OREANDA-NEWS. Fitch Ratings has downgraded UK-based energy group Afren plc's Long-term Issuer Default Rating (IDR) to 'RD' (Restricted Default) from 'C', following the company's default on its USD15m coupon payment under its 2016 notes. The company's senior secured rating is affirmed at 'C'/'RR6'.

The rating action follows Afren's announcement that it has decided, at the expiration of the 30 day grace period, not to pay USD15m of interest originally due on 1 February 2015 under its 2016 notes. Effectively, it means that Afren has defaulted on the obligation.

Afren says it has received an assurance from the ad hoc bondholders committee that the creditors have no current intention to take enforcement action with regard to the 2016 notes; however, we do not view this assurance from the ad hoc committee as legally binding on all bondholders. Afren continues to discuss with its advisers and largest stakeholders a possible financial restructuring. On 2 March 2015 Afren announced it obtained from the lenders of its USD300m Ebok facility a further deferral of the USD50m amortisation payment due at end-January 2015 until end-March 2015.

In the event of a capital restructuring, we will review the rating to reflect the appropriate IDR for the issuer's post-exchange capital structure, risk profile and prospects in accordance with relevant criteria, once sufficient information is available.

KEY RATING DRIVERS

Lower Production, Higher Leverage
Afren's credit metrics have weakened since the beginning of the year, reflecting lower output in 2014 compared with 2013 and lower oil prices. Its funds from operations (FFO) adjusted gross leverage was 2.8x at end-9M14 (1.8x at end-2013), and we believe it will exceed 4x in 2015, assuming moderate production growth, Brent price of USD55/bbl in 2015 and the company's hedging arrangements.

Reserve Revision Adds to Pressure
In January 2015 Afren announced it has revised down gross 2P reserves at the Barda Rash field in the Kurdistan region of Iraq by 190 million barrels of oil equivalent. The movement in reserves and resources is due to the 2014 reprocessing of 3D seismic shot in 2012 and processed in 2013, as well as results from the company's drilling campaign. Although we have not factored in the potential production in Kurdistan in our model, this change removed a potential source of flexibility for the company or recovery for creditors.

Finding New Management Critical
Finding suitable replacements for dismissed executives is a significant challenge for Afren. This is particularly important in view of the company's reduced output in Nigeria and interrupted operations in Kurdistan. Fitch is seeking more information on Afren's strategy and direction to stabilise and increase output, especially if oil prices remain at their depressed levels - which may be difficult in the absence of a permanent CEO with a clear strategic vision.
Production to Stabilise
Afren's net production declined to 27.2 thousand barrels per of oil per day (mbpd) in 3Q14 from 49.6mbpd in 3Q13, reflecting a lower production share after initial cost recovery but also due to lower gross production at Ebok, its major asset.

We expect that in 2014 Afren's net production would have been at or slightly below 32mbpd, 15% lower than we had projected in May. Afren explains that the lower-than-expected production mainly results from operational delays with installing the Central Fault Block Extension platform at Ebok, and maintenance works in 3Q14. The platform, which is set to be finally completed in January 2015, should enable Afren to increase output of the field. Other projects, including the North Fault Block at Ebok and ramping-up OML26, should help Afren stabilise its net oil production in the medium term. We expect the company's net production to average 37mbpd in 2015.

Concentrated Production
Afren's production remains highly concentrated. In 9M14, Ebok accounted for 68% of Afren's total production, and it had no material oil output outside Nigeria. Any swift progress in Kurdistan, where Afren has material reserves, is now less likely than we previously expected due to Kurdistan's unstable political and security environment and higher-than-expected water content. Other challenges include a lack of access to a secure transportation channel and an absence of the associated gas treatment infrastructure. We assume that Nigeria is likely to dominate Afren's output in the medium term. Such concentration exposes Afren to elevated regulatory and tax risks.

Tax Holiday Benefits Cash-Flows
Oil companies are generally heavily taxed in Nigeria - they pay substantial royalties and are subject to the petroleum profit tax (PPT), which normally varies from 50% to 85% of pre-tax profits. Afren's Ebok field is exempt from paying PPT up to May 2016, which significantly benefits Afren's cash flows and should help finance new projects while keeping leverage at a moderate level. However, the recent production decline at Ebok and lower oil prices could make this strategic advantage less pronounced. We expect that Afren's cash tax payments will materially increase in 2017.

KEY ASSUMPTIONS

- Oil price: USD55/bbl in 2015, USD65/bbl in 2016 and USD80/bbl thereafter
- net oil production to average 37mbpd in 2015
- maintenance capex of USD200-USD300m in 2015-2016
- no dividend payments

RATING SENSITIVITIES

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Afren entering into bankruptcy filings, administration, receivership, liquidation or other formal winding-up procedure

Positive: Following the possible financial restructuring and once sufficient information is available, the 'RD' rating will be re-rated to reflect the appropriate IDR for the issuer's post-exchange capital structure, risk profile and prospects in accordance with relevant criteria.

LIQUIDITY AND DEBT STRUCTURE

Fitch views Afren's liquidity risk as high. The company agreed with its lenders regarding a further deferral of the USD50m amortisation payment under the USD300m Ebok facility and has defaulted on its 2016 notes. At 31 December 2014 Afren reported that it had a cash balance of approximately USD235m. The company has now confirmed that actual liquidity available is significantly lower than cash on balance sheet as a result of restricted and segregated cash balances in place to address operational requirements.