OREANDA-NEWS. Fitch Ratings has placed Seven Energy International Limited's (Seven Energy) Issuer Default Rating (IDR) of 'B-' on Rating Watch Negative (RWN). Simultaneously, Fitch has downgraded the senior secured rating of wholly-owned subsidiary Seven Energy Finance Limited's 10.25% USD300m secured notes due 2021 to 'CCC+/RR5' from 'B-/RR4' and placed them on RWN to reflect our reassessment of recovery prospects for secured bondholders.

The RWN is driven by our assessment of Seven Energy's liquidity position, and reflects the risk that the company's plans to address this may not be successful. We expect to resolve the RWN once we obtain clarity on Seven Energy's progress in raising new equity or debt capital, which we expect to happen by end-2015.

Seven Energy has been actively managing its liquidity in 2015 and in July signed a new senior debt facility, Accugas IV, replacing the Accugas II and III facilities, and raising about USD80m of new debt including a USD30m working capital facility. In the event no new funding is secured, our base case shows liquidity as very tight, with limited contingency beyond cutting already reduced capex in the gas business. We understand that Seven Energy is well progressed in discussions for additional facilities and is actively contemplating raising further equity. Given the unpredictability of the Nigerian operating environment, we consider building a further cash buffer as vital for the company to maintain its 'B-' rating.

We downgraded the Recovery Rating on Seven Energy's USD300m secured notes to 'RR5' from 'RR4' to reflect our reassessment of recovery prospects for secured bondholders. As the Accugas IV facility is secured on Seven Energy's gas assets in the South East Delta, the value of the bond holders' security package largely rests on the Strategic Alliance Agreement (SAA) which we expect to generate little FCF in 2015-17. Despite the current market conditions resulting in significantly reduced E&P market valuations, we believe that bondholder recovery prospects may be materially improved in case of a sustained commodity price recovery.

Despite weak oil prices that depressed results and increased leverage in 2015, masking the progress of the largely fixed-price gas business, we anticipate a near-doubling of revenues and EBITDA in 2016 on 2015. Net cash flow from the SAA is expected to be weak, as Nigerian Petroleum Development Company (NPDC) and Seven Energy clear arrears from heavy development expenditure by Seplat Petroleum Development Company (Seplat) in 2013-2015.

We believe that over the medium term, Seven Energy will remain small in size, maintain a complex structure and continue relying on onshore operations in Nigeria. We expect that funds from operations (FFO) net adjusted leverage will peak in 2015 at 5x (end-14: 2.9x) and then decline to under 2x in 2016-2018, commensurate with mid-'B' category.

KEY RATING DRIVERS
Negative FCF, Tightening Liquidity
In 2014, Seven Energy spent USD912m on capex and acquisitions, including USD408m on the SAA and the rest on acquiring licences, the East Horizon gas pipeline and the south east Niger Delta gas infrastructure. Although Seven Energy's capex was down 60% yoy in 1H15 to USD72m through reducing the number of SAA drilling rigs, we project that total 2015 capex will reach USD250m and free cash flow (FCF) will exceed negative USD110m for the year.

On 30 June 2015, Seven Energy had cash on hand of USD60m. While the company is currently discussing with lenders additional borrowings eg, the accordion feature under the Accugas IV, its liquidity still largely depends on successfully raising new equity by end-2015.

SAA Funding Plan Agreed
The SAA covers NPDC's 55% interest in North-West Niger Delta's oil mining licences (OMLs) 4, 38 and 41, which are operated by Seplat. SAA's gross daily production peaked at 81mbopd in July 2015, mainly due to 24 new oil wells drilled in 2014, but its average daily gross production in 1H15 was only 48.8mbopd. This is because of continuing security issues at the Trans Forcados pipeline, its main shipment route, which was shut down for about 30% of 1H15.

In 1H15, the SAA accounted for about 70% of Seven Energy's revenues and over 80% of EBITDA on net oil entitlements and oil liftings (actual volumes that Seven Energy received) of 15.4mbopd and 9.9mbopd, respectively.

In May 2015, NPDC, Seven Energy and Seplat agreed the funding plan. It provides for, among other things, Seven Energy to receive limited net cash flows for the remainder of 2015 with almost all oil allocations to be used for paying cash calls to Seplat.

Further, we are aware that NPDC has accumulated a considerable backlog of capital contributions to operators including Seplat and the international oil companies. In the current environment, it is possible that this might result in a deviation from the funding plan further stretching Seven's liquidity. Therefore, we view the continued successful operation of the funding plan as a pre-requisite for the maintenance of a 'B-' rating.

Positive Gas Business Development
Seven Energy is monetising natural and associated gas by supplying it to regional power stations and industrial consumers. In January 2014, the company started gas deliveries to local consumers under long-term fixed-price take-or-pay contracts from the Uquo field. In May 2014 it completed the construction of train 2 of the Uquo gas processing facility, bringing its total gas processing capacity to 200MMcfpd. Its gas sales volumes in 2014 were 23MMcfpd at the average price of USD2.81 per thousand standard cubic feet (mscf).

In 2015, the company commenced gas deliveries to Calabar and Alaoji National Integrated Power Projects, bringing the total to five customers. Three of Seven Energy's gas supply contracts, with Ibom Power, Calabar and Unicem cement plant, are long-term fixed-price take-or-pay and another two, Alaoji and Notore fertiliser plant, are short term. In 1H15 Seven Energy's gas sales averaged 57MMcfpd at the average price of USD3.81/mscf, increasing the share of gas in its revenues to 27%.

We forecast that this share will increase as the company continues ramping up its gas production. Seven Energy expects gas deliveries to reach 200MMcfpd in 2016 when the Oron - Creek Town pipeline becomes operational for supplying contractual volumes to Calabar NIPP, construction of which has been delayed. Given the SAA funding issues, the South East delta gas business in 2015-2018 should be the primary source of cash for Seven Energy, accounting for about 75% of the company's estimated USD600m in asset FCF in 2015-2017, which would help it service its debt.

Small Nigerian E&P Operations
At 31 December 2014, Seven Energy had total proved and probable (2P) reserves of 220m barrels of oil equivalent, of which 46% were oil reserves. In 1H15, 69% of Seven Energy's hydrocarbon revenues came from selling oil liftings under the SAA, a service-type contract with NPDC, a fully-owned subsidiary of the state-owned Nigerian National Petroleum Corporation. The company's production, including of 16mbopd of oil, is comparable with other Fitch-rated E&P companies with ratings in the 'B' category, in particular, MIE Holdings Corporation (B/Stable, 16mbopd), Kosmos Energy Ltd (B/Stable, 23mbopd) and Kuwait Energy (B-/Stable, 25mbopd). Currently its scale caps Seven Energy's ratings in the mid 'B' category.

RATING SENSITIVITIES
We expect to resolve the RWN on the successful conclusion of Seven Energy's additional fund raising exercise in late 2015. This may include raising additional committed debt facilities or new equity capital.

Positive: Future developments that may, individually or collectively, lead to positive rating action:
-Maintenance of a material liquidity buffer in the form of available cash or committed facilities.
-Continued implementation of the funding plan agreement.
-Maintaining stable production volumes from the SAA, and successful development of contingent oil and gas resources, over the medium term.
-Continued successful implementation of gas strategy, both upstream and midstream, with a track record of timely payment for gas by offtakers by end-2016.

Negative: Future developments that may, individually or collectively, lead to a downgrade to 'CCC':
-Failure to raise new equity and debt capital to improve liquidity.
-A breakdown in the SAA funding plan with adverse cash flow consequences for Seven Energy.
-Continuing security-related shutdowns at the Trans Forcados pipeline in excess of management expectations.
-Failure to achieve gas production targets and/or obtain timely payments for natural gas from offtakers over the medium term.

KEY ASSUMPTIONS
-Brent oil price deck of USD55/bbl in 2015, USD65/bbl in 2016, USD75/bbl in 2017 and USD80/bbl thereafter.
- Limited net cash flows from the SAA in 2016-2017.

LIQUIDITY AND DEBT STRUCTURE
Payment Profile Improves
In 2015, Seven Energy replaced the existing Accugas II and Accugas III with Accugas IV structure with the commencement of principal repayments in March 2016 instead of March 2015. Consequently, Seven Energy has no debt repayments in 2015, only USD50m in 2016 and USD121m in 2017.