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July 18 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has assigned US-based Kosmos Energy Ltd. (KOS) a Long-term Issuer Default Rating (IDR) of ‘B’. The Outlook is Stable. Fitch has also assigned the company’s proposed issue of a senior secured bond an expected rating of ‘B(EXP)'/‘RR4’ . A final bond rating will be assigned upon receipt of completed bond documentation.
KOS is a small but growing oil and gas exploration and production company focused on the offshore Atlantic margin with 2013 net production of 23 thousand barrels per day (mbpd) from the offshore Jubilee field in Ghana (B/Negative). The Jubilee field itself, in which the company has a 24.1% working interest, produces around 100mbpd. In 2013 KOS generated USD645m in EBITDAX (EBITDA before exploration expenses).
KOS’s rating and Outlook are supported by its developed producing asset base at Jubilee, fairly low production costs of around USD10 per barrel, competitive full-cycle development costs compared with similarly sized peers and conservative leverage. The rating is constrained, however, by the company’s small upstream-focused operating scale and low diversification.
Business Scale Determines Ratings
KOS’s scale of operations and limited geographical diversification are dominant drivers of the company’s ‘B’ ratings. Its business profile is constrained by its limited market share relative to other upstream exploration and production peers. KOS intends to boost production by developing two sites in close proximity to the Jubliee field, TEN (Tweneboa, Enyenra, Ntomme) and MTA (Mahogany, Teak, Akasa), but this is unlikely to dramatically change the company’s industry position in the medium term.
We now assume KOS’s net production will not significantly exceed 40mbpd over the next three to five years. KOS’s closest Fitch-rated peers are China- and Kazakhstan-focused MIE Holdings (B/Stable, 2013 production: 15 thousand barrels of oil equivalent per day (mboepd)), Nigeria- and Kurdistan-focused Afren plc (B+/Stable; 47mboepd), and US-based Energy XXI Gulf Coast (Delaware) (EXXI Gulf Coast; B/Stable; pro-forma for acquired assets: 65mboepd).
KOS’s production remains highly concentrated in offshore Ghana. Jubilee now accounts for 100% of KOS’s total production and booked reserve base. At end-2013 KOS had proved oil and gas reserves of 47 million barrels (mmboe), which translates into reserve life of six years; lower than that of MIE Holdings (15 years) and Afren (nine years). However, we estimate it should increase to around nine years and will be on a par with that of Afren once KOS has booked the TEN development reserves. We believe that Ghana is likely to dominate KOS’s output in the medium term despite other exploration projects currently underway off the coast of west Africa. The concentration in Ghana and the company’s current reliance on the Jubilee field expose KOS to elevated geological risks, as well as legal, political and tax risks, in our view.
Elevated Country Risks
KOS is exposed to elevated country risks, as its operations are concentrated in Ghana. Ghana has a strong business environment relative to that of other African countries, ranking 67 out of 189 in the World Bank’s Doing Business Survey. Also, it is safer compared with some other parts of Africa such as the Niger Delta, with local groups often attacking companies in the area leading to interrupted production, and oil theft. However, the country’s public finances are weak.
We expect that the tax regime for oil companies in Ghana will not change over the medium term, and KOS’s tax burden will not materially increase; however, this possibility cannot be ruled out due to Ghana’s high budget deficit. We also assume that KOS’s operations would not necessarily be affected by capital controls or other possible restrictive measures, since the company’s proceeds do not flow through Ghana, and its cash assets are kept primarily outside Ghana. We therefore do not cap KOS’s rating at the sovereign rating or the Country Ceiling. However, we may review this approach if the government attempts to revise the tax regime in Ghana.
Substantive Exploration Portfolio
KOS has a wide exploration portfolio, including several licence blocks in offshore west Africa, Suriname and Ireland. This should help KOS’s replenishment of its reserves, given its fairly low proved reserve life compared with other emerging market peers. However, the company’s exploration budget (around USD500m in 2014-2016) may put a strain on its free cash flow, while the upside from these investments is not guaranteed. A failure to translate exploration spending into increased proved reserves could negatively affect the ratings.
Conservative Mid-Cycle Leverage
We expect KOS’s leverage will increase over the next two years as its operating cash flows decrease because of rising cash taxes and capital intensity. Based on our conservative assumptions we expect the company’s funds from operations (FFO) adjusted net leverage to fluctuate around 2x-2.5x, compared with 1.1x in 2013. This is comparable to mid-cycle leverage of its peers such as Afren (2.0x), EXXI Gulf Coast (2.1x), MIE Holdings (2.5x) and Newfield Exploration Company (BB+/Stable; 2.0x). We also believe KOS will continue to be free cash flow (FCF)-negative until at least 2016-2017. We do not expect KOS to pay any dividends in the medium term, as per its dividend policy.
At 31 March 2014 KOS’s liquidity position was strong. The company had no short-term debt, and available cash of USD528m. Additional liquidity support is also available in the company’s USD1.5bn reserve base lending facility (RBF; USD700m undrawn) and its undrawn USD300m revolving credit facility.
Upcoming Notes Rated ‘B’
The proposed notes are subordinated to KOS’s USD1.5bn RBF; however, we do not notch down the rating of the notes from the company’s IDR given its fairly strong recovery prospects.
At 31 March 2014 the amount outstanding under the RBF was USD800m, and we do not expect it to exceed USD1bn. Moreover, during financial distress KOS would not be able to draw down additional funds under the facility as the available borrowing base is reconsidered at least twice a year, and may be reassessed at the request of the lender. We may, however, notch down the upcoming notes’ rating if the balance under the prior-ranking RBF exceeds USD1bn.
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- Improvement to the upstream business profile (e.g. net production of at least 40mbpd per day)
- Enhanced asset quality (e.g. proved reserve life above nine years)
- Extremely conservative financial profile given the company’s small scale (e.g. FFO adjusted net leverage consistently below 2x)
- Positive FCF on a sustained basis
- Organic reserve replacement ratio sustainably above 100%
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Significant project delays and cost overruns at the TEN and MTA blocks
- Exploration and development expenditure failing to produce a rising reserve base
- Deterioration in liquidity (e.g. cash and credit lines amounting to less than 50% of short-term debt)
- Leverage rising above expectations (e.g. consistently above 3.5x), which would be a distress signal for a company of this size
- Unfavourable tax changes having a direct impact on KOS’s cash generating ability
- Organic reserve replacement ratio significantly below 100%
Fitch’s full rating report on KOS will shortly be available at www.fitchratings.com.