Fitch Assigns DEA's EUR400m Notes Final 'BB' Rating
The notes are guaranteed by DEA Deutsche Erdoel AG (DEA; 'BB'/Stable), its key subsidiaries accounting for 99% of 2015 EBITDAX and 100% of fixed assets at end-2015 and certain parent companies of DEA.
While junior to DEA's USD2bn reserve-based lending facility (RBL) we believe that the overall level of debt in the restricted group is sufficiently low to generate at least average recoveries for senior unsecured creditors, and therefore rate the proposed notes in line with DEA's Issuer Default Rating. The proceeds from the offering are expected to be used to partially repay outstanding RBL amounts.
DEA is a medium-sized oil and gas exploration and production company based in Germany. The company's pro-forma hydrocarbon output totalled 144 thousand barrels of oil equivalent per day (mboepd) in 2015 (on a net entitlement basis and accounting for acquisitions and disposals completed in 2015). DEA's key oil and gas fields are located in Germany, Norway and Egypt. The share of gas in total production is around 50%, which is expected to increase to 80% when new assets in Norway and Egypt add to production.
The ratings are supported by a diversified asset base in 'AAA'-rated countries (mainly Germany and Norway), low cost of production and a clearly stated financial policy with net debt-to-EBITDAX capped at around 2.0x-2.5x. DEA's credit profile is constrained by mature assets in Europe, where production decline is yet to be arrested, and size of production. We deconsolidate oil and gas output from the West Nile Delta (WND) reservoir in Egypt from DEA's financial profile because the company plans to project-finance its stake.
DEA is a wholly owned subsidiary of L1E Acquisitions GmbH (owned by LetterOne Holdings S. A.) following the acquisition of the company from RWE AG (BBB/RWN) in March 2015. LetterOne was founded in 2013 by Mikhail Fridman, German Khan and several other shareholders.
KEY RATING DRIVERS
Production to Decline; Recovery Expected
We expect DEA's production to decrease to 107mboepd in 2016 (excluding the output from the WND project), from 144mboepd in 2015 (excluding production from the UK assets sold to INEOS Offshore BCS Limited and including full year production from assets in the North Sea acquired from E. ON SE (BBB+/Stable)), due to lower output from Skarv and Njord fields in Norway and disposal of assets.
We forecast total liftings to fall to 87 mboepd in 2019 because of declining production in Germany and Norway before recovering to 106mboepd in 2021, following the development of the Dvalin (formerly named Zidane) gas field and higher output from the Skarv Area. In addition, the company is developing the WND project in Egypt, which will lead to its output increasing to 39mboepd in 2021 from 1mboepd in 2015.
In Line with 'BB' Peers
DEA's geographical and asset diversification compares well with peers, such as Kosmos Energy Ltd (B/Stable), which usually have a concentrated asset base located in more politically challenging countries, and is more comparable to Newfield Exploration Company (BB+/Stable) with 2015 output of 139mboepd. This factor, coupled with leverage and the size of production, is commensurate with the mid-'BB' rating category.
'AAA' Countries Support Rating
Around 85% of total production in 2015 came from oil and gas fields located in Germany, Norway and Denmark (GDN), mainly Volkersen, Mittelplate, Skarv, Gjoa and Snorre. This represented almost the entire EBITDAX in 2015. We view assets located in 'AAA' rated countries as positive for DEA's credit profile.
At the same time, assets in the 'AAA' rated countries are mature reservoirs with declining production. The production volume from GDN increased in 2015 on acquisition of assets in the Norwegian North Sea from E. ON for USD1.6bn, but we expect volumes to decrease 44% to 69mboepd by 2019, due to natural decline before recovering substantially to 88mboepd in 2021 on the back of higher production from the Dvalin and the Skarv Area.
Dvalin is a large gas field in Norway with 1P gas reserves of 432Bscf operated by DEA. The company currently holds a 40% stake in the project, which we understand may increase going forward following discussions with partners. The submission of plan for operation and development took place in October 2016 after some delay. DEA plans to tie back the field to the Statoil-operated infrastructure at Heidrun platform with a 15km production flowline.
Production in the Skarv Area started in 2013 (Skarv and Idun fields) and is expected by Fitch to naturally decline from the peak in 2015 until 2020 when production is expected to improve mainly from the development of the Snadd field.
Prospective Assets in North Africa
The company expects production in Egypt and Algeria to increase to 46mboepd in 2019 from 22mboepd in 2015, including 25mboepd from WND. DEA started commercial production from the Disouq concession (100% working interest (WI)) in Egypt (B/Stable) in 2013.
In March 2015, BP plc (A/Stable) and DEA signed the final agreements for WND (WI 17.25%), where the companies expect to develop 5 trillion cubic feet of gas and 55mmboe of condensates. Another significant prospect is the Reggane Nord gas field in Algeria (19.5% WI). Production in Reggane and WND is expected to start in 2017.
We view the company's track record in developing new reservoirs as strong, which supports its ratings. Additionally, WND and Reggane are operated by experienced partners - BP plc and Repsol (BBB/Negative), respectively - with the former project currently one of the core development assets for BP. The output from these assets will help improve DEA's operational profile before production decline in Germany and Norway is halted, which is positive for the credit profile.
At the same time, a higher contribution from lower-rated and less politically stable regions constrains the ratings. Increasing production in Egypt and Algeria will also require significant capex. DEA plans to project-finance its stake in WND, which will reduce its share of spending by USD500m-USD600m from the expected USD850m to develop the field. We therefore deconsolidate WND from our forecasts.
Project Finance for WND
The project finance loan is currently being negotiated. Our base case assumption is that that ring-fencing of DEA from the loans will be strong enough and WND funding and production will be deconsolidated. An alternative scenario would have a neutral impact on DEA's credit profile.
Our forecasts including WND show that leverage metrics are still commensurate with the 'BB' rating, while higher oil and gas production would offset the negative impact on DEA's business profile of higher production from lower rated countries. The neutral impact of potential WND consolidation should also be viewed in conjunction with our expectation of the majority of oil and gas production coming from politically stable regions such as Germany or Norway following the acquisition of assets in Norway from E. ON.
Low Production Costs
Production costs totalled USD7/boe in 2015, down from USD13/boe in 2014, due to cost-cutting measures and the substitution of higher-cost production in the UK with more profitable assets in Norway acquired from E. ON. Costs are expected to remain broadly stable at USD5/boe over the rating horizon of next five years when Egyptian production is counted in. Low production costs support DEA's credit profile.
1P reserves totalled 400 million boe (mmboe) in 2015 (including WND), which translates into eight years of reserve life and compares well with peers such as Kosmos Energy (nine years), Unit Corporation (B+/Negative, seven years), Newfield Exploration Company (10 years). Excluding WND and Njord fields, 1P reserves total 317mmboe and reserve life is six years at the 2015 production level.
EBITDA to Rise From Low
We expect EBITDA to bottom out in 2016 at EUR641m, due to lower production in Norway and Egypt versus 2015 and lower hedging income (EUR120m in 2015), followed by a gradual price-driven increase, in line with our oil price deck of USD42/bbl in 2016, USD45/bbl in 2017, USD55/bbl in 2018 and USD65/bbl over the long term. We expect funds from operations (FFO)-adjusted net leverage to peak at 3.3x in 2016, on the back of a challenging macro environment and high capex in Egypt and Algeria, before decreasing to 2.9x in 2019.
The financing structure comprises a USD2.3bn (USD2,050m drawn) senior secured reserve-based lending (RBL) facility with a comfortable maturity profile. Shareholder loans (EUR.1.1bn at end-2015) were excluded from the debt amount, as they have equity-like characteristics.
DEA plans to maintain net debt-to-EBITDAX at around 2.0x, with a temporary increase up to 2.5x in case of inorganic growth. The company is also obliged to keep net debt-to-EBITDAX below 3.0x under its RBL facility. Our forecasts show net debt-to-EBITDAX will remain below 2.5x until 2019.
New Acquisitions Likely
DEA plans to remodel its portfolio and to further grow through acquisitions. Headroom for debt-financed inorganic growth is currently limited. We therefore assume that a potential transaction would be largely financed with shareholder funds if the expected contribution to EBITDA from acquired assets would not allow the maintenance of the target net debt-to - EBTDAX ratio.
Parent Neutral for Rating
DEA was acquired by LetterOne Holdings S. A. in March 2015. The latter entity is owned by an investment holding of Mikhail Fridman and German Khan and several other shareholders. DEA is domiciled in Germany. LetterOne received all required consents from European authorities to acquire DEA, but the UK authorities obliged LetterOne to dispose of DEA's UK assets, which took place in 2015. We do not view corporate governance as a rating constraint.
DEA is ring-fenced and we view it's the ownership by LetterOne as rating-neutral as is also the case for DEA's private equity-owned peers. LetterOne has ample resources after monetising its stake in TNK-BP and also provided shareholder funding to DEA. Although future support is likely, especially for DEA's inorganic growth, we do not include any rating uplift.
German Investment Guarantees Positive
Most of DEA's investments in North Africa are covered by investment guarantees of Germany. The guarantee covers risk related to expropriation, nationalisation of assets, war or other armed conflicts and cash transfer restrictions. The ability to recover lost investment in case of major problems with operations in Africa is positive for the company's credit profile.
KEY ASSUMPTIONS
- Oil prices of USD42/bbl in 2016, USD45/bbl in 2017, USD55/bbl in 2018 and USD65/bbl in the long term
- Gas prices (NBP) of USD5/mcf in 2016, USD5.5/mcf in 2017, USD6/mcf in 2018 and USD6.5/mcf in the long term
- EURUSD exchange rate 1.1
- Oil and gas output around 5% below management's assumptions
- Non-core cash inflows plus divestments of USD274m in 2016, USD155m in 2017 and USD60m in 2018
- No dividend pay-outs except for partial payback of loan from shareholders in 2016
- Capex in line with management forecasts
RATING SENSITIVITIES
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- Increase in oil and gas output to above 150mboepd (excluding WND)
- Majority of oil and gas production in politically stable regions
- FFO adjusted net leverage below 3.0x on a sustained basis
- Longer track record of operations in the current group/financial structure
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Large debt-financed acquisition
- FFO net leverage consistently above 4.0x
- Reserve life falling below five years
LIQUIDITY
DEA's liquidity is adequate. The group's policy is to ensure a fully funded status for 12 months. DEA does not have any immediate debt maturities. The first maturity is in 2019, when the RBL amortisation schedule begins. As at 30 June 2016 the group had USD250m under the RBL, a USD50m working capital facility from Unicredit and USD141m cash at hand (we assume USD75m is the minimum cash needs of the company in line with our rating methodology and this balance is excluded from DEA's reported cash balance). The bond proceeds should strengthen DEA's liquidity position.
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