invest in, and de-risk, more prospective assets that reduces refinancing and liquidity risk;

Average production trending toward 20 Mboepd on a sustained basis;

Total Debt with Equity Credit / Operating EBITDA sustained below 3.0x.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Erosion of liquidity resulting in FFO Interest Coverage below 1.5x;

Continued below-maintenance investment that heightens refinancing and liquidity risk.

Best/Worst Case Rating Scenario

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

Liquidity and Debt Structure

Liquidity: BlackBrush does not have access to a revolving credit facility, and utilizes on cash on hand ($28 million 3Q21) as their primary source of liquidity. BlackBrush has also managed its liquidity by reducing capex investment, and correspondingly production, to preserve cash. The company has explored and sourced other financing means to support development, including a September 2021 agreement where the company agreed to drill three STS acreage wells, and sell some of its interest in select STS wells for $8 million. Fitch forecasts neutral to positive annual FCF in its base case, supporting modest internally funded production growth.

Debt Structure: BlackBrush's debt consists of an approximately $76.5 million, inclusive of accumulated PIK interest, first lien term loan due 2025 (L+500, 2% PIK) and a $227.5 million, inclusive of accumulated PIK interest, of preferred equity with a mandatory redemption in 2026 (1% PIK). The PIK interest features on both debt instruments reduce the company's total cash interest payment requirements to less than $5 million annually.

KEY RECOVERY RATING ASSUMPTIONS

The recovery analysis assumes BlackBrush would be liquidated in hypothetical bankruptcy rather than being reorganized as a going-concern. The liquidation assumption is informed by the low working interest in its core Karnes county acreage, as well as the more prospective nature of its non-core assets increasing the likelihood of its assets being sold off. Fitch has assumed that an administrative claim of 10% would be incurred in any reorganization.

Going-Concern (GC) Approach

The GC EBITDA estimate reflects Fitch's view of a sustainable, post-reorganization EBITDA level upon which we base the enterprise valuation, which reflects the decline from current pricing levels to stressed levels. Fitch believes that in a weakened commodity price environment, which BlackBrush's lack of 2022 and beyond oil and gas hedges exposes them to, could result in BlackBrush investing at sub maintenance capex levels resulting accelerating production declines after 2022.

An EV multiple of 3.0x EBITDA is applied to the GC EBITDA to calculate a post-reorganization enterprise value. The choice of this multiple considered the following factors:

The historical bankruptcy case study exit multiples for peer companies ranged from 2.8x-7.0x, with an average of 5.2x and a median of 5.4x;

The multiple reflects the BlackBrush's relatively low working interest in their core Karnes county position and difficulty developing its asset base considering the company's limited liquidity and the prospective nature of much of its non-core acreage.

Liquidation Approach

The liquidation estimate reflects Fitch's view of the value of balance sheet assets that can be realized in sale or liquidation processes conducted during a bankruptcy or insolvency proceeding and distributed to creditors.

Fitch considers valuations such as SEC PV-10 and M&A transactions for each basin including multiples for production per flowing barrel, proved reserves valuation, value per acre and value per drilling location.

The allocation of value in the liability waterfall results in a recovery rating of 'CCC+'/'RR4' for the senior secured term loan, in line with the company's IDR.

Issuer Profile

BlackBrush is a small (5Mboepd average in 2021, 71% liquids), privately-owned independent oil & gas exploration and production (E&P) company headquartered in San Antonio, TX that focuses on the development of approximately 255,000 gross acres in the Texas and central Louisiana Eagle Ford and Austin Chalk formations.

ESG CONSIDERATIONS

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

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