The majority of Canadian oil and gas income trusts would be rated in the ‘B’ and ‘BB’ rating categories if they were to be assigned credit ratings, according to a new report by Standard & Poor’s Ratings Services.

Despite the trusts being relatively underlevered compared with similar-sized corporate peers, the commentary, “Assessing Canadian Oil And Gas Income Trusts Reveals Speculative-Grade Credit Quality,” notes that leverage — specifically total debt to total capital — is not the defining factor used to determine credit ratings. Rather, Standard & Poor’s says it incorporates global and regional industry factors, in conjunction with myriad company-specific operational and financial factors, into its assessment of an oil and gas company’s credit profile.

“It’s important to understand that low leverage does not equal an investment-grade rating,” says credit analyst Michelle Dathorne. Standard & Poor’s says it places greater emphasis on cash flow protection measures, which compare fixed charges against operating cash flows, and upstream leverage metrics, which compare debt against a company’s net proven reserve base.

“The mature nature of the group’s asset base, the growth through acquisition strategy, and large cash payouts to investors are the factors that figure prominently in placing Canadian oil and gas income trusts in the speculative-grade space of the rating spectrum,” explains Dathorne.

To reach this rating conclusion, Standard & Poor’s assessed 27 pure upstream oil and gas income trusts, and compared them to the 37 ‘B’ and ‘BB’ rated upstream oil and gas companies in our North American upstream oil and gas ratings universe. The ratings agency reviewed the publicly provided information on the Canadian oil and gas income trusts using our established rating criteria for oil and gas companies.

In comparing the income trusts’ operating and financial performance against those of the speculative-grade rated companies, Standard & Poor’s looked at reserves, reserve replacement statistics, reserve life indexes, finding and development costs, and recycle ratios when assessing business risk, as well as EBIT-to-interest, debt-to-EBITDA, and FFO to total debt for its financial risk assessment. Furthermore, the financial metrics for the Standard & Poor’s rated companies used in this analysis were calculated on an unadjusted basis.