OREANDA-NEWS. Fitch Ratings upgrades Merey Sweeny, L.P.'s (MSLP) \$350 million (\$188.5 million outstanding) senior unsecured bonds due 2019 to 'BBB+' from 'BBB'. The Rating Outlook is Stable.

KEY RATING DRIVERS

The upgrade and Stable Outlook are linked to Fitch's view of the credit quality of Phillips 66, which guarantees the full and timely payment of debt service.

Sponsor Bond Guarantee for Debt Service: Phillips 66 and Phillips 66 Company irrevocably and unconditionally guarantee the full and timely payment of the outstanding senior unsecured bonds.

Lack of Revenue Risk: Revenue volatility is mitigated by the annually adjusted floor price established under the offtake agreement with Phillips 66 Company. The sponsor is obligated to provide MSLP with financial support for operating and capital costs and scheduled debt service via the floor processing fee and capital calls. The offtake agreement with Phillips 66 Company expires in 2024, providing five years of unlevered cash flow after debt maturity in 2019.

Stable Operations: The oil refinery is operated by an experienced investment-grade sponsor with the plant operating as expected.

Low Supply Risk: The project has adequate supply for crude oil through its supply agreement with Petroleos de Venezuela, S.A. (PDVSA; rated 'CCC' by Fitch). Exposure to PDVSA is limited as the project has alternative access to U.S. and Western Canadian crude oil supplies, with the cost absorbed by the sponsor if there is insufficient cash flow at MSLP.

Conventional Debt Structure: The debt is fully amortizing and fixed-rate maturing in 2019, common features of investment grade projects.

RATING SENSITIVITIES

Negative/Positive - Phillips 66 Credit Quality: A change in Phillips 66's credit quality would result in an upgrade or downgrade of MSLP.

SECURITY

The initial security package did not entitle bondholders to any security interest in the project's assets or agreements, which is atypical of most project financings. Under the terms of the Transfer Agreement between ConocoPhillips (COP) and PDVSA, a call event occurred when PDVSA breached its payment obligations in connection with its curtailment of crude supply in 2009. The call event triggered a purchase option in favor of COP, who exercised the option on Aug. 28, 2009 making COP, or Phillips 66 post-separation, the sole sponsor. The Future Pledge Agreement contains a springing lien mechanism that assigned a first priority security interest in the sponsor's 100% interest in the partnership to the bondholders upon the call option being exercised. As a result, a security interest in 100% of the sponsor's equity interest in the project has been assigned to senior bondholders.

CREDIT UPDATE

Financial performance was adequate in 2014 with a debt service coverage ratio (DSCR) estimated to be 1.63x per the project's rate covenant, and based on unaudited financial statements. Fitch estimates the DSCR to be 1.59x after including capital expenditures. The project's financial performance in 2014 was buoyed by a rebound in the average WTI-Maya differential at \$7.39. The high price reflects the volatility in recent years in which the average differential was below \$1.00, resulting in increased reliance on the sponsor's financial support.

Under Fitch's financial analysis of increased operating expenses and a WTI-Maya differential starting at \$3.00, Fitch projects below 1.0x DSCRs through 2019. Coverage ratios reflect the project's need for sponsor support. Pressure remains given the volatility of the WTI-Maya differential and the project's sizeable five-year capital plan with the largest expenditures taking place in 2017 and 2018 (\$16.3 million and \$18.5 million, respectively) primarily for environmental compliance.

As indicated by Fitch in previous reviews, PDVSA challenged COP's exercise of the call option to acquire PDVSA's interest in MSLP on March 1, 2010. Management reports that an arbitral panel issued a partial award on April 23, 2014 having determined that COP had properly exercised the call option. PDVSA's appeal is expected to be considered by a New York court by the end of 2015. Fitch does not view the arbitration determination as a rating constraint, since the results will not alter or limit Phillips 66's liability under the senior bond guarantee.

COP and PDVSA formed a partnership in 1998 to build, own, operate and maintain certain facilities and improvements to the Sweeny Refinery. The project consists of a delayed coker, vacuum tower, and associated facilities within the refinery. The refinery has capacity to process 66,700 barrels per day of light, sweet crude oil as well as 180,000 barrels per day of heavy, sour crude.

MSLP is a wholly owned subsidiary of Phillips 66. Phillips 66 is the project operator and off-taker, and is responsible for any contractual sponsor support obligations.