November 8, 2016 - 12:57 PM EST
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Fitch Expects to Rate FLNG Liquefaction 2 'BBB'; Outlook Stable

Fitch Ratings expects to rate FLNG Liquefaction 2, LLC's (FLIQ2) 4(a) (2) private placement of senior secured notes due 2038 'BBB(EXP)'. Fitch also affirmed the 'BBB' rating on $1.25 billion outstanding senior secured notes at 4.125% due 2038. The new issuance will replace some current bank debt and be pari passu with all existing senior debt. The rating considers a total debt quantum of about $4.080 billion. The Outlook is Stable.

The 'BBB' rating reflects a stable revenue profile from a tolling-style agreement with offtaker BP Energy Company, whose obligations are guaranteed by its strong parent company, BP Corporation North America Inc. Completion risk is manageable and adequately mitigated. The offtaker bears all feedstock supply and cost risks. Proven equipment, experienced operators, excess capacity and pass-through of nearly all power expenses help mitigate operating risk, but the project is exposed to increases in approximately 41% of operating costs. The financial profile under operational and financial stresses is supportive of the rating with debt service coverage ratios (DSCR) averaging 1.73x in Fitch's rating case, potentially falling to approximately1.40x if permitted additional senior debt is issued. The Stable Outlook reflects that the project is still on track to be completed by the substantial completion date of February 2019.

KEY RATING DRIVERS

Manageable Completion Risk [Completion Risk: Midrange]: Development of the minimum 4.64 million metric tons per annum (mtpa) liquefied natural gas (LNG) train is supported by a fixed-price, turnkey engineering, procurement and construction (EPC) agreement with experienced contractors. Liquidity provided by the EPC contractors' letter of credit and the owner's contingency is sufficient to absorb substantial cost overruns and reasonable delay scenarios. The project has been in construction for nearly 24 months, further mitigating the potential for delays and cost overruns. Completion of the common facilities is strengthened by guarantees from Osaka Gas and Chubu Electric and a letter of credit from FLIQ1 to fund FLIQ1's share of the common facilities.

Stable, Contracted Revenues [Revenue Risk: Stronger]: The long-term tolling agreement provides a stable revenue stream, with minimum fixed capacity payments sufficient to meet fixed operating costs and debt service. The offtaker's obligations are guaranteed by investment-grade corporate parent BP Corporation North America Inc. Performance requirements are not onerous and contract termination risk is low.

Stable Operating Profile [Operation Risk: Midrange]: Operating performance risk is mitigated by the application of proven technology, which includes numerous installations worldwide. Excess production capacity and redundant equipment reduce the impact of potential forced outages. Output shared among three LNG trains mitigates the single-site risk of FLIQ2. Fitch expects low margin variability, as more than half of operating and maintenance (O&M) expenses consist of variable power costs, which are nearly all absorbed by the offtaker. The project demonstrates substantial resilience to unexpected cost increases, and can meet required debt service obligations in a 100% cost increase stress scenario.

No Supply Risk [Supply Risk: Stronger]: FLIQ2 has no exposure to the potential variability in feedstock supply or cost, as the offtaker must procure feed gas for LNG operations.

Manageable Debt Structure [Debt Structure: Midrange]: During construction an average of 89% of debt is fixed-rate either through the current bond issuance or interest rate hedging, which minimizes refinance risk. By project completion, 100% of the debt is expected to be refinanced at fixed rates. Equity distribution tests and debt service reserves are consistent with typical investment-grade project finance features. Fitch assesses a total debt quantum of about $4.080 billion. The rating considers the potential for additional allowable debt after project completion.

Investment-Grade Financial Profile: Base case DSCRs average 1.80x with a minimum of 1.74x . Under a combination of stresses of lower capacity output and increased cost, rating case DSCRs average 1.73x with a minimum of 1.68x, which are supportive of the rating.

Peer Comparison: Cameron LNG's rating ('A-'/Stable Outlook) is higher due to a stronger average rating case DSCR of 1.81x compared to 173x for FLIQ2. Cameron's completion risk is lower due to sponsor guarantees, and cost risk is lower as 100% of O&M costs are absorbed by the offtakers. Dolphin Energy ('A+'/Stable Outlook), which extracts gas from offshore fields in Qatar was also permitted to issue incremental debt similar to FLIQ2, which Fitch included in its rating case resulting in an average DSCR of 2.74x. Ras Gas ('A+'/Stable Outlook), an LNG facility in Qatar is fully exposed to merchant pricing, but its rating reflects the project's high financial flexibility to withstand low oil and gas prices with rating case DSCRs averaging 5.27x.

RATING SENSITIVITIES

Counterparty Risk: Downgrade below 'BBB' of Osaka Gas, Chubu Electric or BP Corporation North America would result in a downgrade for FLIQ2.

Completion Delay: Construction delay of more than six months past the guaranteed completion date could result in a downgrade.

Variable Costs and Operating Performance: Unstable plant performance or materially increasing costs that reduce rating case DSCRs below 1.40x could result in a downgrade.

Increased Leverage: Issuance of additional debt that results in a rating case DSCR profile of less than 1.40x could result in a downgrade.

SUMMARY OF CREDIT

FLIQ2 is owned by IFM Global Infrastructure Fund (IFM) and Freeport LNG Expansion, L.P. (FLEX). FLIQ2 will be a minimum 4.64 mtpa train facility that will liquefy U.S. natural gas for export. LNG output of 4.40 mtpa is contracted under a 20-year tolling agreement with BP Energy Company whose obligations are guaranteed by BP Corporation North America Inc. Though FLIQ2 is financed as a standalone special purpose vehicle, the train's operation will be integrated into the total Freeport system, which includes two other trains each with the same amount of LNG capacity, FLIQ1 and FLIQ3. All trains will be managed by the same O&M provider. They will share costs, access to and ownership of various common facilities, and will jointly bear the risk of operating performance.

After installing FLIQ1 and FLIQ2, the existing regasification terminal will have been converted to a bi-directional facility capable of importing and exporting LNG. Upon completion, the liquefaction project will consist of three liquefaction trains, three natural gas pre-treatment facilities, a second marine dock and loading lines, and related equipment and facilities. Total debt proceeds are to support project construction, financing fees and hedge breakage costs.

Merlin, the independent engineer, opined that the project is still on target to achieve substantial completion. Overall engineering, procurement and construction are slightly ahead of schedule (44% achieved vs 38% planned), despite delays in some milestones including construction of the common facilities (41% achieved vs. 48% planned). While the contractors are revising their milestone schedule to catch up, the substantial completion date remains unchanged. As such the overall progress supports maintenance of the Stable Outlook.

Additional information is available on www.fitchratings.com

Applicable Criteria

Rating Criteria for Infrastructure and Project Finance (pub. 08 Jul 2016)

https://www.fitchratings.com/site/re/882594

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form

https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1014481

Solicitation Status

https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1014481

Endorsement Policy

https://www.fitchratings.com/regulatory

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Source: Business Wire (November 8, 2016 - 12:57 PM EST)

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