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July 3 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has revised UK-based BG Energy Holding's (BG) Outlook to Negative from Stable and affirmed its Long-term Issuer Default Rating (IDR) at 'A-'. A full list of rating actions is available below.
The Negative Outlook reflects completion risks associated with BG's new upstream projects, challenges that the company is facing in Egypt, and the potential that funds from operations (FFO) adjusted net leverage may stay above 2.5x in the medium term if there are any delays to project start-ups.
Presently, we view the group's credit metrics as stretched for the current ratings because of BG's ambitious investments coinciding with declining production, despite a series of asset disposals intended to strengthen the group's balance sheet. We currently project 2014 FFO net leverage to exceed 2.5x, before gradually declining provided upstream projects are completed on schedule. We also believe that BG's unexpected CEO resignation in April 2014 gives rise to some uncertainty with regard to the implementation of BG's strategy.
We expect that BG's business profile should improve with the start-up of its major projects in Australia and Brazil. The commencement of operations at the QCLNG facility in Australia and ramping-up of the Santos Basin project in Brazil should help to offset declining production in Egypt. However, we do not expect material cash generation from new production in Australia and Brazil before 2015. Risk associated with the timing of this new cash flow stream is the main factor supporting the Negative Outlook.
KEY RATING DRIVERS
Production Challenges Remain
In the past BG had suffered from a series of production target shortfalls due to several challenges, ranging from delays or shutdowns in the North Sea, political instability in Egypt and scaled-back drilling in the US due to low natural gas prices. The group's 2014 production is likely to be at the lower end of the previously targeted 590,000-630,000 barrels per day (mboe/d) range, according to the group. We assume BG's 2014 output at 590mboe/d, down 7% yoy, mainly due to falling output in Egypt.
Though BG demonstrated better production dynamics in 2009-2013 compared with most international majors, which have generally seen a production decline over the period, we regard BG's recent operational performance as weak, taking into account its significant upstream capex and ambitious targets. For example in 2011 the group had expected that its 2015 output would exceed 1,000mboe/d.
Production Growth is Key
We expect that 2015 will be a turning point for the group's production profile, which is the main assumption supporting the ratings. Delays or setbacks to the Australian or Brazilian projects, which are key to significantly increasing the group's output, will most likely lead to a downgrade. In addition, BG is exposed to potential delays and cost overruns due to the large scale of the projects presently being implemented. These risks are reflected in the Negative Outlook.
We now assume that in 2015 BG's production will rebound to at least 675mboe/d, and should grow further to at least 725mboe/d in 2016 as production in Australia and Brazil ramps up.
Credit Metrics Could Worsen
We project BG's FFO adjusted net leverage could deteriorate to above 2.5x in 2014, up from 1.8x at end-2013, based on the agency's conservative oil and gas price assumptions and falling production in 2014. We assume Brent price of USD96/bbl in 2014, USD91/bbl in 2015, USD85/bbl in 2016 and USD80/bbl in the long term. This deterioration in leverage is also due to our assumption that BG's capex will remain high in 2014, before declining thereafter, and the uncertain timeframe for any additional asset sales. Leverage should decline after 2014-2015, however, as higher output leads to greater cash flow generation and capex intensity falls.
Asset Sales Help
The negative impact on credit ratios from its ambitious capex programme is partially blunted by asset sales. Most recently the group disposed of its 62.8% stake of the Central Area Transmission System (CATS) located in the North Sea for USD954m, including a deferred amount of USD66m. In addition, in 2012-2013 BG released USD8.5bn through assets sales, which helped to finance the group's high capex and supported the ratings.
BG says it continues to review its portfolio and new disposals may follow; however, the timing, scale and effect on production of such potential disposals are largely uncertain. In our base case forecast we assume no future asset sales, except for the agreed CATS deal.
Volatile Egyptian Production
Egypt used to account for 20% of BG's upstream production in 2012, but was just 10% in 1Q14. This decline is a result of both lower production entitlement as Egypt redirects more volumes for domestic off take, and poor reservoir performance. The latter may deteriorate further as the group has decided to limit its capex in the country until the investment climate improves. BG's LNG sales fell by 10% to 10.9 million tons per annum (mtpa) in 2013, reflecting lower supplies from Egypt.
BG is now considering an option to supply its LNG plant with gas from the offshore Leviathan field in Israel, and a preliminary agreement has been reached with the project's partners. However, this possible solution is unlikely to deliver any short-term results, as the field development has not yet been sanctioned, and it may only reach the production stage in 2017 at best. If approved, the project would require BG to construct a new undersea pipeline, which would mean additional capex.
Adverse political developments are having a negative impact on the country's hydrocarbon exports, and we are mindful of the impact disruptions are having on BG's export commitments and cash generation. BG says that the political deterioration in Egypt will negatively impact the group's 2014 production profile and BG is currently reviewing its plans in the country. Although the political risk is factored into BG's ratings, a worsening of this risk leading to even less production, or rising overdue receivables balance (USD700m at 31 March 2014) resulting in material negative working capital movements could still lead to a downgrade.
Solid Reserve Base
We classify BG's production scale and reserve base as "medium", according to Fitch's methodology. BG's 2013 production of 633mboe/d is in between that of global majors, including Total SA (AA/Negative; 1,546mboe/d, excluding affiliates), Eni SpA (A+/Negative; 1,503mboe/d) and ConocoPhillips (A/Stable; 1,410mboe/d), and that of less diversified producers, like Marathon Oil Corporation (BBB+/Stable; 484mboe/d), Repsol, S.A. (BBB/Positive; 333mboe/d) and OMV AG (A-/Stable; 278mboe/d). The group's proved reserves of 3,538 million barrels of oil equivalent translate into a healthy reserve life of 15 years. BG's organic reserve replacement ratios have significantly exceeded 100% over the past several years, which should support its long-term production profile.
Strong LNG Business
BG's business profile benefits from the group's strong positions in LNG production and marketing. In 2013 BG sold 10.9 million tons (mt) of LNG, sourced from BG's equity production in Trinidad and Tobago (3.4mt) and Egypt (1.7mt), as well as from independent suppliers. While LNG sales may edge down in 2014 due to gas supply shortage in Egypt, we expect higher production volumes in 2015 as the first train of the Australian QCLNG project starts up in 4Q14. In 2013, the LNG segment contributed 35% to BG's operating profit, and we believe it will remain an important source of cash flows for the group.
The group has no exposure to European refining, which favourably distinguishes it from other integrated oil and gas producers, as the industry is now plagued by regional imbalances and intense competition with overseas refineries. This has resulted in low refining margins and we do not expect recovery in the short term.
LIQUIDITY AND DEBT STRUCTURE
We view BG's liquidity position at 31 March 2014 as strong and in line with the 'F2' rating, despite the negative free cash flow we expect in 2014. BG's liquidity position comprised USD6.3bn cash and USD5.2bn of unused stand-by bank facilities expiring in 2016-2017. This amount more than covers BG's short-term debt obligations of USD478m. In addition the group has access to an unused commercial paper programme (USD6bn) and an unused portion of euro medium term note programme (USD9bn).
We rate BG's USD2.1bn subordinated unsecured hybrid securities due 2072 two notches below the company's IDR, in line with Fitch's methodology (Treatment and Notching of Hybrids in Non-Financial Corporate and REIT Credit Analysis - December 2013). We allocate it 50/50 between debt and equity.
Positive: Future developments that may, individually or collectively, lead to the Outlook being revised to Stable include:
- Through-the-cycle FFO-adjusted net leverage of 2x-2.5x on a sustained basis, stemming from production growth and/or further divestments
- Production growth to at least 675mboe/d in 2015, associated with ramping-up in Brazil and bringing QCLNG on stream. In particular, we will monitor whether BG will bring into production FPSO 4 and 5 in Brazil and will ship the first cargo from QCLNG by end-2014, as it currently expects
- Decreased capital intensity after 2014, with neutral or positive free cash flow through the cycle
Positive: Future developments that may, individually or collectively, lead to an upgrade to 'A':
- Through-the-cycle FFO-adjusted net leverage lower than 2x on a sustained basis
- In the longer term, a re-established track record of delivering above-industry average production targets. We may consider an upgrade if BG's production exceeds 750mboe/d on a sustained basis
- Decreased capital intensity after 2014, with positive free cash flow through the cycle
Negative: Future developments that may, individually or collectively, lead to a downgrade include:
- FFO-adjusted net leverage above 2.5x for a prolonged period of time, due to lower-than-expected production growth, high dividends or inability to decrease its capital intensity after 2014
- Major delays and/or cost overruns in Australia and Brazil, or further production decline in Egypt, resulting in 2015 production at below 600mboe/d
- Significant negative working capital movements associated with a rising amount of overdue receivables in Egypt
FULL LIST OF RATING ACTIONS
BG Energy Holdings
Long-term IDR: affirmed at 'A-'; Outlook Revised to Negative from Stable
Short-term IDR: affirmed at 'F2'
BG Energy Finance Inc.
Short-term debt rating: affirmed at 'F2'
BG Energy Capital plc
Senior unsecured rating: affirmed at 'A-'
Short-term debt rating: affirmed at 'F2'
Subordinated hybrid debt: affirmed at 'BBB'
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