Fitch Ratings has assigned Kuwait Energy plc’s (Kuwait Energy, B-/Stable) USD250m 9.5% notes due 2019 a final senior unsecured ‘B-’ rating.
We rate the notes at the same level as Kuwait Energy’s Long-term foreign currency Issuer Default Rating (IDR) of ‘B-’ and cap their Recovery Rating at ‘RR4′ due to the company’s exposure to Egypt (B-/Stable).
Bondholders will benefit from guarantees provided by certain subsidiaries of Kuwait Energy (the initial guarantors) that together with the issuer represented 78.7% and 81.4% of Kuwait Energy’s consolidated EBITDAX and average daily working interest production, respectively, for the three months ended 31 March 2014. Kuwait Energy expects to use its best efforts to cause Kuwait Energy (Eastern Desert) Petroleum Services SAE (the post-closing guarantor) to issue a note guarantee within 120 days of the issue date. Together, the issuer, the initial guarantors and the post-closing guarantor represented 100% of Kuwait Energy’s consolidated EBITDAX and average daily working interest production, respectively, for the three months ended 31 March 2014.
Proceeds from the notes will be used to refinance existing debt and to fund capital projects.
Kuwait Energy’s ratings take into consideration its track record of producing hydrocarbons in difficult geographic areas in which it is present ie Egypt, Yemen, Oman, its experienced management, and its prudent attitude to debt funding, with financial metrics on a par with oil & gas companies rated in the ‘BB’ rating category. Constraints on the company’s ratings include its small size, limited reserves, operations mainly through quasi- production-sharing agreements (PSAs) with national oil companies, as well as its focus on a limited number of production areas, dominated by Egypt, and a significant ongoing gas development project in Iraq. The Stable Outlook reflects our expectation that Kuwait Energy will be able to maintain adequate liquidity and sustain and/or increase output over the medium term, despite operating in countries with high geopolitical and economic risks.
KEY RATING DRIVERS
Business Scale Determines Ratings
Kuwait Energy is a small company by production. Its 2Q14 oil production of 23.1 thousand barrels of oil per day (mbopd) on a working interest basis came from three countries: Egypt (71%), Yemen (18%), and Oman (11%). It is also developing a number of assets in Iraq, mainly in gas. Kuwait Energy’s total hydrocarbon production is close to that of similarly-rated peers in the ‘B’ category. We conservatively forecast that once its development projects, in particular in gas, are completed, Kuwait Energy’s production will remain under 30 thousand barrels of oil equivalent per day (mboepd), peaking at around 2016.
Move into Iraqi Gas
Most of Kuwait Energy’s 166MMboe 2P (proved and probable) reserves on the working interest basis at 31 May 2014 are located in Iraq (80%) and are predominantly made up of natural gas. To monetise these reserves, Kuwait Energy is currently developing gas assets in Iraq at the Siba field, which is scheduled to come on-stream in mid-2015. Siba is located in the south-east of Iraq, approximately 600km from the area currently under threat from the ISIS insurgency.
While the diversification of Kuwait Energy into gas is rating positive, the company is entering a market that is highly dependent on its ability to obtain timely and full payments from its gas off-takers. Currently, the company has a long-term take-or-pay gas supply agreement with the Iraqi government. However, as this is a new venture for the company with no track record of production or payments, we treat the Iraqi gas assets as a future factor that may help improve Kuwait Energy’s creditworthiness once the project is fully operational and becomes cash-generative.
Collection Risk in Egypt Remains
Historically, Kuwait Energy has had large receivables in Egypt. Egyptian General Petroleum Corporation (EGPC), a national oil company of Egypt, acts as a primary off-taker to Kuwait Energy with respect to its production entitlement under the PSAs there and is responsible for the service agreement payments. EGPC’s payments to Kuwait Energy have historically been made on an irregular basis, and typically several months in arrears, eg, on average, after 11.5 months in 2012, 6.5 months in 2013 and 6 months in 1H14. At 30 June 2014 the total receivables due to Kuwait Energy from EGPC were USD124.4m, up from USD116.7m at end-2013, of which USD76.1m were considered past due, but not impaired as at that date, down from USD89.5m at end-2013. At the date of the release, Kuwait Energy stated that EGPC receivables are down to USD98m. We believe that although the receivables crisis has been largely resolved, the collection risk in Egypt remains given the weak state of the sovereign’s finances.
Operating Performance to Drive Leverage
The issued notes will increase Kuwait Energy’s funds from operations (FFO) adjusted gross leverage by about 1x, but will leave considerable headroom for the rating until at least end-2017. Thereafter, the combination of a failure to renew licenses, delays in the launch of Block 9 in Iraq despite high capex, and/or inability to acquire new acreage or replace reserves could lead to a spike in leverage immediately before the notes become due in August 2019.
LIQUIDITY AND DEBT STRUCTURE
Liquidity to Improve in 2015
Post-placement, Kuwait Energy’s debt will consist of USD250m notes plus two convertible loans of USD100m in total due in 2018-2019. Starting from 2015, Kuwait Energy expects to reduce capex significantly, leading to strong free cash flow generation with the Siba project coming on stream in mid-2015.
We note that Kuwait Energy could draw (with the presence of co-investors) on an additional $50m from the convertible loans outstanding with Abraaj. However, this represents expensive financing for the company and hence we do not expect this facility to be used further. We also note that Kuwait Energy’s non-guarantor subsidiaries that currently have no debt are not precluded from raising secured borrowings in the future.
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
-Successful launch of the gas business in Iraq with a track record of full and timely payments of gas.
-Successful renewal of licenses in Egypt that are set to expire in 2016-2017.
-Maintaining strong liquidity and conservative financial profile given the company’s small scale, e.g., FFO-adjusted net leverage below 2x (end-2013 – 0.97x) on a sustained basis.
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
-Continued problems with cash collection in Egypt.
-Failure to launch the gas business on time and within budget and problems with cost recovery.
-FFO-adjusted net leverage above 3x on a sustained basis.
-A downgrade of Egypt, Kuwait Energy’s principal production location.
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