Fitch Affirms Kosmos Energy at 'B'; off Watch Negative
The affirmation follows the start-up of TEN, Kosmos's second large producing asset, in August 2016, and progress made by Kosmos and its partners in rectifying the damage to the floating production, storage and offloading vessel (FPSO) at the Jubilee field in Ghana.
We expect Kosmos' leverage to increase on low oil prices and high capex in 2016-17, and in some periods funds from operations (FFO) adjusted net leverage to temporarily exceed our negative rating action guidance of 3.5x. However, this is mitigated by Kosmos' strong hedging discipline, sound liquidity, and a relaxed debt maturity profile with repayments starting only in 2019.
Kosmos is a small but growing oil and gas exploration and production (E&P) company focused on the offshore Atlantic margin. It has interests in two offshore producing assets in Ghana (B/Negative), Jubilee and TEN. Kosmos' net production should rise above 30mbpd by 2018 from 23mbpd in 2015 on the TEN start-up in August 2016 and successful resolution of the FPSO turret bearing issue at the Jubilee field. In 2015 Kosmos generated USD510m in EBITDAX (EBITDA before exploration expenses).
KEY RATING DRIVERS
Jubilee Production Resumed
In February 2016 Kosmos and its partners announced a potential problem with the FPSO at Jubilee. The production from Jubilee, Kosmos's only producing field at that time, was suspended from 20 March to 3 May 2016 as the vessel's turret bearing was damaged. Production has resumed through the use of a dynamically-positioned shuttle tanker and a storage tanker as a short-term solution.
As a long term solution, Kosmos and its partners have decided to convert the vessel to a permanently spread moored facility, with offtake through a new deepwater offloading buoy. This solution will be implemented in several phases over 2016-18 and should involve short periods of production interruptions.
We understand from management the risks associated with the vessel conversion are manageable and expect Kosmos to be largely reimbursed by its insurers for additional capex and opex, as well as lost production.
TEN Improves Business Profile
The TEN project brought on stream in August 2016 is an important milestone for Kosmos as it has improved the company's scale of operations and asset diversification. TEN is located in close proximity to the Jubilee field, and a separate FPSO is used to produce from the field. The project should gradually ramp up to the full capacity of 80mbpd by end-2016 (net to Kosmos - 13.6mbpd).
The TEN start-up should offset lower production at the company's Jubilee field, as well as potential risks related to the FPSO conversion. We may upgrade Kosmos to 'B+' if its production sustainably exceeds 35mbpd-40mbpd. Assuming the long-term solution for the damaged FPSO is fully implemented and TEN is ramped up this level is achievable by 2018-19.
Ghana-Ivory Coast Border Dispute
Ghana and Ivory Coast have never officially agreed on their maritime border, and in September 2014 Ghana took legal action under a UN convention to resolve the dispute as it could affect the TEN project. In April 2015 the Hamburg-based International Tribunal for the Law of the Sea ordered to suspend all new drilling in the disputed area until the final decision is taken in late 2017; however, it allowed production from wells already drilled.
Kosmos announced it expects TEN to proceed as planned as all the wells required for the 'first oil' phase have been drilled. We agree that the risks there are limited; however, we are unlikely to give Kosmos the full credit for the project until the dispute has been fully resolved.
Hedging Mitigates Falling Oil Prices
A consistent hedging strategy has allowed Kosmos to mitigate the negative effect of falling oil prices and finance its ambitious capex while keeping the debt load under control. Kosmos has hedged 3 million barrels for 2H16 (16mbpd) at an average floor price of USD82/bbl, and 8 million barrels (22mbpd) at USD57/bbl in 2017. At our current price deck we expect that the company's hedging arrangements will contribute around USD150m to operating cash flow in 2H16-2017, in addition to USD102m realised in 1H16.
At end-2015 Kosmos had proved oil and gas reserves of 76 million barrels (MMboe). Its proved (1P) reserve life of nine years and proved and probable (2P) reserve life of 17.5 years are in line with the median for Fitch-rated speculative-grade peers (10 and 18 years, respectively).
Kosmos' per-barrel profitability is strong due to a favourable tax regime, fairly low lifting costs and concentration on liquids. In 2015, its funds from operation (FFO) per barrel produced amounted to USD36/bbl and USD9/bbl, with and without derivative hedges, respectively.
Elevated Country Risk
Kosmos is exposed to high country risks, as its operations are concentrated in Ghana. Ghana has a strong business environment relative to other African countries, ranking 114 out of 189 in the World Bank's 2015 Doing Business Survey. It is also safer compared with some other parts of Africa such as the Niger Delta. 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, though Kosmos' cash taxes will materially increase in 2018-19 as the company's capital allowances will be largely utilised. However, the possibility of tax regime change cannot be ruled out due to Ghana's large budget deficit.
We also assume that Kosmos' 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 cash assets are kept primarily outside Ghana. We therefore do not cap Kosmos' 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.
Extensive Exploration Portfolio
Kosmos' exploration success in offshore Mauritania / Senegal could help the company diversify its production base over time. In March 2016 Kosmos announced it drilled the fourth exploration well in the region, and that its estimated gross resource estimates for the Greater Tortue Complex increased to 20 trillion cubic feet (Tcf), or 566 billion cubic meters (bcm), a large field by industry standards. Potential commercialisation options include a farm out, and a floating LNG project.
The discovery has improved Kosmos' financial flexibility as the field can be farmed down; however, depending on the commercialisation route yet to be chosen it could increase Kosmos's capital intensity and completion risks.
Kosmos has an extensive exploration portfolio, including several licensed blocks in offshore west Africa, Portugal, Suriname and Sao Tome. It may help the company replenish its reserves, but success is not guaranteed and the exploration budget may put a strain on the company's free cash flow (FCF). A failure to translate exploration spending into increased proved reserves over time could negatively affect its credit position.
Limited Leverage Headroom
Kosmos' leverage will increase in 2016 on lower oil prices, higher capex, and consequences of the FPSO damage, as there may be a time lag between materialisation of losses and insurance reimbursement. We expect Kosmos' FFO adjusted net leverage to exceed 5x in 2016, above our negative rating action trigger of 3.5x, and to average 3.5x in 2017-19 as its production increases and capital intensity falls. Kosmos' FFO adjusted net leverage adjusted for exploration expenses (by adding back cash exploration expenses to FFO) is projected to be lower at 3.7x in 2016 and 2.9x on average in 2017-19. The company's FCF is likely to remain negative in 2016-17, but should turn positive in 2018-19.
We expect Kosmos to comply with its financial covenants, including maintaining unadjusted net debt-to - EBITDAX below 3.5x. According to our base case projections this ratio may marginally exceed 3x in 2016 but should remain below 3x in 2017-19.
Fitch's key assumptions within our rating case for the issuer include:
- Brent oil price: USD42/bbl in 2016, USD45/bbl in 2017, USD55/bbl in 2018 and USD65/bbl thereafter
- Production rising to 36mbpd in 2018 from 20mbpd in 2016
- Cash flow from hedging based on existing hedging contracts: USD198m in 2016, USD54m in 2017 and USD2m in 2018;
- No dividends
- Capex peaking in 2016 on TEN development and continued exploration in Mauritania and Senegal and declining thereafter;
- Successful resolution of the Jubilee FPSO turret bearing issue, with incremental opex and capex largely absorbed by insurers
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
-Net production rising consistently above 35mbpd-40mbpd, combined with a conservative financial profile (FFO adjusted net leverage below 2.5x)
-Successful implementation of the long-term solution for the Jubilee FPSO, with incremental capex and opex largely covered by insurance companies
- Consistently positive FCF
- Successful resolution of the maritime border dispute between Ghana and Ivory Coast
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
-Unfavourable development of the Jubilee turret bearing, leading to significantly lower production or material additional costs
-Net production falling below 20mbpd
- Suspension of the TEN project or a material change in fiscal terms arising from the maritime border dispute between Ghana and Ivory Coast
-Deterioration in liquidity (e. g. cash and credit lines amounting to less than 50% of short-term debt and projected cash outflows)
- FFO adjusted net leverage consistently above 3.5x over the rating horizon
-Expectations that the utilised balance under the reserve-based lending (RBL) facility will exceed USD1bn-1.2bn may result in worse recovery prospects for 2nd lien creditors, including bondholders, and may trigger a downgrade of the senior secured rating
At 30 June 2016 Kosmos' liquidity comprised USD113m of cash and cash equivalents and USD1,102m of undrawn credit facilities, including the unutilised balance of USD702m under the USD1.5bn RBL facility (total availability under the RBL was marginally cut to USD1,427 in March 2016 as a result of the routine re-determination process). This compares well with Kosmos' cash uses. The company has no maturities until 2019 (with the exception of the currently unutilused USD400m revolving credit line, which is due in November 2018), and we expect its negative FCF to be around USD650m over the next two years.
Strong Recovery Prospects
Kosmos' notes are subordinated to the company's USD1.5bn reserve-based facility (RBF); however, we do not notch down the rating of the notes from the company's IDR given its fairly strong recovery prospects, as reflected in the 'RR4' rating. We may consider notching down Kosmos's notes if the utilised balance under the company's RCF is expected to exceed USD1-1.2bn.