Complex Made Simple

Fitch affirms Dolphin Energy’s bonds after additional debt issue

The rating action reflects Fitch's view that the additional debt does not have a negative impact on the credit quality of DEL's bonds.

Fitch Ratings has affirmed Dolphin Energy Limited’s (DEL) USD1,250m 5.888% secured bonds due 15 June 2019 and USD1,300m 5.5% secured bonds due 15 December 2021 at ‘A+’. The Outlooks are Stable. The affirmations follow DEL signing a USD863m commercial facility agreement with several banks on 25 November.

The rating action reflects Fitch’s view that the additional debt does not have a negative impact on the credit quality of DEL’s bonds. Incremental debt is effectively only USD363m (about 11%) higher than our previous assumption under Fitch’s rating case, which already factored in additional permitted debt of USD500m. The commercial facility will accede to the existing debt structure ranking pari passu with the other senior debt (including the bonds) and will amortise from 2016 to 2030.

Projected debt metrics under Fitch’s updated cases are now generally stronger, reflecting the most recent performance and contractual structure, in particular the additional volumes under the long-term contract with ADWEC and an upward revision of price assumptions for interruptible gas sales. The extension of the final debt maturity to 2030 does not worsen the credit profile due to the limited debt addition during the project’s tail years, sufficient reserves remaining and some buffer before the end of the Development and Production Sharing Agreement (DPSA) in 2032.

KEY RATING DRIVERS

We assess DEL as Stronger in respect of revenue risk despite partial exposure to market commodity prices. The project’s long-term fixed-price gas supply contracts currently account for over 40% of DEL’s gross margin and substantially mitigate DEL’s exposure to commodity prices from upstream revenues. DEL can withstand significant oil price declines, able to break-even at a price of USD1.3/bb under Fitch’s base case. DEL is directly affected by the currently low oil price environment, but should easily withstand it due to its high financial flexibility. Fitch’s rating case factors in stressed oil price levels (see ‘Oil and Gas Price Assumptions November 2015’ dated 9 November 2015), which now assume lower stressed oil price levels of USD45/bbl in 2016 and USD50/bbl in 2017, but the same stressed price of USD55/bbl from 2018.

Fitch revised its previous price assumption for interruptible gas sales to about USD6/MMbtu from USD4.7/Mmbtu increasing with inflation each year. This is based on the historical track record, updated market advisor’s projections and additional comfort from approximating the cost of alternative supply (importing liquefied natural gas or diesel).

The exposure to unrated long-term gas offtakers (ADWEC, DUSUP and Oman Oil Company) is mitigated by DEL’s competitive gas prices under long-term contracts. These are significantly lower than the cost of alternative supply or prices negotiated under short-term interruptible agreements, which approximate market spot prices.

The project’s exposure to supply risk is assessed as Stronger. The reserve consultant NSAI provided an updated reserve study in 2015 showing that 1P developed reserves (the level of production which represents the level likely to be reached or exceeded with a 90% probability) are sufficient to cover the base case requirements until October 2026 instead of the previous estimate of 2027. DEL commenced the implementation of the reservoir management optimisation project (RMOP) with the objective of achieving homogenous reservoir depletion, particularly of liquids. Additional drilling works will be carried out during 2016-February 2019. NSAI estimates that these measures will extend the production plateau to April 2034 in case of partial RMOP implementation and to October 2039 in case of full implementation. Our assessment of supply risk remains Stronger based on these reserve life extension estimates beyond debt maturity and NSAI’s view that such projects are common in the oil and gas industry.

Fitch assesses DEL’s operational risk as Midrange, as the project’s facilities are relatively complex but have been performing strongly. On-going technical issues are resolved during scheduled maintenance shutdowns with no significant impact on production and availability, as confirmed in an updated technical due diligence report. DEL has consistently met the maximum production targets under the DPSA, supporting the positive operational track record of the asset. We have therefore revised the availability assumption to 95% from 90%. DEL’s operating costs have been in line with or below expectations, but Fitch will conservatively continue to apply a 10% cost stress in our base case and a 20% stress in our rating case.

Fitch assesses DEL’s debt structure as Midrange, reflecting the complexity of the project’s structure (upstream-midstream split, dual waterfall etc.) together with fairly strong structural features. Refinancing risk related to the 2021 bullet bond and associated shareholder debt is addressed by the sinking fund. Under the revised projections, this mechanism now traps 100% of the bullet requirement under Fitch’s rating case compared with our previous estimate of 80%.

Despite the sinking fund feature, we assume that the 2021 bond will be re-financed with an amortising loan maturing in 2030. With the addition of USD863m of bank debt, the maturity of the debt has been extended to 2030 from 2027 (the previous cash flow horizon) and the tail remaining until the end of DPSA is reduced to 1.5 years from 4.5 years. As the new bank loan is based on a floating rate (LIBOR), the proportion of debt exposed to floating interest rates has increased to about 28% from the previous low level of under 5%. The debt structure is consistent with Fitch’s Midrange assessment.

Debt Service

The latest reported annual debt service coverage ratio (DSCR) was a solid 4.69x as of June 2015. Under the revised projections, Fitch’s base case average DSCR is 4.22x with a minimum of 2.65x until 2030. Under a conservative rating case, the average DSCR is now 3.64x with a minimum of 2.35x, compared with our previous estimates of 2.74x and 2.01x, respectively.

These metrics compare favourably with the guidance in Fitch’s Rating Criteria for Thermal Power Projects (the closest proxy to oil and gas projects), which specifies an average DSCR of 1.5x-1.7x for partially contracted projects to be able to achieve ‘BBB’ category ratings.

DEL has started several internally funded capital projects (with RMOP the main one) to improve operations and extend the production plateau. Investments related to upstream operations (about 70% of the overall USD 1.2bn capex programme) are recoverable through upstream revenue over five years as per DPSA provisions. However, due to the time lag significant cash outflows are expected in the next few years. This capex is not subtracted from cash flows available for debt service when calculating debt metrics in line with the project’s documentation as debt service ranks senior to discretionary capex in the cash waterfall. However, Fitch notes that even if this capex was entirely funded from operational cash flows as it occurs, it would not jeopardise debt service, demonstrating the strength of the cash flow profile.

RATING SENSITIVITIES

Fitch is unlikely to upgrade DEL’s ratings given the single-site nature of the project’s processing facilities in Ras Laffan and the single subsea export pipeline. DEL’s ratings would come under downward pressure should the project experience major operating problems, if there is a severe reduction in the length of the production plateau, a prolonged blockade of the shipping route via Strait of Hormuz or a material deterioration in the credit quality of Abu Dhabi, the main market for DEL’s natural gas, and Qatar. Fitch currently rates Qatar and Abu Dhabi at ‘AA’.

The ratings could also come under pressure in case of deterioration of the debt metrics under Fitch’s rating case to levels close to or below 2.4x for average DSCR.

SUMMARY OF CREDIT

DEL operates a large oil and gas project extracting gas from offshore fields in Qatar, processing it at Ras Laffan in Qatar and then exporting around 2 billion cubic feet a day of clean gas via a 364 km subsea pipeline to Abu Dhabi for onward sale in the UAE and Oman, mostly under long-term contracts. The project also produces a significant amount of condensate and liquefied petroleum gas which are by-products of the gas processing.