Fitch Rates Pacific Rubiales' USD400MM Proposed Issuance 'BB-'; Outlook Stable

Fitch Ratings has assigned foreign and local currency Issuer Default Ratings (IDRs) of 'BB-' to Pacific Rubiales Energy Corp., as well as a 'BB-' long-term rating to the company's proposed USD400 million of senior unsecured notes issuance due 2016. The Rating Outlook is Stable.

The ratings are supported by the company's leadership position as the largest independent oil and gas player in Colombia and strong management with recognized expertise in heavy oil exploration and production. The ratings also reflect its strong liquidity and adequate leverage, which is tempered by the company's small scale of production and reserve profile as well as its concentration in the Rubiales-Piriri and La Creciente fields.

Solid Financial Profile:

The ratings also reflect the company's adequate financial profile characterized by relatively low leverage and strong interest and debt service coverage. As of the last 12 months (LTM) ended June 30, 2009, the company reported leverage ratios, as measured by total debt (including the unsecured subordinated convertibles of USD220 million) to EBITDA and total debt-to-total proved reserves of 1.5 times (x) and USD2 per barrels of oil equivalent (boe), respectively. Total debt to Proved Developed Producing (PDP) reserves, although high at approximately USD4.6/boe as of June 30, 2009, is considered adequate for the rating category. On a pro forma basis after the proposed issuance, leverage as measured by total debt to EBITDA is expected to increase to above 2.0x and decline over time as the company increases production and improves margins with the Oleoducto de los Llanos (ODL) pipeline capacity expansion. As of June 30, 2009, debt of approximately USD415 million was primarily composed of USD209 million unsecured subordinated convertibles notes due in 2013 and approximately USD180 million drawn off of a USD250 million syndicated credit facility. The later is expected to be prepaid with the proceeds of the proposed debt issuance. As of the LTM ended June 30, 2009, Pacific Rubiales reported an EBITDA, as measured by operating income plus depreciation and stock-based compensation, of USD272 million.

Improving Operating Metrics:

Pacific Rubiales operating metrics have been improving rapidly and the company's growth strategy is considered somewhat aggressive, which will require significant funding. The company reserve replacement ratio was 300+% in 2008 and its current reserve life index is approximately 16.4 years using June 2009 production levels, net of royalties of 29 thousand boe per day. During the past two years, the company quadrupled Rubiales-Piriri gross production, its main field where the company has 45% participation, from approximately 20,000 barrels per day (bbl/d) to approximately 90,000 bbl/d nowadays. This rapid increase has resulted in a significant demand for funds, which has been met for the most part with internal cash flow generation. As of December 2008, Pacific Rubiales' proved (1P), proved and probable and proved developed producing (PDP) reserves, net of royalties, amount to approximately 173 million, 209 and 81 million boe, respectively. The company's reserves are composed of heavy crude oil (64%) and natural gas (32%), with the balance being light and medium oil (4%). As of June 30, 2009, Pacific Rubiales had almost three million acres of exploration base in Colombia, which will require significant funds to develop. In the short term, the company plans to devote its efforts developing the Quifa block, which surrounds the Rubiales-Piriri block.

The completion of ODL pipeline is viewed as positive for the company as it significantly lowered transportation costs and eliminated transportation bottlenecks that limited Rubiales-Piriri production field. ODL was built as a project finance special purpose vehicle (SPV) in association with Ecopetrol (IDR 'BB+' by Fitch). Once fully functional, ODL's pipeline will increase transportation capacity from approximately 50,000 bbl/d using trucks to 170,000 bbl/d reducing transportation cost by USD5 per barrel. Currently the pipeline is operating with provisional pumps, limiting transportation capacity to approximately 60,000 bbl/d. Furthermore, Pacific Rubiales benefits from Ecopetrol's minority interest participation in some of the company's most important assets such as Rubiales-Piriri, Quifa and ODL. This is relevant as Ecopetrol has been contributing its proportional share of capital expenditure in the company's different investments.

Small and Concentrated Production Profile:

Pacific Rubiales ratings reflect the company's production concentration and relatively small reserve base and production. Although Pacific Rubiales currently has interest in eight productive blocks and exploration agreements in another 23 blocks, today's net production of approximately 36 thousand boe production is concentrated in two fields, Rubiales-Piriri and La Creciente. Rubiales-Piriri, which produces heavy crude oil and has a concession that expires in 2016, accounts for 85% of current production. La Creciente, which produces natural gas, accounts for 15% of current production. This limited diversification exposes the company to operational as well as economical risks associated with small scale heavy oil production. In the future, diversification away from Rubiales-Piriri geographic location would be positive for the company's credit quality.

Negative Free Cash Flow Due to Large Capex:

Free cash flow (cash flow from operations less capital expenditures) has and is expected to be negative in the short term given the company's growing stage. For the LTM ended June 30, 2009, free cash flow was negative USD128 million mainly due to the significant capital expenditure of USD374 million during the same period. Pacific Rubiales' significant capital expenditures plans over the next few years will likely result in negative free cash flow in the near term. Increasing production at the Rubiales-Piriri and reserves in the surrounding Quifa block are expected to account for the bulk of the company's capital expenditure, which is expected to be approximately USD1.9+ billion over the next four years.

Strong Liquidity Position:

The company's current liquidity position is considered strong, characterized by robust cash on hand, strong cash flow generation and manageable short-term debt obligations. As of the LTM ended June 30, 2009, Pacific Rubiales funds from operations (FFO) generation was USD205 million and its cash on hand was USD139 million, while its short-term debt amounted to only USD35 million. Going forward, the company is expected to have a manageable debt amortization, although its liquidity position will be somewhat weaker due to its aggressive capital expenditure plant that will demand significant financial resources, which are expected to be funded with a combination of internal cash flow generation, debt and equity.

Stable Outlook:

Factors that could result in a positive rating action include an increased diversification or the production profile of the company, consistent growth in both production and reserves, positive free cash flow generation and/or the extension of the Rubiales-Piriri concession which expires in 2016. Factors that could result in a negative rating action include sustained adjusted leverage above 3x and/or production and reserve declines.

Additional information is available at www.fitchratings.com.

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