Fitch Affirms Peru LNG At ‘BB-‘; Negative Outlook

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(Fitch, 10.Sep.2020) — Fitch Ratings has affirmed Peru LNG S.R.L’s (PLNG) Long-Term Foreign and Local Currency Issuer Default Ratings (IDRs) at ‘BB-‘. The Rating Watch Negative has been removed, and a Negative Outlook has been assigned. The rating also includes PLNG’s $940mn senior unsecured notes due 2030.

PLNG’s Ratings and Negative Outlook reflects weaker operational performance given the declining international prices for natural gas, and consequent higher leverage due to decreasing EBITDA generation. Per Fitch’s recently updated Oil & Gas Price Deck reflecting a slight upward trend scenario for Henry-Hub (HH) and depressed National Balance Point (NBP) indexes, materially higher leverage has been forecast for PLNG, with net leverage metrics expected to reach a peak of 17x during 2020, and remain above 8x during 2021, exacerbating the company`s cash flow volatility. Fitch expects PLNG`s net leverage to reach 5x during 2023, in line with international gas prices recovery.

Fitch believes lower international gas prices should result in a slower deleverage trajectory for Peru LNG than initially expected for the next few years and then decreasing as bond start amortizing. Fitch expects PLNG will remain with adequate liquidity, offsetting the high leverage during 2020-2021. As of June 2020 PLNG, reported $163mn of cash on hand, with an additional $75mn on committed undrawn credit line facility, covering annual interest payments of roughly $50mn of PLNG`s outstanding $940mn notes. Going forward, Fitch expects PLNG to not distribute any dividends over the rating horizon, combined with EBITDA to Debt Service to average approximately 0.9x during the amortization period, and that PLNG is expected to build up its cash position over the next few years to cover the shortfall in debt service, as the notes amortization payments start in September 2024.

KEY RATING DRIVERS

Deteriorated EBITDA Due to Lower Gas Prices: For the LTM as of June 2020, PLNG`s EBITDA registered $52mn, mainly explained by a gross profit decrease reflected on the company’s margin contractions due to lower international LNG prices. Fitch expects PLNG`s EBITDA during 2020 will reach approximately $50mn, assuming 67% of shipments sent to HH-indexed destinations, making a substantial portion of PLNG’s operational performance linked to this index, and the remaining portion evenly distributed between NBP and JKM indexes. Given the company’s structure of its Purchase Agreement with Shell International Trading Middle East Limited (SITME), Fitch estimates the exposure to commodity price risk remains a key issue for PLNG given low HH and NBP gas prices.

Leverage Remains High: Per Fitch’s Oil & Gas price assumptions, natural gas prices for HH and NBP will remain pressured during 2020-2021, reflecting European natural gas supply glut, exacerbated by the coronavirus crisis, while Henry Hub price assumptions reflect lower associated gas production in the U.S. Declining international gas prices should result in a slower deleverage trajectory for Peru LNG, with net leverage staying above 4.5x for the next few years, reaching a peak of 17x during 2020. FCF is forecast to remain negative during 2020, turning positive through the medium term including additional capex related to the projects of ethane recovery and port availability. Fitch expects PLNG to not distribute any dividends over the rating horizon in order to accumulate cash to make front-to-debt amortization payments starting in September 2024.

Moderate to Low Business Profile: PLNG’s ratings reflect its moderate to low business-risk profile, stemming from its Sales and Purchase Agreement (SPA) with Shell International Trading Middle East Limited (SITME), which has no volume risk, but has commodity price exposure to Liquefied Natural Gas (LNG) prices. As per the company’s Contracted Sales Prices (CSP) Structure with SITME, PLNG is committed to deliver a fixed volume to its off taker under a take or pay structure until 2028. SITME delivers natural gas cargos to international markets, which are paid at different pricing indexes depending on actual natural gas supply and demand in those markets. PLNG receives payments from SITME defined on indexes such as HH, NBP and Japan Korea Marker (JKM). Subsequently, PLNG pays Camisea, through the Gas Supply Agreement (GSA) based upon the multiple destinations natural gas cargos were dispatched.

Strong Off-Taker and High-Quality Shareholders: The company’s ratings are supported by the strength of PLNG’s gas buyer: Royal Dutch Shell Plc (AA-/Stable). Fitch estimates that PLNG’s production represents 3% to 5% of Shell’s global integrated gas sales. In addition, Shell is PLNG’s second largest shareholder with a 20% stake in the company, after Hunt Oil with a 50% stake, which is also the operator of PLNG. SK Innovation owns a 20% stake and the Japanese industrial conglomerate Marubeni Corporation with the remaining 10% stake of PLNG’s shares. Strong shareholder agreement shows the commitment to maintaining the viability of the company both in the supportive contracts to which they are party to, as well as in the form of direct support, including a $60mn capital injection in 2016 that bolstered PLNG’s already robust liquidity position.

Strategic Asset in the Country: PLNG’s operations are a key link in the chain of royalties, which has historically contributed up to $650mn in payments to the government. Although depressed oil and gas prices have diminished these cash flows, Fitch estimates that the government still stands to receive between $100mn and $150mn annually over the medium term related to both natural gas production and, more importantly, associated liquids from Block 56 in the Camisea field. PLNG consumes approximately 50% of Camisea’s natural gas production, exporting to international markets almost all of its production, contributing to the country’s monetization of its liquid’s resources.

In addition, PLNG is gradually being integrated into Peru’s domestic gas supply strategy in the form of expanded trucking services for transportation within its borders. Although currently small-scale, this is a service that gains some measure of additional importance in light of the suspension of Southern Gas Pipeline project. Fitch estimates these factors as mitigation to the kind of social and environmental obstacles that can disrupt companies in the sector.

Natural Monopoly: PLNG is insulated from competitive risk within Peru by virtue of high investment barriers and a gas supply agreement (GSA) that effectively gives it exclusive rights to much of the country’s exportable gas supply, allocated in Block 56. PLNG’s total construction costs reached $3.8bn during 2010 and remains South America’s sole liquefaction plant. Additionally, the company has secured a forty-year investment agreement with the government, protecting PLNG from any modification or amendments upon the terms agree through a unilateral decision.

Given the NG supply characteristics of the continent, it seems unlikely that additional investments in capacity will be forthcoming. Within Peru, liquefaction capacity is also limited, primarily as function of the allocation of gas resources and PLNG’s GSA with Block 56 of the Camisea field. The bulk of the country’s reserves are located within the Camisea consortium’s Block 88, but this block is exclusively reserved for domestic NG consumption. Nearly 90% of the country’s remaining gas reserves are within Blocks 56 and 57, whose production is ultimately committed to PLNG.

Manageable Capex Program: Fitch estimates total capex of $18mn during 2020, including PLNG`s investments to increase port availability ($8mn), and ethane recovery project ($2.3mn) and total capex during 2021 will reach approximately $30mn, including $17.6mn, to complete the port availability project, $5.4mn for ethane recovery, and $7mn for maintenance at the plant. Going forward the agency expects PLNG’s regular maintenance capex flat at $5mn over the rating horizon. Fitch believes PLNG could cover these investments, with the company`s internal cash flow generation without incurring in additional debt.

DERIVATION SUMMARY

PLNG has limited regional peers. Even outside Latin America, LNG plants tend to operate on a more purely take-or-pay, capacity-based on a tolling business model, whereas PLNG incorporates commodity price risk. Tolling based peers such as Transportadora de Gas del Peru (BBB+/Stable) and GNL Quintero S.A. (BBB+/Stable) benefit from the related cash flow stability afforded by their revenue structure. GNL Quintero, in particular, supports a significantly higher leverage (between 6.0x to 7.0x through the medium term), as it operates a tolling terminal unloading, storing and re-gasifying liquefied natural gas on behalf of gas buyers under 20-year exclusive term use-or-pay agreement.

While TGP has a projected leverage of 2.5x in the near term, its revenues derived from long-term ship or pay contracts to transport natural gas and natural gas liquids from the country’s main gas production formation, Camisea, to the main consumption area and export terminal. Similar to GNL Quintero, PLNG is considered a strategic asset for the country, while GNL Quintero allows the liquefaction from imported natural gas in Chile, PLNG is the main infrastructure allowing Peru to export natural gas. In terms of operation, both terminals present high efficiency levels with an average of 91.7% during 2019 for PLNG and 99.5% for GNL Quintero.

In the U.S. corporate universe, Cheniere Energy Partners’ (BB/Stable) rating is supported by a secured debt structure and subsidiary business models consistent with the aforementioned tolling structure. Its rating is primarily linked to its deep structural subordination, with roughly $14bn out of $16bn of non-recourse debt structurally senior to Cheniere’s bonds. TransCanada PipeLines Limited’s (A-/Negative) large scale and diversity across regulatory-based and long-term contracted businesses in natural gas pipelines warrants a higher rating compared with PLNG’s single operation.

KEY ASSUMPTIONS

–Fitch’s Gas price deck for Henry Hub (HH) at $2.1 per MMBtu during 2020 and long-term price at $2.45;

–Fitch’s Gas price deck for National Balance Point (NBP) at $2.5 per MMBtu during 2020, $3.75 in 2021, $4.5 during 2022 and long-term price at $5.0;

–HH-indexed destinations receive 67% of shipments, with the remainder evenly distributed between NBP and JKM-indexed destinations;

–Transportation costs annually adjusted by the U.S. Producer Price Index;

–Annual capex of $18mn during 2020 and $30mn in 2021, including the port availability and ethane recovery projects. Long term maintenance capex of $5mn;

–No dividends payments during rating horizon.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

–Amendments to contracts that would reduce price and volume risk, similar to its tolling-based peers in the region;

–Net leverage consistently below 3.5x;

–Built up cash consistently over the rating horizon with EBITDA interest coverage consistently over 3.5x;

–Hedge strategy to mitigate the company’s exposure to commodity price risk;

–Greater visibility on medium- to long-term re-contracting options.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

–Any cash distribution to shareholders combined with acceleration in repayments of $110mn drawn credit line with SITME;

–Consecutive years of negative FCF preventing the company to accumulated cash to serve its debt payments;

— Failure to reach total net debt to EBITDA below 5x; and EBITDA interest paid coverage ratio above 2.5x by 2023;

–Material disruptions in gas supply or other operational outages eroding the company’s cash flow generation.

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

LIQUIDITY AND DEBT STRUCTURE

Adequate Liquidity: As of June 2020, the company reported $163mn of cash on hand. Going forward, Fitch estimates an average annual capex for maintenance purposes $7mn, with additional capex of $33mn during 2020 and 2021 for projects. PLNG faces no significant maturities in the short term, as the bond starts amortizing during 2024. In addition, PLNG has a $75mn undrawn committed credit line.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG CONSIDERATIONS

The highest level of ESG credit relevance, if present, is a score of 3. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity(ies), either due to their nature or to the way in which they are being managed by the entity(ies). For more information on Fitch’s ESG Relevance Scores, visit www.fitchratings.com/esg.

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