Fitch Downgrades Talisman's Long-Term IDR to 'BBB-' & Short-Term IDR to 'F3'; Outlook Stable

Fitch Ratings has downgraded Talisman Energy Inc.'s (Talisman; NYSE: TLM) Long-term Issuer Default Rating (IDR) and senior unsecured ratings to 'BBB-' from 'BBB'. Fitch also downgrades the company's Short-term IDR and commercial paper program to 'F3' from 'F2'. The Rating Outlook has been revised to Stable from Negative.

The downgrade primarily reflects the company's forecasted continued negative free cash flow (FCF) profile and heightened reliance on asset sales to alleviate pressure on leverage metrics.

Approximately $4.7 billion of debt is affected by today's rating action. A full list of rating actions follows at the end of this release.

KEY RATING DRIVERS

Talisman's ratings consider the company's size, expected achievement of core asset FCF neutrality by 2016, adequate liquidity position, and manageable maturities profile. These considerations are offset by the company's lower production and reserve profiles, relatively high finding, development & acquisition (FD&A) costs, increased exposure to natural gas, remaining non-core asset sale obstacles and extended development horizon, and possibility for higher leverage metrics without the execution of targeted asset sales.

The company reported net proved reserves of 891 million barrels of oil equivalent (mmboe) at year-end 2013 and net production of 291 thousand boe per day (mboepd), including consolidated subsidiaries and joint ventures, as of June 30, 2014. This results in a reserve life of about 8.5 years. The Fitch-calculated one- and three-year average organic reserve replacement rates are 115% and 67%, respectively. Total production and reserves are down nearly 20% and over 25%, respectively, since 2009 mainly due to asset sales. The natural gas production mix has grown to roughly 65% in 2013 (North American natural gas represented 45% of total production) from about 50% in 2009, which has contributed to lower product diversification. Management's focus on liquids production (core liquids growth of 25% since the first quarter 2013) should help improve product mix medium-term.

ASSET PROFILE CONTINUES TO EVOLVE

Management continues to divest/dilute non-core positions in an effort to focus on its core North American and South East Asian plays and improve capital efficiency, as well as close funding gaps. These core assets tend to have favorable liquids characteristics, exposure to premium pricing, location advantages, and/or beneficial cost structures. Talisman has illustrated its ability to execute asset sales by exiting seven non-core positions and completing $6.6 billion in dispositions, including carries, since 2011. However, Fitch believes the company's remaining non-core assets may prove to be challenging to divest/dilute, particularly its North Sea positions. Management has targeted non-core asset sales of approximately $2 billion over the next 12 - 18 months.

LEVERAGE PROFILE LINKED TO ASSET SALES

Talisman's 2013 leverage metrics increased year-over-year due to an over $800 million increase in borrowings to fund capital expenditures, while the production volume and liquids mix declined. The company ended 2013 with debt/EBITDA of 2.0x, which was anticipated by Fitch and marginally better than expectations. Further, Fitch-calculated year-end debt/proved (1p) reserves and debt per flowing barrel metrics, including equity affiliates, were approximately $6/boe and nearly $18,400, respectively. LTM debt/EBITDA improved to 1.6x supported by higher North American natural gas prices and the repayment of the company's outstanding revolver and a portion of its commercial paper (CP) balance funded mainly with asset sale proceeds. Management expects the company's core assets to achieve a production and cash flow CAGR of 5% and 10%, respectively, through 2018 and FCF neutrality by 2016, but Fitch recognizes that in non-core segments, particularly North Sea, negative FCF concerns remain.

Fitch's base case forecasts Talisman will be about $1.3 billion FCF negative, including equity affiliates and dividends, in both 2014 and 2015, using Fitch's oil & gas price deck. Fitch's base case assumes the shortfalls in 2014 and 2015 will be primarily funded with $1.4 billion in completed and $2 billion in targeted asset sales. This results in debt/EBITDA of 1.7x and 1.6x in 2014 and 2015, respectively. Debt/1p reserves and debt per flowing barrel metrics, including equity affiliates, are forecast to improve to approximately $4.70/boe and $14,300, respectively, by 2015. This, however, is dependent on the company's ability to achieve the targeted $2 billion in non-core assets, while not materially reducing cash flows, 1p reserves, and production. Fitch forecasts upward pressure on leverage metrics in 2016.

Fitch expects Talisman's leverage profile to remain closely linked to asset sales and believes that an inability to execute at targeted levels and under favorable terms could pressure the rating. Fitch estimates that, subject to market prices and asset profile, base case 2015 debt/EBITDA, debt/1p reserves, and debt per flowing metrics could increase approximately 0.2x, $0.55/boe, and $1,600, respectively, for each incremental $500 million in asset sale shortfalls.

The company utilizes a combination of swaps and two-way collars to manage cash flows and support development funding. As of June 30, 2014, the company had entered into derivatives contracts through 2016.

ADEQUATE LIQUIDITY POSITION

Talisman had unrestricted cash and equivalents of $356 million as of June 30, 2014. Restricted cash, representing the company's share of funds held in escrow to satisfy Yme removal obligations, totaled $186 million ($125 million short-term) as of June 30, 2014. Additional cash and equivalents of $223 million, as of June 30, 2014, are held by the company's joint ventures.

Supplemental liquidity is provided by the company's $3.0 billion and $200 million senior unsecured credit facilities due March 2019 and October 2018, respectively. The company's $3.0 billion credit facility includes a $1 billion sublimit for the issuance of letters of credit. Further, the company maintains a $1.0 billion CP program. Available borrowing capacity under the credit facilities was nearly $2.9 billion, as of June 30, 2014, due to $315 million of CP outstanding.

MANAGEABLE MATURITIES PROFILE

Maturities equal to $375 million, UK250 million (about $410 million), and $700 million in 2015, 2017, and 2019, respectively, are due over the next five years. These represent the company's 5.125% senior notes due May 2015, 6.625% senior notes due December 2017, and 7.75% senior notes due June 2019. This excludes $315 million in CP borrowings and $6 million ($46 million total) in Tangguh LNG project financing payments as of June 30, 2014.

Talisman, as defined in its $3.0 billion bank credit facility agreement, is subject to a quarterly consolidated debt-to-cash flow ratio of less than 3.5x on a trailing twelve-month basis (1.9x as of June 30, 2014). Other covenants consist of lien limitations and transaction restrictions.

OTHER LIABILITIES

Talisman's defined benefit pension plan was about $101 million underfunded at year-end 2013, or an over 55% funded status. Fitch believes that the expected size of service costs and contributions are manageable relative to fund flows from operations at less than 5%. Other contingent obligations totaled $3.3 billion, exclusive of the divested Montney and other non-core western Canada assets, on a multi-year, undiscounted basis as of proforma Dec. 31, 2013. Obligations are primarily comprised of transportation and processing commitments ($1.8 billion), office and vessel leases ($580 million), and other service contracts ($879 million). Additionally, the company's share of Yme field settling costs and liabilities were $223 million, as of June 30, 2014, which is cash collateralized. The entire Yme field obligation is expected to be satisfied by 2016.

Talisman's asset retirement obligations (AROs) were $1.9 billion, as of June 30, 2014, which is up from the $1.8 billion reported at year-end 2013 mainly due to a change in discount rate. The company expects to pay $43 million in AROs over the next 12 months. Fitch notes that about half of the reported AROs ($3.2 billion undiscounted as of Dec. 31, 2013) are associated with the North Sea. Fitch recognizes that North Sea rationalization risk exists given the challenging sale environment and production profile of Talisman's positions. This could accelerate decommissioning costs and materially impact cash flows. Fitch views the acceleration of decommissioning costs as an event risk, since the current intention is to redevelop and divest these assets.

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to a positive rating action include:

--Rationalization of the company's reserve base that leads to a portfolio with favorable netbacks retaining size, scale, and diversification;

--Achievement of a mid-cycle debt/EBITDA at or below 1.5x on a sustained basis;

--Realization of debt/1p reserves below $5.00/boe and/or debt/flowing barrel under $15,000.

Fitch believes the company's evolving asset profile, North Sea challenges, limited near-term growth prospects, and forecasted negative FCF are credit overhangs. Talisman still faces several obstacles as it continues divesting non-core assets in order to streamline its portfolio and meet near-term funding requirements, which Fitch believes lessens the probability of positive rating actions over the near term.

Negative: Future developments that may, individually or collectively, lead to a negative rating action include:

--Mid-cycle debt/EBITDA of above 2.0x on a sustained basis;

--Debt/1p reserves of over $6.00/boe and/or debt/flowing barrel approaching $20,000;

--An inability to divest $1.5-$2.0 billion in non-core assets that requires the use of debt to close funding gaps;

--A sustained weak crude and natural gas pricing environment without a corresponding reduction in capex;

--Increased dividend payments or commencement of share repurchases inconsistent with the expected cash flow profile.

Fitch does not anticipate a negative rating action in the near term, but recognizes that the company's financial flexibility is limited. Further rating actions will be closely linked to the management's ability to balance and execute its operational, divestiture/dilution, and financial targets.

Fitch has downgraded Talisman's ratings as follows:

--Long-term IDR to 'BBB-' from 'BBB';

--Senior unsecured notes to 'BBB-' from 'BBB';

--Senior unsecured bank facilities to 'BBB-' from 'BBB';

--Cumulative perpetual preferred stock to 'BB' from 'BB+';

--Short-term IDR to 'F3' from 'F2';

--Commercial paper program to 'F3' from 'F2'.

The Rating Outlook has been revised to Stable from Negative.

Additional information is available at 'www.fitchratings.com'.

Applicable Criteria and Relevant Research:

--'Corporate Rating Methodology Including Short-Term Ratings and Parent and Subsidiary Linkage' (May 28, 2014);

--'Updating Fitch's Oil and Natural Gas Price Deck' (Aug. 8, 2014);

--'Full Cycle Costs for North American E&P (Production Costs Moderate in 2013)' (July 30, 2014);

--'North American Energy Outlook and LNG' (July 16, 2014);

--'North American Exploration and Production Handbook' (July 16, 2014);

--'Global Impact of US Shale Oil - Rising Production Tempers World Prices' (Feb. 10, 2014);

--'Cash Flow Trends in the U.S. Energy Sector-Shareholder Activism Having an Impact' (Feb. 4, 2014);

--'Scenario Analysis: Lifting the U.S. Crude Export Ban' (Jan. 27, 2014).

Applicable Criteria and Related Research:

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749393

Fitch Raises Crude Oil & U.S. Natural Gas Price Deck

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=201134

Updating Fitch￢ﾀﾙs Oil and Gas Price Deck

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=714596

Full Cycle Costs for North America E&P (Production Costs Moderate in 2013)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=753198

North American Energy Outlook and LNG

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=751784

North American Exploration and Production Handbook

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=749557

Global Impact of U.S. Shale Oil (Rising Production Tempers World Prices)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=735415

Cash Flow Trends in the U.S. Energy Sector (Shareholder Activism Having an Impact)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=733556

Scenario Analysis: Lifting the Crude Export Ban (Overall Credit Impact Limited but Varies by Industry)

http://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=732055

Additional Disclosure

Solicitation Status

http://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=883434

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