OREANDA-NEWS. Fitch Ratings has assigned Kosmos Energy Ltd.'s (KOS; B/Stable) upcoming senior secured notes an expected 'B(exp)' rating with a Recovery Rating 'RR4'.

The notes are rated in line with KOS's Long-term Issuer Default Rating of 'B' as they will represent direct, senior and unconditional obligations of the company.

The assignment of the final rating is contingent on the receipt of final documents conforming to information already reviewed.

The notes will be issued at the holding company level and will mirror the existing USD300m notes due 2021. The issue proceeds will be used to repay a part of the company's reserve based facility (RBF) and to enhance its liquidity position.

KOS is a small but growing oil and gas exploration and production company focused on the offshore Atlantic margin, with 2014 net production of 23 thousand barrels of oil per day (Mbpd) from the offshore Jubilee field in Ghana (B/Negative). The company has a 24.1% working interest in the Jubilee field, which produces around 100Mbpd. In 2014 KOS generated USD723m in EBITDAX (EBITDA before exploration expenses).

KEY RATING DRIVERS

Hedging Mitigates Falling Oil Prices
We expect KOS's EBITDA to decline in 2015 but to be mitigated by its strong hedging position. Around 70% of the company's 2015 production is hedged. Its net leverage will be higher than previously expected (current expectation: 1.8x at end-2015 for funds from operations (FFO) adjusted net leverage; around 2x through the cycle), though it should still be comfortably below our negative rating action trigger (3.5x) in spite of heavy capital spending primarily associated with the TEN project.

At end-March 2015 Brent was trading at around USD55/bbl, compared with USD110/bbl in early July 2014. We expect prices to rebound to the marginal cost of supply of USD80 Brent by 2017, which we now use as a base case.

Business Scale Determines Ratings
KOS's scale of operations and limited geographical diversification are dominant drivers of its 'B' ratings. Its business profile is constrained by its limited scale of operations relative to other upstream exploration and production peers. KOS intends to boost production by developing two sites in close proximity to the Jubilee field, TEN (Tweneboa, Enyenra, Ntomme) and possibly MTA (Mahogany, Teak, Akasa), but this is unlikely to dramatically change the company's industry position in the medium term.

Concentrated Production
KOS's production remains highly concentrated in offshore Ghana. Jubilee now accounts for 100% of KOS's total production. At end-2014 KOS had proved oil and gas reserves of 75 million barrels (MMboe), which translates into reserve life of nine years, typical for 'B'-rated names.

Ghana is likely to dominate KOS's output in the medium term despite other exploration projects currently underway off the coast of west Africa. The concentration in Ghana and the company's current reliance on the Jubilee field expose KOS to elevated geological risks, as well as legal, political and tax risks.

Elevated Country Risks
KOS is exposed to elevated country risks, as its operations are concentrated in Ghana. Ghana has a strong business environment relative to that of other African countries, ranking 70 out of 189 in the World Bank's 2015 Doing Business Survey. It is also safer compared with some other parts of Africa such as the Niger Delta, where local groups often attack companies, leading to interrupted production and oil theft. However, the country's public finances are weak.

We expect that the tax regime for oil companies in Ghana will not change over the medium term, and KOS's tax burden will not materially increase. However, this possibility cannot be ruled out due to Ghana's large budget deficit. We also assume that KOS's operations would not necessarily be affected by capital controls or other possible restrictive measures, since the company's proceeds do not flow through Ghana, and its cash assets are kept primarily outside Ghana. We therefore do not cap KOS's rating at the sovereign rating or the Country Ceiling. However, we may review this approach if the government attempts to revise the tax regime in Ghana.

Substantive Exploration Portfolio
KOS has a wide exploration portfolio, including several licence blocks in offshore west Africa, Portugal, Suriname and Ireland. This may help KOS's replenishment of its reserves. However, success is not guaranteed, and the company's exploration budget may put a strain on its free cash flow (FCF). A failure to translate exploration spending into increased proved reserves could negatively affect the ratings.

Conservative Mid-Cycle Leverage
KOS's leverage will increase over the next two years but will remain rather conservative compared with other 'B'-rated peers. Its operating cash flows will decrease because of lower oil prices, and capital intensity will remain high. Based on our conservative assumptions, we expect the company's FFO adjusted net leverage to fluctuate around 2x, higher than at end-2014 (0.5x) but still a fairly moderate level. We also believe KOS is likely to be FCF-negative in at least 2016 and 2017.

LIQUIDITY AND DEBT STRUCTURE

Strong Liquidity
As of 31 December 2014 KOS's liquidity position was strong. The company had no short-term debt, and available cash of USD555m. Additional liquidity support was also available in the company's USD1.5bn RBF (USD1,000m undrawn) and its undrawn USD300m revolving credit facility. The upcoming notes should further improve the company's liquidity position.

Upcoming Notes
The upcoming notes are expected to mirror the existing 7.875% senior secured notes due 2021. Notes will be subordinated to KOS's USD1.5bn RBF. However, we do not notch down the rating of the notes from the company's IDR given its fairly strong recovery prospects, as reflected in the 'RR4' rating.

KEY ASSUMPTIONS
- Brent gradually recovering from USD55/bbl in 2015 to USD65/bbl in 2016 and USD80/bbl thereafter
- Crude production stable in 2015
- 2015 profitability supported by hedging
- No dividend payout

RATING SENSITIVINESS

Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- Improvement to the upstream business profile (e.g. net production of at least 40mbpd per day)
- Enhanced asset quality (e.g. proved reserve life above nine years)
- Extremely conservative financial profile given the company's small scale (e.g. FFO adjusted net leverage consistently below 2x)
- Positive FCF on a sustained basis
- Organic reserve replacement ratio sustainably above 100%

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Significant project delays and cost overruns at the TEN and MTA blocks
- Exploration and development expenditure failing to produce a larger reserve base
- Deterioration in liquidity (e.g. cash and credit lines amounting to less than 50% of short-term debt)
- Leverage rising above expectations (e.g. consistently above 3.5x), which would be a distress signal for a company of this size
- Unfavourable tax changes having a direct impact on KOS's cash-generating ability
- Organic reserve replacement ratio significantly below 100%.