March 20, 2018/S & P Global Ratings
- Seplat Petroleum Development Company PLC is an independent indigenous Nigerian oil and gas exploration and production company focused on onshore production in the Niger delta.
- After major operational disruptions in 2016-2017, following the 16-month long shutdown of its key export terminal, we now see a path to production growth in 2018-2019.
- Recently Seplat issued $350 million of notes maturing in 2023 to refinance its existing debt.
- We are assigning our ‘B-‘ long-term rating to Seplat.
The positive outlook reflects the possibility of an upgrade in the next 12 months, subject to Seplat maintaining smooth operations and us getting a clearer view of the company’s future growth.
S&P Global Ratings today assigned its ‘B-‘ long-term issuer credit rating to Nigeria-based oil and gas producer Seplat Petroleum Development Company PLC. The outlook is positive.
At the same time, we assigned our ‘B-‘ issue rating to Seplat’s proposed $350 million senior unsecured notes.
These ratings are in line with the preliminary ratings we assigned on Feb. 28, 2018.
The rating on Seplat reflects our assessment of the company’s vulnerable business risk profile and aggressive financial risk profile based on the proposed capital structure. The rating also captures a potential midsize acquisition, in line with the company’s strategy, which may translate into weaker credit metrics.
Our assessment of Seplat’s business risk is driven by its operations in Nigeria, which we view as a very high-risk jurisdiction. This is because of security risks including downtimes, militancy, and theft. From 2016, tensions between some groups in the Niger Delta and the Nigerian government have escalated, which resulted in the explosion of the offshore loading arm of Shell’s Forcados export terminal. Following talks between the groups involved and limited interruptions in the last six months, a lull appears to be prevailing, although the political situation remains precarious.
Other elements include Seplat being a relatively small exploration and production player, with net working interest production of around 47,522 barrels of oil equivalent per day (boepd) from June to year-end 2017 and with 2P (proved plus probable) reserves standing at 477 million boe as of Dec. 31, 2017, evenly split between oil and gas.
The February 2016 explosion of the Forcados pipeline, which is Seplat’s main export route, and the extended period until it resumed operations, materially hindered the company’s operational performance. Seplat saw a decline in its total production to about 26,000 boepd in 2016 and in the first half of 2017, compared with about 43,000 boepd in 2015. The firm had to take sweeping measures to keep operating during the period, including significant operating and capital expenditure (capex) cuts and debt restructuring, as well as establishing an alternative export route via Warri Refinery.
Since the third quarter of 2017, we have seen a gradual increase in production which, as of today, is above pre-crisis volumes. We assume the company will reduce its reliance on the Forcados terminal in the coming year with the commission of the Escravos pipeline in the third quarter of 2018, and retain the ability to access the Warry refinery jetties, as it did recently.
Positively, we note the development of Seplat’s gas business in the past two years. We understand that sales from this business accounted for about 30% of the company’s total sales in 2017. The gas is consumed locally, supported by healthy demand and ongoing price increases, de-linked from oil prices. Under our base case, we project that sales from the gas business will increase to $250 million-$300 million in 2020 from about $124 million in 2017, providing the company with some diversity.
Our assessment of Seplat’s aggressive financial risk profile is underpinned by its ability to maintain S&P Global Ratings-adjusted funds from operations (FFO) to debt of 30%-45% over the coming years. Our assessment takes into account the company’s strategy of allocating a significant portion of its cash flows to develop the business, both organically and through mergers and acquisitions (M&A).
In addition, we factor in some buffers to absorb either operational issues or volatility in prices. Our threshold for the rating may change over time as the company continues to develop its portfolio, especially if it reduces its concentration risk. For example, a sizable acquisition that improved the portfolio and produced stable cash flows could result in a lower credit metrics threshold for the current rating. At this stage, we have limited visibility on the timeline of a potential acquisition, scale, contribution to the cash flow, and other related factors.
After the refinancing, the company’s debt is expected to be about $550 million, including notes of $350 million and $200 million drawn under a new revolving credit facility (RCF) replacing the existing $300 million facility. On the other hand, we estimate a cash position of about $350 million.
In 2017, Seplat reported $199 million EBITDA, of which about two-thirds is linked to the second half of the year (following the re-commissioning of the Forcados terminal), reflecting the normal production level and the benefits of the company’s cost-saving initiatives.
Looking to 2018, we expect to see a material strengthening of EBITDA to $400 million-$420 million, with further upside in 2019. This improvement stems mainly from oil production returning to historical levels, a ramp-up of the gas operations, and some increase in oil prices.
Our projections are underpinned by the following assumptions:
- An average Brent oil price of $60 per barrel (/bbl) in the rest of 2018, declining to $55/bbl in 2019. Gas price of $3/Mscf (one thousand standard cubic feet) over the entire forecast period. The Brent oil spot price is about $65/bbl.
- Total production of about 50,000 boepd in 2018, followed by 55,000-60,000 boepd in 2019. We believe that most of the upside in the production will come from the ramp-up of the gas production in its main fields (OML4, OML38, and OML41). According to our calculations, a more rapid ramp-up of the gas business in 2018 will have only a modest effect on EBITDA.
- Operating expenditure/barrel oil equivalent around $10 in 2018-2019.Our capex assumption of $150 million-$200 million in 2018, slowly increasing in 2019. We note that the company’s capex is discretionary and is therefore very flexible. In practice, we believe that if spot prices stick, the company would accelerate its drilling effort in the second half of 2018 and in 2019.
- We factor in the collection of some of Nigerian Petroleum Development Company (NPDC) past obligations (about $117 million as of Dec. 31, 2017).We do not expect a delay in the collection of receivables to have a direct effect on the rating.
- No acquisitions, given the uncertainty around timing, cash outflow, and future contribution. That said, our rating captures a potential midsize acquisition on a holistic basis as part of the company’s financial policy.
Resuming dividends in 2018. In our view, over time, the total distribution will be subject to the spending on growth.
Based on these assumptions, we arrive at the following credit measures (our adjusted debt doesn’t take into account the company’s outstanding cash and can change upon changes in the RCF utilization):
- Adjusted debt to EBITDA of around 1.2x-1.3x in 2018 and 2019.
- S&P Global Ratings adjusted FFO to debt of about 50%-55% over the forecast period.
- Positive free operating cash flow (FOCF) of $60 million-$80 million in 2018. In our view, FOCF in 2019 would largely rely on the company’s capex budget.
In our view, the positive FOCF in the next two years (over $100 million), together with the cash on the balance sheet ($437 million as of Dec. 31, 2017), are likely to be used to fund potential acquisitions, and to some extent, dividends. According to Seplat, potential targets will be cash flow generative onshore or shallow water assets in Nigeria.
The positive outlook reflects that we could upgrade Seplat in the next 12 months. In our view, a higher rating would depend on the company maintaining smooth operations, with some elements of de-risking (commission of the Escravos pipeline and increase the gas production), as well as us getting a clearer view of the company’s future growth.
Under our base-case scenario, we expect Seplat to generate EBITDA of at least $400 million in each of the coming two years, translating into positive FOCF and a higher cash balance, allowing it to further develop its portfolio, either organically or by M&A.
We could raise the rating by one notch if we see progress on the following items:
· Smooth operations with execution of ongoing projects. This includes a longer track-record of operations, with sustainable production level of at least 50,000 boepd and commissioning of the Escravos pipeline later on this year.
· Better visibility on the company’s expansion program, and the evolution of the company’s capital structure.
In our view, an improvement in the company’s credit metrics is not likely to lead to a higher rating without progress in the abovementioned areas. While we expect the company to maintain adjusted FFO to debt of 30%-45% for the current rating, we would reassess the commensurate range for a higher rating as we become clearer about the company’s growth plans. Some of the considerations would include the size of any potential acquisition, price, cash flow contribution, source of funds, and the likelihood of Seplat pursing additional acquisitions.
In addition, any positive rating action will be subject to no negative news in regards to the political conflict in the Niger delta.
We could revise the outlook to stable if the Escravos pipeline commissioning were delayed or if Seplat failed to achieve production levels in line with its potential because of new operational disruptions. Rating pressure would also arise if liquidity weakened because of lower-than-expected cash generation or an increase in debt to finance a large acquisition.
Furthermore, we might take a negative rating action if the company experienced production disruptions of a more permanent nature or in the case of escalation in the political conflict in the Niger delta.