Fitch Ratings has placed Kuwait Energy plc’s Long-Term Issuer Default Rating (IDR) of ‘B-‘ on Rating Watch Negative (RWN). Simultaneously, Fitch has placed the ‘B-‘ senior unsecured rating of Kuwait Energy’s USD250m 9.5% notes due in 2019 with Recovery Rating of ‘RR4’on RWN.
The RWN reflects growing liquidity risk, specifically in light of the reduction in available cash balances in recent months. While we are aware of company plans to raise additional credit facilities by end-2016 these facilities currently remain unsigned.
We aim to resolve the RWN once we have obtained more clarity on Kuwait Energy’s progress in obtaining new funding by end-2016.
KEY RATING DRIVERS
Weakening Cash Balance and Liquidity
At 30 September 2016, Kuwait Energy’s cash balance was USD22.8m, down from USD54.4m at 30 June 2016. On average, Kuwait Energy has been using up about USD8.5m-USD9m in cash monthly in 2015-1H16, principally on greenfield development capex, while its net cash flow from operations dropped to USD15m in 1H16, mainly on weak Brent prices.
The company’s semi-annual cash interest payments amount to about USD18m. If Kuwait Energy fails to raise additional funding over the few next weeks, there is a risk in the absence of other measures to preserve cash that the company could deplete its cash reserves before end-2016.
The company is actively pursuing several options to increase its liquidity that include, in addition to the first 300 thousand barrel (bbl) oil cargo from Iraq expected to be lifted in late October and cash to be received in early November, prepayment facilities for up to USD100m and a reserve-based loan (RBL) facility for up to USD50m. It has also agreed extended payment terms with its main drilling contractor in Iraq that may help it save tens of millions of US dollars over a period of time.
Small MENA Oil Producer
Kuwait Energy is a small MENA-focused oil and gas company with an average working interest (WI) production of 23.9mboepd in 2Q16, down from 25.7mboepd in 1Q16. In 1H16 Kuwait Energy’s oil production came from Egypt (77%), Iraq (B-/Negative, 13%) and Oman (10%). The company’s four Egyptian assets had WI production of 19mboepd in 1H16, which was declining due to natural factors. Its operations in Yemen have been on hold since March 2015 when the civil war broke out there.
At end-2015, Kuwait Energy’s proved and probable (2P) reserves were 818 million barrels of oil equivalent (mmboe), over 96% of which are located in Iraq, up from 90% at end-2014. Its 2P reserves in Egypt of 31mmboe imply a reserve life of only about four and a half years, based on 1H16 production volumes. Kuwait Energy’s total hydrocarbon production and reserves are in line with that of Fitch-rated ‘B’ oil companies.
Iraq Gives Production Boost
Kuwait Energy is accelerating the development of its greenfield Block 9 in Iraq, in which it currently has a 60% WI. The Faihaa-1 well produced around 3.3kbopd on a WI basis in 1H16. Following the launch of the Faihaa-2 well in October 2016, Kuwait Energy has doubled its WI production in Iraq to about 6.6mboepd. The company expects that the Faihaa-3 well that is currently scheduled to go live in early 2017 will perform at similar rates, thus further boosting the company’s WI production in the country.
Block 9 is a 20-year service-type take-or-pay contract with Iraqi state-owned South Oil Company with service fees of USD6.2 per barrel of oil equivalent (boe). The company expects a plateau production of at least 120mboepd (gross, not WI). After the initial cost recovery, service fees to Kuwait Energy are independent of oil prices and, hence, should generate steady cash flow. We believe that Block 9, when fully operational, should help Kuwait Energy diversify oil production away from Egypt, albeit subject to production and payment risks.
Project Delays Hamper Siba
Siba, a greenfield gas project in Iraq, has been delayed beyond the 2H16 full-scale production launch expected last year. Siba is a 20-year take-or-pay agreement with South Oil Company, with a plateau production of 100 million cubic feet of gas per day (mmcf/d) and USD7.5/boe service fees. Kuwait Energy aims to bring Siba online in 1H17 and plans to spend around USD20m on its capex in 2017.
In April 2015 Egypt’s Petrojet, a subsidiary of the state-owned Egyptian General Petroleum Corporation (EGPC), was awarded the Siba engineering, procurement and construction (EPC) contract. Kuwait Energy has just finalised the farm-out for the 20% stake in Siba to EGPC. Although the closing does not bring any immediate cash to Kuwait Energy, it will benefit the company over the next few months by reducing its cash capex payments to Siba, while the company will still be able to receive its proportionate share of revenues after the project becomes operational.
RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action:
– Maintenance of a material liquidity buffer of at least USD50m in the form of available cash or committed facilities at each quarter-end.
– Successful launch of Iraqi greenfields with a track record of full and timely payments.
– Maintaining a conservative financial profile, e.g., funds from operations (FFO)-adjusted net leverage below 3x (end-2015: 3.9x) on a sustained basis.
Negative: Future developments that may, individually or collectively, lead to a negative rating action:
– Inability to secure any additional funding resulting in a worsening of the current liquidity profile.
– Problems with cash collection in Egypt.
– Failure to launch Siba on time, to ramp-up Block 9 production or to obtain cost recovery.
– FFO-adjusted net leverage above 3x on a sustained basis.
– A downgrade of Egypt, insofar it remains Kuwait Energy’s principal production location.
KEY ASSUMPTIONS
– Brent oil price deck of USD42/bbl in 2016, USD45/bbl in 2017, USD55/bbl in 2018.
– Service fees for Iraqi production of USD7.5/boe for Siba and USD6.2/boe for Block 9.
– Siba launch in 1H17.
– 2016-2017 capex of around USD200m mainly to complete Siba and to ramp-up Block 9 production.
– USD100m-USD150m cash raised to sustain a comfortable liquidity position for the next 12 months.
LIQUIDITY AND DEBT STRUCTURE
At 30 September 2016, Kuwait Energy’s cash and cash equivalents declined to USD22.8m and the company had no available unused credit facilities. While the company has no material debt repayments until the convertible bonds mature in December 2018, its mandatory cash outflows include interest payments of around USD35m per annum and committed post-farm-out capex for Siba of around USD20m in 2017.
In accordance with Fitch’s policies the issuer appealed and provided additional information to Fitch that resulted in a rating action which is different than the original rating committee outcome.