OREANDA-NEWS. Fitch Ratings has downgraded Nigeria-based Seven Energy International Limited's (Seven Energy) Issuer Default Rating (IDR) to 'CC' from 'B-'. Simultaneously, Fitch has downgraded the senior secured rating of wholly-owned subsidiary Seven Energy Finance Limited's 10.25% USD300m secured notes due 2021 to 'C' from 'CCC'. The Recovery Rating on the notes remains at 'RR6'.

The IDR downgrade reflects our re-assessment of the significant ongoing liquidity, security and execution risks that Seven Energy continues to face. While the company is making progress in its negotiations with lenders to defer repayments under the USD377m Accugas IV facility, which if and when completed should improve its short-term liquidity, liquidity over the medium-term is likely to remain very tight and will remain largely determined by external developments.

The external developments include a ramp-up in natural gas sales to around 150 million cubic feet per day (MMcfpd) by end-2016, from 95MMcfpd in 1H16; the Forcados oil terminal re-opening in 4Q16 following its closure since February 2016; and a reduction of the oil under-lift position under the Strategic Alliance Agreement (SAA) with Nigerian Petroleum Development Company (NPDC) that reached USD312m as at 30 June 2016. If any of these developments fail to materialise by end-2016, we believe that Seven Energy may be forced to start re-negotiations with all its creditors, including the bondholders.

Nigeria's onshore-based Seven Energy is a small oil and gas production and gas processing, distribution and marketing company with a complex structure. The company's oil business in the Nigeria's North West has been hampered by NPDC's weak financial position and security issues leading to the prolonged shutdown at the Forcados oil terminal. In 1H16, Seven Energy's EBITDAX was USD66m, and its free cash flow (FCF) was a negative USD81m.

Seven Energy's equity-raising of USD100m in February 2016 allowed the company to continue making interest and principal payments in 1H16 of USD50m and USD14m, respectively. However, absent another equity raise or debt restructuring Seven Energy may run out of cash by end-2016.

KEY RATING DRIVERS

Deteriorating Liquidity Leads to Downgrade

Seven Energy's cash on hand at 30 June 2016 was USD33m, well below the company's short-term debt of USD97m. In addition, the company reclassified USD303m of long-term debt as short-term at end-June 2016 after it failed to comply with financial covenants.

The company is actively working to improve its liquidity, eg, to extend the Accugas IV maturity profile and to replace a portion of the Accugas IV facility with longer tenor debt following ongoing discussions with various development finance institutions (DFIs). However, these measures may not be enough to restore Seven Energy's liquidity over the medium term as current operating cash flows predominately from gas sales are insufficient to cover capex and interest payments. Apart from the debt maturity extension, the company's liquidity in 2016-17 largely rests on the ramp-up of gas sales volumes, the successful completion of the Oron to Creek Town gas pipeline, and the re-opening of the Forcados terminal in 4Q16. All these are subject to uncertainty and increase the likelihood of debt restructuring, in our view.

Developing Natural Gas Business

In 1H16, Seven Energy's average deliveries of natural gas were 95MMcfpd, up from 70MMcfpd in 2015. Its gas offtakers include three power stations (Alaoji, Calabar and Ibom), a cement plant and a fertiliser factory in Nigeria. The company projects gas sales of 150MMcfpd by end-2016, as power stations commissioning works and electricity transmission infrastructure are being completed. Fitch's base rating case assumes gas sales volumes of 110MMcfpd in 2016 and 150MMcfpd in 2017-2018.

The ramp-up of gas sales to 150MMcfpd depends on the successful completion of the Oron-to - Creek Town gas pipeline, which was originally expected by mid-2016. In addition, the installation works of electricity distribution infrastructure to allow the power station to run at full capacity are still in progress. Further construction delays cannot be ruled out given Nigeria's weak public finances and deteriorating security situation. As the financial position of some offtakers remains fragile, Seven Energy is planning to enter into a partial payment risk guarantee for the take-or-pay contract with Calabar, its largest gas customer.

Weak SAA Cash Flows

NPDC and Seven Energy are continuing to clear capex arrears incurred through to 2015 by Seplat Petroleum Development Company (Seplat), the operator of OMLs 4, 38 and 41. Seven Energy's interest in these OMLs is determined by the SAA with NPDC. SAA's 2015 average oil production was 57 thousand barrels of oil per day (mbpd). While its January 2016 production reached 65mbpd, all SAA oil liftings have stopped since mid-February 2016 following shutdown at the Forcados oil terminal due to damage at the facility. Management expects SAA oil production to restart in 4Q16 and we forecast SAA to generate negative FCF in 2016.

USD300m Notes Downgraded to 'C'

The 'C'/'RR6' senior unsecured rating on the USD300m notes reflects weaker-than-average recovery prospects for bondholders. As the USD377m Accugas IV facility is secured on Seven Energy's gas assets in the South East Delta, the value of the bondholders' security package largely rests on the SAA.

The downgrade of the notes follows the downgrade of the IDR to 'CC', as the senior secured rating is notched down from the IDR in line with Fitch's Recovery Ratings and Notching Criteria for Non-Financial Corporate Issuers.

Naira's Convertibility

Seven Energy's natural gas revenues are dollar-pegged but are received in naira. We understand from management that difficulties exist in Nigeria in exchanging naira into US dollars, which are needed to service its US dollar debt at the official exchange rate. This negatively impacts the company's liquidity as the Forcados terminal remains idle and the company at present receives no dollar revenue under the SAA.

KEY ASSUMPTIONS

-Brent oil price deck of USD42/bbl in 2016, USD45/bbl in 2017, USD55/bbl 2018.

-SAA's negative FCF from in 2016, positive FCF of around USD30m p. a in 2017-2018.

-110MMcfpd gas sales volumes in 2016 and 150MMcfpd a year in 2017 and 2018 from Uquo/Accugas.

-No dividends in 2016-2018.

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead an upgrade:

-Maintaining a material liquidity buffer in the form of available cash or committed facilities.

-Extension of debt maturities, including Accugas IV, in a manner which we do not classify as a distressed debt exchange.

-Re-opening of the Forcados pipeline; continued implementation of the SAA funding plan agreement resulting in oil liftings by Seven Energy.

-Natural gas sales ramping up to 150-200 MMcfpd.

Negative: Future developments that may, individually or collectively, lead to a downgrade:

-Default, including debt restructuring falling under Fitch's definition of distressed debt exchange.

LIQUIDITY

Seven Energy's cash balance at 30 June 2016 was USD33m, mainly in US dollars, compared with the company's short-term debt of USD97m. We forecast the company's FCF to be negative at around USD100m in 2016 before turning marginally positive in 2017, subject to the Forcados re-opening and natural gas sales ramping up to 150MMcfpd.