Energean Israel Finance Ltd. — Moody’s assigns Ba3 rating to Energean Israel Finance’s senior secured notes, stable outlook

Rating Action: Moody’s assigns Ba3 rating to Energean Israel Finance’s senior secured notes, stable outlookGlobal Credit Research – 28 Feb 2021London, 28 February 2021 — Moody’s Investors Service (Moody’s) has today assigned a Ba3 rating to $2.5 billion proposed senior secured notes to be issued by Energean Israel Finance Ltd. (Energean Israel Finance). The outlook is stable. This is the first time Moody’s has assigned a rating to Energean Israel Finance.Energean Israel Finance is a special purpose vehicle owned by Energean Israel Ltd. (Energean Israel). The proposed notes to be issued by Energean Israel Finance are secured by first-priority fixed and floating pledges on certain assets of Energean Israel, including the leases to the Karish (Karish Main), Karish North and Tanin gas fields, a first priority fixed pledge on the shares of Energean Israel, and certain cash accounts.RATINGS RATIONALEThe rating reflects, as positives, the substantial and low-cost gas and condensate reserves in the Karish Main, Karish North and Tanin fields, which collectively had 1P proved reserves of 66.3 billion cubic meters (bcm) of gas and 62.6 million barrels of oil equivalent (mmboe) of condensate as of 31 December 2020. This includes 32.9 bcm and 38.2 mmboe in Karish Main, where development wells have been completed and are expected to achieve commercial production in early 2022. Moody’s expects the project to generate strong cash flow following commissioning, based on the reservoir consultant’s projection that 1P reserves will be produced significantly faster than existing fields in Israeli waters.The rating also benefits from Energean Israel’s long-term gas offtake agreements with a diversified group of high-quality counterparties in Israel’s chemical and electricity (independent power production) industries. The contracts include minimum take-or-pay volumes of 5.5 bcm/year over a weighted average life of sixteen years, covering all of Moody’s base case production and around 90% of the reserve consultant’s 1P forecast production over the term of the notes. Although prices under most of these contracts are indexed to Israel’s electricity generation tariff, they are currently close to floor prices, significantly reducing price uncertainty. The value of these offtake agreements is, however, limited in some cases by provisions that allow offtakers to terminate their agreements in 2026 if Energean Israel is unable to ensure required output, which beyond 2028 will require the successful development of probable (2P) reserves at Karish Main, Karish North and Tanin, or of additional prospective resources.The rating is constrained by uncertainty around the completion of the Karish Main project, plans for ongoing development and exploration activity to maintain production at contracted levels and support further growth, high financial leverage and significant flexibility to maintain or increase this over the life of the notes, limited liquidity and reliance on a single asset in a region with significant geopolitical risk.Although the three Karish Main development wells have been completed, construction of the Floating Production Storage and Offloading (FPSO) unit and certain subsea works are ongoing and the engineering consultant believes that practical completion will not be achieved until March 2022, 12 months later than the original target, with potential for further delay into the second quarter of 2022. Sail-away of the FPSO from Singapore, originally scheduled for October 2020, has been delayed until at least 15 September 2021 due to a 3.5-month delay in hull fabrication in China and further COVID-related delays to fit-out in Singapore. Although Energean benefits from a comprehensive engineering, procurement, construction, installation and commissioning (EPCIC) contract with subsidiaries of TechnipFMC plc (Ba1 Stable) that provides for liquidated damages in case of delays to practical completion, Moody’s does not expect Energean to receive material compensation because of force majeure provisions in this contract that includes delays due to pandemic.The financing structure includes additional cash reserves during the period between financial close and run-rate production that are intended to provide some protection against further delays, including an Interest Payment Account sufficient to cover interest to 30 June 2022 and a Debt Payment Fund of $100 million. However, the project may have insufficient liquidity if delays extended beyond mid-2022, unless Energean Israel receives significant liquidated damages from its EPCIC contractor or defers capital expenditure planned for 2021 and 2022.Despite continuing uncertainty around the timing of completion, the risk that the project ultimately fails to achieve minimum production levels is mitigated by the EPCIC contract, Energean’s comprehensive insurance policies, and the significant progress to date, with the FPSO 93.6% complete and subsea works 76.8% complete in January 2021. Reservoir risk is reduced by the project’s proximity and geological similarity to the established Tamar field (22% owned by Delek Drilling Limited Partnership, Delek Drilling, and financed through Delek & Avner (Tamar Bond) Ltd., Baa3 negative), Leviathan field (45% owned by Delek Drilling and financed through Leviathan Bond Ltd., Ba3 stable) and former Mari B field.Commissioning delays could result in the loss of some offtake contracts. Specifically, some offtakers can choose to terminate or renegotiate contracts if production is not achieved by specified dates, even if the delay is attributable to force majeure. However, the prices under these contracts are currently lower than those offered by other gas providers in the Israeli market, which in Moody’s opinion mitigates the risk that these termination provisions would be exercised.Moody’s expects Energean Israel to engage in ongoing exploration activity beyond the original three fields, including exploration of the adjacent Block 12 lease in 2022. In addition to unlimited spend on Karish Main, Karish North and Tanin, and on Block 12 once it has been added to the fixed pledge, Energean Israel is permitted to spend up to $100 million annually on exploration and development of present or future leases granted by Israel’s Petroleum Commissioner (the « non-core assets »). Additional expenditure on non-core assets is permitted out of distributable cash flow. Moody’s regards oil and gas exploration and development as a higher-risk activity than is typical for a project financing.The exploration licences for Block 12 and the non-core assets are not currently included in the fixed pledge, although Energean must apply for regulatory approval to add them before drawing down the proceeds of the notes. Although it must make « commercially reasonable » efforts to add Block 12 to the fixed pledge, Energean Israel is not obliged to add the non-core assets unless it raises additional debt to fund their development.The rating is also constrained by reserve funds that, following run-rate production and the release of the Debt Payment Fund, will be small relative to the outstanding debt and, in the case of the Principal Reserve Fund, unfunded until 12-18 months before each bond maturity. Although Moody’s base case is that Energean Israel will generate sufficient cash flow to repay each maturity if it chooses to, management has significant discretion to maintain or increase leverage. Energean Israel is restricted from issuing new notes or paying dividends if the net present value (NPV) of future project cash flows is less than 1.5 times the company’s net secured debt, and restricted from paying dividends if the NPV of future project cash flows falls below $750 million. The value of these covenants is weaker than those included in many other rated project financing transactions because they rely on a third-party consultant’s estimate of future cash flow. Successful exploration activity could significantly increase the NPV, and thereby the company’s ability to incur debt and pay dividends, without a corresponding increase in cash flow over the term of the notes.In order to increase the outstanding notes to more than $3.0 billion, Energean Israel would need to obtain confirmation from Moody’s and other rating agencies that the issuance would not lead to a downgrade of the ratings from the then-current level.Moody’s assessment takes into consideration the reservoirs’ location in a region and country exhibiting significant geopolitical risk. It also considers the project’s concentration in a single asset, although this will diminish over time as other fields are developed.RATIONALE FOR STABLE OUTLOOKThe stable outlook reflects Moody’s expectation that Energean Israel will successfully ramp-up to full production without material additional delays and then achieve strong financial metrics, in particular the ratio of Funds From Operations (FFO) to debt, with a progressive deleveraging.FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGSAn upgrade to the ratings is not currently anticipated. However, the ratings could be upgraded in the longer term if expected production and sales are achieved, and if successful completion of development activity results in significantly lower debt relative to proved reserves while maintaining strong cash flow based credit metrics and cash flow visibility.The rating could be downgraded if practical completion is subject to further delay, absent measures to improve liquidity. Following run-rate production, the ratings could be downgraded if total debt does not decline at least in line with developed reserves, if cash flow visibility deteriorates, if targeted production levels are not achieved or subsequently disrupted, or if it appears that Energean Israel Finance will be unable to refinance maturities in a timely fashion.The principal methodology used in these ratings was Generic Project Finance Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1194215. Alternatively, please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.Energean Israel Finance is a special purpose vehicle established to issue bonds secured by a first priority fixed pledge on Energean E&P Holdings’ shares of Energean Israel, first-priority fixed and floating pledges on certain assets of Energean Israel, including the leases to the Karish, Karish North and Tanin gas fields, and certain cash accounts. Recourse against Energean Israel and Enegean E&P Holdings is limited to the pledged collateral.REGULATORY DISCLOSURESFor further specification of Moody’s key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. 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