Fitch Ratings has assigned Seplat Petroleum Development Company Plc's (Seplat; B-/Positive) upcoming senior notes an expected senior unsecured rating of 'B-(EXP)'. The Recovery Rating is 'RR4'. The assignment of the final rating is contingent on the receipt of final documentation with terms and conditions being substantially in line with the information already provided.
The new senior notes will benefit from the same upstream guaranty package from Seplat West Ltd, Newton Energy Ltd and Seplat East Swamp Ltd as Seplat's existing USD350 million 9.25% senior notes due in 2023.
The new notes will be subordinated to the company's USD350 million senior secured revolving credit facility (RCF) due at end-2023 (following a successful refinancing of the senior notes) that benefits from a pledge over the shares of Seplat West Ltd and Newton Energy Ltd. We also view the USD100 million Eland reserve-based lending facility (RBL) due in March 2026 as ranking senior above Seplat's senior notes.
Proceeds will be primarily used to redeem the company's existing USD350 million senior notes and repay drawings under the RCF, without cancelling the commitment thereafter, as well as general corporate purposes. The planned notes will allow Seplat to extend its maturity profile, which will support financial flexibility over the medium term.
The 'B-' Long-Term Issuer Default Rating (IDR) of Seplat incorporates the small scale of its operations, concentration of its asset base in Nigeria (B/Stable) and a historically unstable operating environment in the troubled Niger Delta. The rating also reflects moderate leverage, conservative financial policies and a growing domestic gas business.
The Positive Outlook reflects our view that the Amukpe-to-Escravos oil pipeline will diversify export routes and mitigate cash-flow volatility, and the company's strong financial profile.
Key Rating Drivers
Small Nigerian E&P Company: Despite the acquisition of Eland Oil and Gas (Eland), Seplat remains a small oil and gas producer with operations concentrated around the Niger Delta region. The Nigerian oil and gas sector has been characterised by high operational risks and regulatory uncertainty. Its main assets are the Oil Mining Leases (OMLs) 4, 38 & 41, which accounted for around 76% of 2020 production and are reliant on the Trans Forcados pipeline that was out of operation for more than a year between 2016 and 2017 due to sustained breaches by militants.
Ramp-up to 2024: We expect Seplat to ramp up its daily oil and gas output to around 60kboe/d until 2024 from around 51kboe/d in 2020. Currently, its crude oil production is subject to the OPEC+ cuts (primarily its Eastern assets by 20%). We conservatively assume that Seplat will slightly increase production to around 52kboe/d in 2021 and still remain compliant with the current OPEC+ quotas. We believe that even following Seplat's expected production ramp-up, it will remain a small E&P company with a significant onshore asset concentration in one country.
Escravos Pipeline Delayed: Fitch views the completion of the 160kbbl/d third-party-operated Escravos pipeline as a key factor for a potential upgrade. This is because it will reduce over-reliance on one particular export route that had adversely affected business in the past. The Escravos route will materially improve the assets' production uptime (83% in 2020) and shrink losses from crude theft and reconciliation (9.4%). The commissioning of this export route was initially expected in 2014, but several delays to payments between the owners and the contractor, outside of Seplat's control, have stalled progress. Seplat now expects commencement of exports in 2H21.
Adequate Cash for Short-Term Disruption: In the extreme scenario that the currently primary export route of Trans Forcados is not operational for over a year and with no alternative other than the two jetties at the Warri refinery, we expect Seplat to be able to operate for around 12 months before running out of cash based on the current debt maturity profile, before the new bond placement. We would also expect in such a scenario that work on the Escravos pipeline will be accelerated.
Cost Optimisation Ongoing: Seplat is undertaking cost-cutting measures and identifying synergies within its newly acquired Eland assets to reduce its cost base. With the acquisition of Eland, Seplat's operating expenditure increased to around USD8.9/boe in 2020 from about USD6.2/boe in 2019. Cost optimisations include supplier cost savings, water-management optimisation, barging cost reduction along with legal and other similar cost savings.
Alternative Routes De-risk Operations: The Escravos pipeline will allow additional oil exports of 40kbbl/d and will be used together with the Trans Forcados pipeline as the main export routes. We regard the usage of the more costly Warri refinery route, which allows exports of 30kbbl/d gross, as unlikely unless force majeure occurs. Furthermore, the Eland acquisition provides the opportunity to develop its own export route and offshore terminal, leveraging the Amukpe to Escravos pipeline where together the OMLs 4, 38, 41 and OML 40 crude could be evacuated.
Inorganic Growth: We expect management to continue to actively seek opportunities for inorganic growth, mainly onshore and shallow water offshore in Nigeria but also abroad without compromising the current ratings. Domestic opportunities exist as oil majors continue to streamline their portfolios, exiting Nigeria. We view Seplat's financial policies as conservative for the rating with funds from operations (FFO) net leverage of below 1.5x in 2021-2024, underpinned by debt-reduction initiatives, as well as flexibility to suspend dividends and cutting capex during the troubled 2016-2017 period. We consider acquisitions an event risk.
Growing Gas Business Provides Stability: Fitch views positively the growing share of natural gas in the production mix as contracted offtake volumes and pricing enhance stability and visibility of FFO. Seplat currently supplies about 30% of the Nigerian gas to power volumes, a market that is set for strong growth.
ANOH JV to Commence 1H22: The 50-50 ANOH gas development JV between Seplat and Nigerian Gas Company Limited (NGC) underpins Seplat's effort to further expand gas operations, adding 300mmscf/d to the existing 525mmscf/d gross wet gas processing capacity. The JV partners finalised USD260 million of non-recourse debt financing to fund the remaining of this USD650 million project. Covid-19 related delays have pushed commencement into 1H22. Seplat expects to start receiving dividends already from 2023, although we conservatively do not include any contribution in our rating case.
ESG - Social: Seplat has an ESG Relevance score of 5 for Human Rights, Community Relations, Access & Affordability due to its focus on upstream operations in the troubled Niger Delta region of Nigeria. Historically, this area has been a high-risk environment driven by militancy, crude oil theft, pipeline sabotage, as well as environmental pollution arising from militant strikes against oil infrastructure. This has a negative impact on its credit profile and is highly relevant to the ratings. The completion of the new alternative pipeline will support a positive rating action.
The Trans Forcados pipeline, the company's primary export route, was shut down for 305 days in 2016 and more than 182 days in 2017, adversely affecting Seplat's operations. Deeper communication and cooperation between the government, Seplat and local communities have since seen a significant reduction in targeted attacks on oil infrastructure. Militancy activities reduced significantly since the force majeure and the Trans Forcados export system saw an improved uptime of 83% in 2020 compared with 50% in 2017.
Onshore Nigeria-based Seplat is a small oil & gas E&P company by production and reserves.
We rate Ithaca Energy Ltd (B/Rating Watch Negative) one notch above Seplat as Ithaca benefits from lower leverage, a more robust hedging position, higher production volumes (about 65kboe/d) and its focus on the UK North Sea, which is a more stable operating environment compared with that of Seplat, which only focuses on Nigeria. This is partially mitigated by Seplat's bigger reserve base and higher reserve life (Ithaca: four years on a 1P basis). The RWN reflects the potential pressure Ithaca may face due to continued liquidity issues experienced by its 100% parent, Delek Group.
Compared with Kosmos Energy Ltd. (B/RWN), Seplat has bigger reserve base, higher reserve life (Seplat: 26.7 years on a 2P basis) and stronger credit metrics with no material maturities in the near term. These strengths are offset by Kosmos' more diversified asset base in a more predictable business and operating environment - including the US - compared with Seplat's high exposure and concentration to areas characterised by geopolitical risk. Kosmos' new note issue this year allows the company to meet near-term debt maturities and marks a positive step in its refinancing cycle but will not be sufficient to fund upcoming committed capex. Sustainable improvement of its liquidity profile remains subject to successful sale & leaseback of the floating production storage and offloading (FPSO) asset and an extension of the RBL amortisation beyond the near term, the completion of which may support the RWN resolution.
- Oil price deck of USD58/bbl in 2021 and USD53/bbl until 2024
- Domestic gas prices of about USD2.9/mcf on average until 2024
- Upstream production ramping up to above 60kboe/d in 2023
- Dividends of about USD59 million a year up to 2024
Fitch's Key Assumptions for Recovery Analysis:
- The recovery analysis assumes that Seplat would be restructured as a going concern rather than liquidated in an event of default
- Seplat's post-reorganisation, going-concern EBITDA is estimated at around USD223 million, based on the current asset base. A drop in EBITDA to the going-concern level reflects risks associated with hydrocarbon price volatility, potential unplanned downtime and other adverse factors
- We have applied a distressed enterprise value (EV)/EBITDA multiple of 4.5x to calculate a going-concern EV, reflecting a mid-cycle multiple for the natural resources sector in the EMEA region and the risks associated with the operating environment in the country of operation.
- We assume a 10% administrative claim to be deducted from the going-concern EV
- Our principal waterfall analysis assumes the USD350 million senior secured RCF and a USD100 million Eland RBL rank senior to Seplat's senior notes
- Taking into account our Country-Specific Treatment of Recovery Ratings Criteria, our waterfall analysis generated a ranked recovery in the 'RR4' band, indicating an expected 'B-(EXP)' instrument rating.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
- The successful completion and commencement of the Escravos oil pipeline, positive free cash flow (FCF) generation on a sustained basis along with production ramp-up resulting in forecast FFO net leverage (2.0x at end-2020) below 3.5x, could result in an upgrade of the IDR to 'B'.
- We may also consider a positive rating action if the company successfully refinances its indebtedness and improves its debt maturity profile so as to be able to survive more than two years of force majeure in the Forcados export system.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
- As the rating is on Positive Outlook, negative rating action is unlikely in the short term. However, failure to maintain FFO net leverage at below 3.5x on a sustained basis or further delay to completion of the Escravos oil pipeline, along with insufficient liquidity to cope with protracted operational disruptions, could lead to the Outlook being revised to Stable.
- Inability to refinance upcoming maturities would lead to a downgrade.
- Higher-than-forecast downtime as a result of unforeseen events, resulting in material loss of production or downgrades of Nigeria and of local banks where Seplat has historically kept most of its cash could also lead to a negative rating action.
Best/Worst Case Rating Scenario
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years.
The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance.
Liquidity and Debt Structure
Adequate Liquidity: As at end-2020, Seplat had around USD325 million of liquidity, including around USD225 million of readily available cash and USD100 million availability under its USD350 million senior secured RCF. The company has no scheduled debt maturities for the rest of 2021 after the recent successful refinancing of the Eland RBL, which is now due in March 2026 and will start amortising in March 2023.
At end-September 2020, Seplat's indebtedness stood at USD700 million, including USD350 million of senior notes, USD250 million drawn under its USD350 million senior secured RCF and a fully drawn USD100 million Eland RBL. Our modelling suggests that Seplat will be FCF-positive after dividends until 2024.
Exposure to Nigerian Banks Reduced: Seplat has historically held most of its cash at Nigerian banks, which have ratings from Fitch of 'B'/Stable and below. As a general policy, the company usually retains around 70% of its total cash in US dollars and around 70% of the US dollar cash is held offshore. Nevertheless, we believe that Seplat has large exposure to the Nigerian banking system and we believe that cash holdings at Nigerian banking institutions are vulnerable to a sharp deterioration in oil prices and the naira.
Summary of Financial Adjustments
Fitch reclassified around USD3.5 million of depreciation of right-of-use assets and around USD0.3 million of interest on lease liabilities as lease expenses, reducing Fitch-calculated EBITDA by around USD3.8 million in 2020.
Seplat has an ESG Relevance Score of 5 for Human Rights, Community Relations, Access & Affordability due to its focus on upstream operations in the troubled Niger Delta region of Nigeria. This has a negative impact on its credit profile and is highly relevant to the ratings.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity.