S&P: State of Rio de Janeiro 'CCC-' Rating Placed On CreditWatch Negative Following Missed Debt Service Payment
The credit driver for the upgrade is an improvement in the construction phase stand-alone credit profile (SACP) one notch to 'bbb-' from 'bb+', based on our conclusion that construction funding sources exceed need in our construction phase downside case. Our operations phase SACP remains unchanged at 'bbb-', though some changes in underlying assessments have occurred.
Construction phaseBechtel Oil Gas & Chemicals Inc. is building the trains under fixed-price, date certain engineering, procurement, and construction (EPC) contracts. Train 1 is fully operational. Train 2 began producing LNG in July and is in completion testing. It will likely achieve substantial completion soon. As of the end of July 2016, Bechtel completed engineering and procurement for trains 3 and 4, but it is several weeks behind the target completion date for construction, which is several months prior to the contractual completion date. The contractor completed 84% of engineering and 47% of procurement for train 5, and it is essentially completing foundation works.
Lummus Consultants International Inc. (the independent technical expert overseeing the construction phase) reports that while Bechtel is well within the EPC guarantee completion dates, it is several weeks behind the target completion dates for train 3 and possibly 4 due largely to weather and allocation of personnel to complete work on trains 1 and 2. Our revised assessment of construction funding takes the range of delay into account.
SPLIQ expects to add and fund a process flare improvement project in all trains beginning in the third quarter of 2016. This will likely be done by a change order to the EPC contract. At the end of June 2016, SPLIQ had about $421 million in contingency, so it should be able to absorb the flare project within current funding capacity, and we do not expect this would weaken the current funding adequacy assessment.
The key change in our assessment is that sources of funding (equity, credit facility capacity, notes proceeds, and cash flow from operations, contractor security backing) exceeds the funding needs in our downside case, which factors in likely growth in construction expenses, including increases in EPC costs and SPLIQ's own costs, and which assumes that a six months debt service reserve is funded prior to entering the full operating phase. Our downside case assumes EPC and SPLIQ scope cost growth is lower than our previous estimates due to completion levels and spending to date. We also give SPLIQ the full benefit as a source of funding of the working capital facility it obtained in 2015.
Operations phaseOur operations phase stand-alone credit profile of 'bbb-' reflects modest performance risk of an LNG train and minimal market risk due to 20-year sale-and-purchase agreements (SPA) with BG Gulf Coast LNG LLC, Gas Natural Aprovisionamientos SDG S. A., KOGAS, GAIL (India) Ltd., and Total Gas and Power North America and Centrica PLC. Revenues consist of a fixed fee regardless of offtake and additional revenues for off-taken LNG based on a fixed margin over the Henry Hub benchmark natural gas price.
SPLIQ continues to strengthen operations capabilities for the transition from the construction phase into the operational phase and has hired key personnel that are highly experienced at other similar LNG plants worldwide. SPLIQ continues to complete arrangements to minimize fuel supply risk, which we believe to be key to the investment grade rating. It has secured arrangements to obtain natural gas supplies from major natural gas basins in the U. S. directly with producers and will have direct connections with four major supply pipeline systems.
Our base case includes higher operating costs than SPLIQ forecasts given the ongoing high demand for project labor on the Gulf Coast and Henry Hub prices reflecting our price deck of $3.00 per million Btu in 2018, which we escalate at 2% thereafter. We believe SPLIQ can meet SPA performance requirements with some headroom and that SPA termination conditions are unlikely to occur.
SPLIQ's debt matures between year-end 2020 and 2026. We assume each debt issue is refinanced at its respective maturity to an amortizing structure that declines to zero within the range of time the SPAs terminate (2036 to 2038). We do not include any of the working capital facility into our debt-service coverage ratio (DSCR) calculation since we think it would be used to backstop an letter of credit (LOC) for a debt service reserve and to support natural gas purchases. Notably, it is possible that SPLIQ could refinance its debt in other ways that could lead to different financial performance.
Our base-case assumption result in debt service coverage ratios of 1.49x minimum and 1.57x average. We assume plant production will exceed SPA requirements but that operations and maintenance (O&M) costs will be about 7% above SPLIQ's forecast. Our downside case results indicate DSCRs will hover around 1x over the debt tenor. In the downside, we assume higher O&M costs and increased debt refinancing rates; we also stress availability, though we note that doing so has no impact in this case. These base and downside cases result in operations phase SACP of 'bbb' prior to applying counterparty constraints. We expect this outcome to hold if SPLIQ raises a large amount of new notes debt to replace a similar amount of credit facility capacity.
We apply a cap of 'bbb-' to the operations phase SACP to reflect our assessment of creditworthiness of SPA counterparty Gail (India).
SPLIQ is developing train 6, and it could raise debt to build it that would rank pari passu with the current senior secured debt. There are some conditions to such additional expansion funding, but majority noteholder approval is not among them. We do not assume a train 6 expansion in our base case.
CounterpartyThe 'BB' rating of SPLIQ's ultimate parent Cheniere Energy Partners L. P (CQP) is not a rating constraint. SPLIQ relies on its parents for much of its management personnel, and it also relies on CQP subsidiaries Sabine Pass LNG L. P. and Cheniere Creole Trail Pipeline L. P. for material operations. We think SPLIQ could find replacement operators and has other pipeline transportation options given its location. As noted, our view of Gail's creditworthiness is a rating constraint.
ModifiersNo modifiers affect the construction phase or operations phase SACP. Our upgrade of the rating factors in SPLIQ's decision to make modifications to the indenture so that our assessments of parent linkage and structural protections will not have a negative impact on the debt rating. We assume SPLIQ will make these modifications soon.
Liquidity is assessed as neutral. Sources exceed uses by more than 1x during the first 12 months of operations, and there are no expected covenant compliance issues.
The stable outlook over the forecast period of the next two years reflects our conclusion that construction will progress as planned and that costs will not rise materially from our current expectations. Our stable outlook takes into account the likely impact on financial performance if SPLIQ undertakes additional large notes issuance to reduce credit facility capacity. In this case, we would expect base case DSCRs to decline slightly from our current expectations, but we do not expect the construction phase or operations phase SACPs to change given there is sufficient headroom at the current level.
Upside scenarioDuring the next two years of construction, an upgrade would require an improvement in the construction phase analysis, which would require that the funding provided by the credit facility and pre-completion cash flow from operating trains were more certain, but we consider this a remote possibility. Credit facility draws are subject to conditions precedent and reliance on pre-completion cash flows to fund construction is likely to persist through most of the construction phase. Additionally, an upgrade in the rating would require an improvement in our assessment of Gail's creditworthiness.
Downside scenarioFactors that could lead to a downgrade in the next two years would be a material increase in construction costs or significantly lower pre-completion cash flow, but we consider these remote possibilities right now. The rating would also likely fall if we lower our view of Gail's creditworthiness, since we consider it to be an irreplaceable counterparty during the operations phase. We do not know if SPLIQ could replace it with another off-taker on the same terms and under what timeframe.