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May 29 (The following statement was released by the rating agency)
Fitch Ratings has affirmed Afren plc's Long-term Issuer Default Rating (IDR) at 'B+'. The Outlook is Stable. A full list of rating actions is at the end of this release.
Afren continues to generate solid operating cash flows, which are sufficient to finance its ambitious exploration and development programme. In the past the company has demonstrated its ability to meet ambitious production targets as it significantly boosted oil output in Nigeria in 2012 and 2013. Afren's profitability is supported by the tax holiday in place at Ebok, its largest producing field. However, Afren's production remains highly concentrated, which gives rise to elevated geological, country and tax risk, and its scale of operations is small. We view the possible oil industry reform in Nigeria as a risk, as its timing and key parameters, including tax implications, are unclear.
These factors constrain Afren to the 'B' rating category. This could be improved if Afren manages to substantially ramp-up production in the Kurdistan region of Iraq, where it has vast reserves.
Afren is a small-scale exploration and production (E&P) company with producing assets in Nigeria and Kurdistan. In 2013 its net production reached 47 thousand barrels of oil equivalent per day (mboe/d), predominantly liquids, which generated USD960m in EBITDA.
KEY RATING DRIVERS
Strong Operational Performance
In 2013, Afren's net production (working interest including cost recovery) averaged 47mboe/d, up 13% yoy and almost 2.5 times higher than in 2011, which was reflected in our June 2013 upgrade to 'B+' from 'B'. This growth was mainly attributable to Ebok, Afren's largest offshore field brought on stream in 2011.
In 2013, Afren also had a sound 2P reserve replacement rate (155%) and maintained low lifting costs (below USD5/bbl). However, it had a relatively small proved reserve life (nine years overall; six years in Nigeria), typical for E&P companies of this size.
In 1Q14, Afren's net production went down to 35.5mboe/d as it recovered the initial investments at Ebok and its working interest in the field decreased. We expect Afren's 2014 net production to be within 35-40mboe/d, rebounding to 40-50mboe/d in 2015, mainly thanks to moderate output growth at Ebok and ramping up of OML26 in Nigeria and Barda Rash in Kurdistan.
Afren's production remains highly concentrated. In 1Q14, Ebok accounted for 73% of Afren's total production, and only 1% of oil was produced outside of Nigeria. Afren has significant 2P reserves in Kurdistan (114 million barrels, 40% of its total) and is hoping to boost production at its Barda Rash field soon. However, any significant progress there will only be possible if Afren gets access to a secure export channel. We now assume that Nigeria is likely to dominate Afren's output in the medium term. This concentration exposes Afren to elevated emerging market country and tax risks.
Tax Holiday Benefits Cash Flows
Oil companies are generally heavily taxed in Nigeria. They pay substantial royalties and are subject to the Petroleum Profit Tax (PPT), which normally varies from 50% to 85% of the bottom line. Afren's Ebok field is exempt from paying PPT until May 2016, which significantly benefits Afren's cash flows and should allow it to finance new projects, while keeping leverage relatively moderate for the 'B' rating category. The company believes that the Petroleum Industry Bill (PIB), if finally passed by the local parliament, should not affect the tax holiday. At the same time, we believe that the proposed oil industry reform creates some uncertainty over Afren's future tax payments and makes its cash flows less predictable, since the reform's key parameters have not been finalised. The PIB, which calls for an increase of the government's revenue from the sector and changes in taxes and royalty structures, has been debated since 2009 and re-drafted several times. We have no views regarding the timing of the bill's passage into law.
Country Risks Remain
Afren is exposed to high emerging market country risks as its operations are concentrated in Nigeria (BB-/Stable). Historically, development of the oil and natural gas sector has been constrained by instability in the Niger Delta, with local groups often attacking companies in the area leading to shut-in production, as well as by oil bunkering, or theft. Afren is less vulnerable to these risks as all of its largest assets in the country, excluding OML 26, are offshore. The company is also exposed to high regulatory and especially tax risks in Nigeria. Afren's entry to Kurdistan should partially mitigate these risks over time, but we will only be able to give the company credit for some geographical diversification when it manages to boost production outside Nigeria to more than 30%-40%.
Uncertainty Over Kurdistan
In order to monetise its massive oil reserves in Kurdistan Afren needs to get access to a secure export channel. In 1Q14 its Barda Rash field yielded around 500 barrels of oil per day, all sold domestically, and ramping-up production to above 5mboe/d may not be feasible without access to a pipeline. The central government of Iraq and Kurdistan Regional Government (KRG) have been in a dispute over the regulation and taxation of the oil industry in Kurdistan, prompting Kurdistan to build an alternative 300mbbl/d export pipeline to Turkey, which was commissioned in 2013 but has remained mostly idle due to political concerns. We believe that the company's growth strategy in Kurdistan may be affected by highly unpredictable political factors and assume in our modelling that progress there will be rather slow.
Substantive Exploration Portfolio
Afren has a wide exploration portfolio, including seven licence blocks in East Africa. Its exploration activity has borne some fruit, in 2013 the company announced it made a significant oil discovery at the Ogo prospect in Nigeria, which can potentially enhance its reserve base and production prospects. Afren's relatively low proved reserve life relative to peers means that the company needs to constantly replenish its reserves, and the vast exploration portfolio may be helpful in this respect.
Solid Financial Profile
Afren now has a relatively low debt burden for the 'B' rating category. Funds from operations (FFO) adjusted gross leverage stayed at 1.8x at end-2013, and although we believe it may moderately increase on the back of high capital intensity, it should stay below 2.5x on a sustained basis under our conservative assumptions, including declining price deck and no substantial production upside. Afren can also be free cash flow negative in some periods. We do not expect Afren to pay any dividends in the medium term, as per its dividend policy.
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- Net production exceeding 100mboe/d on a sustained basis.
- Production becoming less concentrated, with no single country accounting for more than 2/3 of the overall output on a sustained basis.
- FFO adjusted gross leverage below 2x on a sustained basis.
- Sustainably positive FCF.
- More clarity regarding the evolution of tax environment in Nigeria.
- Getting access to secure export channels in Kurdistan and ramping-up production at Barda Rash.
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- FFO adjusted gross leverage exceeding 2.5x on a sustained basis.
- Net production declining and settling below 35mboe/d.
- Unfavourable tax changes in Nigeria having a direct impact on Afren's cash generating ability.
- Significant project delays and cost overruns.
At 31 March 2014 Afren had no short-term debt, and cash of USD361m. In 2013, the company improved its debt maturity profile by issuing a USD360m secured bond due 2020 and partially repaying its USD500m bond due 2016 (currently outstanding: USD253m) and USD300m bond due 2019 (currently outstanding: USD250m).
LIST OF RATING ACTIONS
Foreign-currency Long-term IDR: affirmed at 'B+', Outlook Stable
Senior secured rating: 'B+'/'RR4'
Senior unsecured rating: 'B+'