Fitch Ratings has affirmed Civitas Resources, Inc.'s (Civitas) Long-Term Issuer Default Rating at 'BB-', its Reserve Based Loan credit facility at 'BB+'/'RR1' and it senior unsecured notes at 'BB-'/'RR4'.

The Rating Outlook has been revised to Positive from Stable.

The Positive Outlook reflects Civitas' improved post dividend FCF profile, the scale of its operations, the expectation Civitas will remain one of the lowest levered exploration and production (E&P) companies supported by a relatively low amount of debt in its capital structure, as well as Fitch's improved comfort that Civitas will be able to navigate Colorado's regulatory process such that it won't unduly affect to is operations.

Key Rating Drivers

Low Debt and Low Leverage: Fitch forecasts Civitas to have midcycle total debt with equity credit-to-operating EBITDA leverage of approximately 0.2x during its forecast. This is exceptionally low, particularly for a non-investment-grade rating and translates to a debt to flowing barrel of below $2,500/barrel (bbl). With Civitas formation occurring in 4Q21 and having multiple leadership team changes since then, it has not yet developed a track record of maintaining a conservative policy, but the company targets and has maintained a notably low 0.5x leverage level since its formation. Civitas' leverage is supported by a low absolute debt level, currently $400 million, consisting of a single issue maturing in 2026.

DJ Basin Consolidator: Since forming with the staged consolidation through 2021 of Bonanza Creek, HighPoint Resources, Extraction Oil and Gas and Crestone Peak Resources to create the largest pure-play Denver-Julesburg (DJ) Basin producer, Civitas has continued to consolidate the DJ Basin by acquiring Bison Oil and Gas in 1Q22. The resulting 2Q22 production of 175 thousand barrels of oil equivalent per day (mboepd) is currently the highest production scale within Fitch's North American 'BB-' rating category E&P peers.

Fitch expects Civitas to continue to act as a consolidator in the DJ Basin when accretive acquisition opportunities become available and expects non-DJ Basin acquisitions to be unlikely. Civitas' single-basin focus increases its risk to basin-specific factors, including Colorado's relatively more rigorous permitting environment and risk of community opposition.

Near Two Years of Permits in Hand: At 2Q22 Citivas had nearly all of its 2022 development plan permitted and approximately 20% of 2023 fully approved. Civitas' permitting status consists approximately 575 wells in various stages of process on top of 270 locations that were approved prior to 2022, the latter of which at Civitas current drilling pace would provide almost two years to maintain production.

Civitas balances its three-rig program with drilling rig allocations between its Southern position (e.g. Adams county, Arapahoe county) where it has large blocky inventory positions that are oilier and more rural, its rural Eastern position (e.g. eastern Weld county and acquired Bison Oil & Gas acreage) and its Western position (e.g. Broomfield county, Boulder, western portion of Weld county) which is more developed, but is more likely to experience permitting challenges.

FCF Prioritized Over Drill Bit Growth: Civitas aims to keep organic production flat to benefit FCF generation. 50% of its FCF, gross of working capital changes, is distributed to shareholders through a variable dividend on top of a quarterly fixed dividend that currently costs $39 million per quarter to maintain.

Under Fitch's base case, Civitas is forecast to generate post fixed and variable dividend distribution FCF of approximately $700 million annually in both 2022 and 2023, which would provide Civitas with funding for potential cash supported M&A, development activities or further shareholder activities. Civitas FCF is underpinned by its scale and a high liquid cut of 70% in 2Q22 (46% oil, 24% natural gas liquids [NGLs], 30% gas) that supported a quarterly unhedged cash netback of $56.2/bbl.

Hedging: At 2Q22 Civitas had approximately 27% and 2% of its respective expected 2022 and 2023 oil production hedged, as well as approximately 48% and 15% of its respective expected 2022 and 2023 natural gas production hedged. Civitas hedging percentages, although reduced from the levels at its 2021 formation, provide support to cash flow visibility to support its annual total capex requirements at maintenance levels of approximately $1 billion.

Colorado Regulatory Risk: Fitch continues to assess regulatory risk within Colorado as high relative to other hydrocarbon-producing states. However, Fitch believes since the beginning of 2021 the risk has lessened following the overhaul of state laws that changed the Colorado Oil & Gas Conservation Commission's (COGCC) mission from fostering the development of oil and gas resources to regulating their development. The current rules, which established a single-permit process rather than the previous multistep process, have provided a tough but navigable framework that producers are learning to operate within.

Fitch anticipates knowledge gained from permit applications and continued collaboration with the COGCC and communities will help the permitting process become more efficient over time. Civitas' ESG investments to achieve a Scope 1 and Scope 2 carbon neutral position through a combination of operational improvements and emission offset credits also support its ability to continue to permit development plans.

Derivation Summary

Civitas is the largest producer within Fitch's 'BB-' rating category with 2Q22 production of 175mboepd. This compares to Permian Resources Corporation's expected approximately 145mboepd in 4Q22, SM Energy's 2Q22 production of 147mboepd and Vermilion Energy 85mboepd. Above the 'BB-' rating category, Civitas' production is roughly in line with 'BB+' rated Murphy Oil's 173mboepd, materially trails 'BB' rated Chesapeake Energy at 688mboped and 'BB+' Occidental Petroleum at 1,150mboped.

Compared to the aforementioned peers, Civitas' unit economics compare relatively well. With a 2Q22 unhedged cash netback $56.2/bbl. Civitas, as non-Permian E&P, compares relatively well against typically strong performing Permian peers such as SM Energy at $57.8/bbl due to its low-cost structure and oil percentage (46% in 2Q22). Compared to smaller sized 'BB-' peer Vermilion Energy, who is currently benefiting from exposure to European prices with a realized gas price of approximately $13/mcf in the quarter, Civitas unhedged cash netback trails its approximately 64.7/bbl netback.

In addition to currently being the largest E&P in terms of production scale within Fitch's North American E&P portfolio at the 'BB-' category, Civitas, has the lowest absolute debt level at $400 million, which supports forecast gross leverage of approximately 0.2x in 2022. Civitas' gross leverage, expected to be below 0.5x through Fitch's forecast, is notably low compared with peers. The company's concentration in the DJ Basin and its associated regulatory and capital market risks temper the impact of Civitas' low leverage on its rating.

Key Assumptions

WTI of $95/bbl in 2022, $81/bbl in 2023, $62/bbl in 2024 and $50/bbl thereafter;

Henry Hub of $7/mcf in 2022, $5/mcf in 2023, $4/mcf in 2024 and $3/mcf thereafter;

No organic production growth, assumed cash funded DJ basin bolt-on acquisition in 2023 and 2024

Midstream operations in line with historical results;

Total capex of approximately $1 billion annually during forecast period;

Base dividend portion of dividend increases during the forecast period;

Assume no unmet firm capacity commitments after 2022;

No share repurchases during the forecast period.

RATING SENSITIVITIES

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

Further developing a permitting track record within the state regulatory regime without unreasonable delays;

Proven economic access to debt capital markets that moderates potential future liquidity and refinance risks;

Increased scale in areas within the DJ Basin or out of basin diversification that helps mitigate overall regulatory and community opposition event risks;

Midcycle total debt with equity credit maintained at or below 1.5x.

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

Midcycle total debt with equity credit/operating EBITDA sustained over 2.0x;

A regulatory change that affects unit economics or visibility on future operations;

Sustained negative post-dividend FCF stressing liquidity or underinvestment in asset base.

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

Simple Capital Structure: Civitas has a simple capital structure with no short-term refinancing risk. At 2Q22 its liquidity position consisted of a reserve-based loan credit facility with a $1 billion elected commitment that is fully available outside of $12.4 million letters of credit used, as well as $439 million of cash on its balance sheet. The approximately $1.4 billion in liquidity sources is expected to be supported by positive post dividend FCF through Fitch's forecast.

Civitas' only debts are its revolving facility maturing in 2025 and its $400 million senior unsecured debt issuance that matures in 2026.

Issuer Profile

Civitas Resources, Inc. is an oil and gas producer focused on developing and producing crude oil, natural gas and NGLs in Colorado's Denver-Julesburg Basin.

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

Civitas Resources, Inc. has an ESG Relevance Score of '4' for Exposure to Social Impacts due to the oil and gas sector regulatory environment in Colorado 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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