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Fitch Upgrades Nigeria's Seven Energy to 'CC'

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Wednesday, February 22, 2017 10:28 AM / Fitch Ratings

Fitch Ratings has upgraded Nigeria-based Seven Energy International Limited's Long-Term Issuer Default Rating to 'CC' from 'RD' (Restricted Default) following completion of the consent solicitation for the company's 10.25% USD300 million senior secured notes due 2021. Simultaneously, Fitch has affirmed wholly owned subsidiary Seven Energy Finance Limited's USD300 million senior secured notes at 'C' with a 'RR6' Recovery Rating.

Following the completion of Distressed Debt Exchange (DDE) in December 2016, Seven Energy may choose to pay interest on the notes in kind for up to four coupon payments between 11 October 2016 and 11 April 2018, subject to certain conditions.

However, its short-term liquidity remains extremely weak due to accumulated accounts receivables for sold natural gas, a limited ability to convert naira into dollars, and the ongoing Forcados export pipeline closure since February 2016. Management has taken steps to improve the company's liquidity, but we believe the current debt structure may be unsustainable and a default of some kind is probable.

Key Rating Drivers

Forcados Closure Continues
All Seven Energy's oil liftings from OMLs 4, 38 and 41 under the strategic alliance agreement (SAA) with the state-owned NPDC have stopped since February 2016, as the Forcados oil pipeline and terminal remain shut due to the threat of militant attacks. Management has given no estimate on when Forcados will be restarted. As an alternative option, the company is considering barging oil via the inland Warri refinery. This option has not yet been tested by Seven Energy and we believe projected barging volumes would not compensate for the loss of the Forcados pipeline volumes.

On 7 February 2017, Seven Energy announced that Nigerian Petroleum Development Company Limited (NPDC) may terminate the SAA after 17 March 2017 unless the company meets outstanding cash calls. We understand from Seven Energy that it plans to challenge this potential action to preserve its contractual rights under the SAA. This may further worsen the company's liquidity position and affect its operational profile; however, these risks are captured in the 'CC' rating.

Developing Natural Gas Business
The natural gas business in Nigeria's southeast is an important growth driver for the company. It is now on track to ramp up gas sales to 150MMcfpd and more. The construction of the power grid to allow local power stations to run at full capacity has been completed and the Calabar power station (NIPP), one of the major off-takers, is able to generate additional electricity.

Uncertain Cash Flows from Gas
Near-term cash flows from the gas business are uncertain as sale volumes remain volatile and the company's major gas off-takers, state-owned power stations, delay payments for consumed gas. In November 2016, Seven Energy agreed a USD112 million partial payment guarantee with Nigeria's federal government for gas supply to the Calabar power plant and other customers; however, the guarantee is still unavailable pending finalisation of ancillary documentation.

Liquidation Risk
Seven Energy's midstream gas infrastructure assets are fully ring-fenced and serve as security for the company's Accugas IV loan. There is a risk that the Accugas IV lenders may decide to enforce the security, stripping the company of its main cash-generating asset and effectively forcing it into liquidation.

Naira Convertibility Issues
Seven Energy's natural gas revenues are US-dollar pegged but are received in naira. Nigerian companies are facing difficulties exchanging naira into US dollars, which Seven Energy needs to service its US-dollar debt, at the official exchange rate. To alleviate the problem, the company is working to convert the Accugas IV facility into naira. The foreign currency conversion issue negatively affects the company's liquidity as long as Forcados remains shut, as the company receives little US dollar revenues from other operations.

Derivation Summary
Nigeria's onshore-based Seven Energy is a small-scale oil and gas production and gas processing, distribution and marketing company with a complex structure. Its rating is currently driven by a weak financial profile, which remains in distress even after the company completed a DDE in December 2016.

Key Assumptions
- Brent oil price deck: USD45/bbl in 2017, USD55/bbl in 2018 and USD60/bbl 2019.

- SAA's free cash flow (FCF)-negative in 2016; turning marginally positive in 2017-2018.

- Natural gas sales volumes gradually ramping up to 150MMcfpd a year.

- Short-term liquidity remains weak.

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

- Entering into a grace or cure period following non-payment of a material financial obligation;

- Default under the company's obligations;

- Restructuring that constitute a DDE under Fitch's methodology.


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

- Sustainable re-capitalisation of the business;

- Improved liquidity, e.g. due to sustainable cash flows from the natural gas business, or under the SAA agreement.


Liquidity
Weak Liquidity
Seven Energy's current liquidity position is very weak. Management has taken steps to improve near-term liquidity, including negotiating the deferral of interest on the bonds following the DDE, deferral of amortisation schedule on the Accugas IV facility into 2018-19, and entering into the USD50 million debt guarantee facility.

However, in the absence of stable cash flows from the SAA the company's current debt structure is unsustainable. The company may face difficulties in meeting its financial commitments in the next one to two months.


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