Fitch Ratings has assigned a 'B+' First-Time Long-Term Issuer Default Rating (IDR) to California Resources Corporation (CRC).

Fitch has also assigned a 'BB+'/'RR1' rating to the company's secured reserve-based lending credit facility (RBL) and a 'BB-'/'RR3' rating to the company's senior unsecured notes. The Rating Outlook is Stable.

CRC's ratings reflect its large, low-decline asset base with exposure to Brent pricing, conservative capital structure, forecast sub-1.5x leverage, expectations of positive FCF through the rating horizon, strong liquidity and proactive hedging program that limits downside risks. These factors are partially offset by the company's high cost structure, which limits economic drilling prospects and exposure to California's stringent regulatory environment that could disrupt permitting, drilling and financing options in the medium and long term.

Key Rating Drivers

Large, Low Decline Asset Base: CRC operates exclusively in California and is the largest producer in the state with 1Q23 production averaging 89 thousand barrels of oil equivalent per day (Mboe/d) (62% oil). The company controls approximately 1.9 million net mineral acres with net revenue interest of approximately 85%, operates integrated midstream assets which include 543 million cubic feet per day (MMcf/d) of gas processing capacity and manages 643 megawatts (MW) of electricity generation capacity. CRC's wells have low-teen decline rates, which allow for reduced drilling expenditures during periods of low oil prices and enhanced liquidity without severely affecting production.

Modest Near-Term Production Declines: Management's $200 million-$245 million capital plan for 2023 includes reducing its total rig count to 1.5 rigs and increasing maintenance and workover activity to de-risk uncertainty around Kern County litigation and permitting. The program targets development of the highest return projects with permits in hand, particularly in the Wilmington field, and management of the expected 5%-7% total production declines in 2023.

Fitch expects the company could return back to a three-rig program by mid-2024 and believes it also has the ability to secure individual field-level permits, although the process can be slower and more burdensome. Fitch believes the company's large, multi-play asset base does provide capital and operational optionality to navigate regulatory disruptions.

Strong Correlation to Brent: Demand for oil is strong in California, but with minimal pipeline capacity from the east, the state is dependent on imports, which allows CRC to benefit from Brent-type pricing, which is typically higher than WTI. Fitch's current price deck assumes Brent at $85.00/bbl and WTI at $80.00/bbl in 2023, but the higher Brent pricing is partially offset by CRC's higher operating costs compared with peers.

High Cost, Low Netback Producer: CRC's cost structure is higher than most Fitch-rated U.S. onshore E&P peers. Fitch-calculated 2022 total cash operating costs (which includes operating costs, transportation expenses, G&A and production taxes) of $36.0 per barrel of oil equivalent (boe) remain at the higher-end of Fitch's aggregate E&P peer group and lead to lower unhedged cash netbacks.

Near-Term Hedging Protection: Fitch believes CRC is likely to reduce its hedge coverage in the medium-term given its low leverage metrics and continued FCF generation. The company is currently hedging approximately 65% of its 2023 oil production with a total weighted average effective price of approximately $73 WTI and has no natural gas hedges in place. CRC switched to leverage-based hedging requirements with its April 2022 amendment to its credit facility, which requires minimum hedging of 50% to 0% with leverage above 2.0x or below 1.5x, respectively.

Fitch believes the company will still hedge its future production, albeit at lower levels, given forecast sub-1.5x leverage metrics, which could leave the company susceptible to weakened commodity prices.

Positive FCF; Sub-1.5x Leverage: Fitch forecasts positive post-dividend FCF generation of approximately $450 million in 2023 and $125 million in 2024, at Fitch's base case prices of $80/bbl and $70/bbl, respectively. CRC will reduce annual upstream capex spend to approximately $200 million in 2023 as it drops to 1.5 rigs, but should increase back toward three rigs in 2024 and thereafter after permitting is secured.

Fitch-calculated gross debt/EBITDA is forecast to remain below 1.0x in 2023 and 1.5x through the remainder of the forecast given the company's conservative capital structure. Fitch does not expect incremental draws on the RBL and believes FCF will be allocated towards the company's Carbon Management (CM) initiatives, shareholders via dividends and incremental share repurchases.

Carbon Management Initiatives: CRC continues to advance its Carbon Management businesses, driving management's goal of reliable, safe and ESG-driven operations. The company's strategic JV with Brookfield Renewable helps advance CRC's energy transition strategy, substantially de-risks its CM funding needs and should help reach the JV's goals of first CO2 injection by the end of 2025 and five million metric tons of CO2 storage per annum (200 million metric tons of total CO2 storage capacity) by the end of 2027.

Fitch views the JV favorably given its focus on reducing carbon emissions, Brookfield's significant expertise and investment with CM projects, and the potential cash flow streams and tax credits the segment could provide in the medium and long term. Fitch's base case scenario includes the company's expected capital investments, but does not include any revenues from CRC's CM businesses given the uncertainty around timing and magnitude of cash flows along with the potential for separation of the E&P and CM businesses.

California Regulatory Considerations: California has adopted some of the most restrictive regulations on in-state produced energy as the state shifts toward cleaner, more renewable forms of energy. The state has established limits on greenhouse gas (GHG) emissions, which decline annually to a target of at least 40% below the 1990 level by 2030. This is in addition to the established policy toward becoming carbon neutral by 2045. While there is a need to drill in California to meet the excess demand for oil and gasoline in the state, Fitch cautions that regulatory and legislative actions in the state could disrupt drilling, permitting and financing options for the company.

Derivation Summary

CRC is a mid-sized operator with 1Q23 average daily production of 89 Mboepd (62% oil). The company is of similar size to Canadian producer MEG Energy Corp. (B+/Stable; 95.3 Mboepd in 2022), larger than Earthstone Energy, Inc. (B+/Stable; 78.2Mboepd in 2022) and Canadian operator Baytex Energy Corp. (B+/Positive; 83.5 Mboepd in 2022), but smaller than Permian operators Matador Resources Company (BB-/Stable; pro forma production profile will approach 140-145Mboepd by YE23) and SM Energy Company (BB-/Stable; 145.1 Mboepd in 2022). CRC's capital structure is lean with only $600 million of gross debt outstanding leading to peer-leading mid-cycle leverage metrics of sub-1.0x.

CRC's realized prices are typically higher than peers given the exposure to premium Brent pricing and the low-decline asset base leads to lower capital intensity versus peers. This is partially offset by the company's high cost structure which results in lower Fitch-calculated unhedged cash netbacks compared to Fitch's aggregate peer average.

Key Assumptions

Fitch's Key Assumptions Within the Rating Case for the Issuer

Brent oil prices of $85/bbl in 2023, $75/bbl in 2024, $65/bbl in 2025 and $53/bbl thereafter;

Henry Hub prices of $3.50/mcf in 2023, $3.50/mcf in 2024, $3.00/mcf in 2025 and $2.75/mcf thereafter;

Average production of 88 Mboepd in 2023, followed by relatively flat growth thereafter;

Upstream Capex of $225 million in 2023 with growth-linked spending thereafter;

Measured increases to shareholder returns;

No material M&A activity.

RATING SENSITIVITIES

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

Diversification through meaningful EBITDA generation from Carbon Management or other non-E&P business lines;

E&P diversification outside of California that leads to total production approaching 150 Mboepd;

FCF generation that supports the liquidity profile and limited borrowings under the RBL;

Commitment to conservative financial policy resulting in mid-cycle EBITDA leverage sustained below 1.5x.

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

Unfavorable regulatory actions that reduce permitting availability and/or drilling prospects leading to production sustained below 75 Mboepd;

Deteriorating liquidity profile, including material revolver borrowings and inability to generate positive FCF;

Mid-cycle EBITDA leverage sustained above 2.0x.

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

Strong Liquidity: As of March 31, 2023, CRC had $477 million of cash on its balance sheet and $454 million of borrowing capacity under the $602 million RBL, net of approximately $148 million of outstanding letters of credit. The RBL is subject to a semi-annual borrowing base redetermination in addition to financial covenants including a maximum total net leverage ratio of below 3.0x and a minimum current ratio of at least 1.0x. Fitch believes CRC's forecast FCF generation supports the liquidity profile and does not expect incremental RBL borrowings throughout the base case.

Clear Maturity Profile: CRC's maturity schedule remains light with no maturities until the senior unsecured notes and recently amended and restated RBL come due in 2026 and 2027, respectively.

RECOVERY ANALYSIS

KEY RECOVERY RATING ASSUMPTIONS

The recovery analysis assumes that CRC would be reorganized as a going-concern in bankruptcy rather than liquidated;

Fitch has assumed a 10% administrative claim.

Going-Concern (GC) Approach

Fitch's projections under a stressed case price desk, which assumes Brent oil prices of $70 in 2023, $45 in 2024, $35 in 2025, $45 in 2026 and $48 in the long-term.

The GC EBITDA assumption reflects Fitch's view of a sustainable, post-reorganization EBITDA level, upon which the agency bases the enterprise valuation, which reflects the decline from current pricing levels to stressed levels and then a partial recovery coming out of a troughed pricing environment. Fitch believes a weakened pricing environment would lead to production declines and materially erode the liquidity profile.

An EV multiple of 3.25x 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 5.2 and a median of 5.4x;

The multiple reflects the expectation that the value of CRC's oil producing properties will decline given the company's high cost structure and reduction in capex to preserve liquidity. The multiple considers the stringent California regulatory environment and highly concentrated market, which severely limits the number of potential buyers and valuation for the assets. The multiple also incorporates the company's highly valued and sought-after Huntington Beach acreage, which Fitch believes the company would be able to sell for considerable value in a distressed scenario.

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.

The RBL is assumed to be fully drawn upon default. The allocation of value in the liability waterfall results in recovery corresponding to 'RR1' recovery for the first-lien RBL credit facility and a recovery corresponding to 'RR3' for the senior unsecured notes.

Issuer Profile

California Resources Corporation is an integrated public E&P company that operates solely in California. The company is the largest producer in California, has a large asset position covering 1.9 million net mineral acres, 543 million MMcf/d processing capacity and 643 MW of electricity generation capacity.

Date of Relevant Committee

06 April 2023

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

CRC has an ESG Relevance Score of '4' for Exposure to Social Impacts due to the oil and gas sector regulatory environment in California and its exposure to social resistance, which has a negative impact on the credit profile, and is relevant to the rating in conjunction with other factors.

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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