NEW YORK--(BUSINESS WIRE)--Fitch Ratings has downgraded the rating on the $1.185 billion of Midwestern Disaster Area Revenue Bonds (the bonds) issued by the Iowa Finance Authority on behalf of Iowa Fertilizer Company LLC (IFCo) to 'B+' from 'BB-'. The Rating Outlook remains Negative.
KEY RATING DRIVERS
The downgrade reflects continuing completion delays and increased costs likely to exhaust available contingency funding. The Negative Outlook reflects the potential for delays and cost increases that may exceed current projections. Once operational, the project is exposed to potentially volatile operating margins with rating case coverage near breakeven levels in the early years.
Construction Significantly Over Budget
Although the engineering, procurement, and construction (EPC) agreement is a fixed-price contract, fully-wrapped by an experienced contractor, ongoing change orders led to a substantial increase in EPC project costs. The project fully exhausted its contingency and issued an additional $100 million of combined senior debt and sponsor equity in June 2015, and additional funding will be required to complete the facility. Further change orders and contractor claims are still being negotiated, indicating that final costs could rise further.
A substantial delay in start-up is expected to necessitate a draw on the cash-funded debt service reserve for mandatory 2016 payments. These payments and construction cost shortfalls are expected to be funded by a $150 million letter of credit-backed (LOC) subordinated loan facility from sponsor OCI N.V. When the project achieves operation, relatively high equity distribution triggers will support debt repayment and replenishment of reserves during potential periods of low operating cash flow. Operating and major maintenance reserves will help shield the project during the operational phase.
Nitrogen Market Price Exposure
IFCo will sell its nitrogen products to farmers, distributers, wholesalers, cooperatives, and blenders at market prices. The project's main products have historically exhibited considerable price volatility as evidenced by the average five- and 10-year one standard deviation ranges of 25% to 30% and 35%, respectively. Fitch recognizes that a shift in the supply-demand balance could negatively impact prices, as a 10% change in nitrogen product prices will result in a 0.40x-0.50x change in debt service coverage ratios (DSCRs).
Natural Gas Price Risk
The project will procure its natural gas feedstock via an existing pipeline at prices linked to Henry Hub. IFCo has entered into natural gas call swaptions for the first seven years of the project to moderate the risk of a reversal in gas pricing trends. In addition, the project will fund a feedstock reserve and can enter into further call swaptions to help mitigate price risk during the non-hedging period.
Manageable Operating Risks
IFCo will utilize commercially proven technologies with relatively low maintenance risk. Fitch believes that the project's oversized and flexible production capacity helps mitigate operating performance risk. Non-feedstock O&M and maintenance cost projections have increased significantly from original projections, and the project may require several years of operations to establish a stable cost profile.
Speculative-Grade Forecasted Financial Profile
The Fitch rating case imposes revenue and expense stresses for all operating years, resulting in an average DSCR of 1.15x over the 10-year term. Coverage is particularly vulnerable in the first four years of operations during which time the project will repay the additional debt at a consolidated rating case DSCR averaging 1.00x. While natural gas price exposure has been moderated, margin risk is a rating constraint as the nitrogen fertilizer price remains subject to the U.S. trade balance, cost of production, and changes in supply and demand. The relatively short debt term moderates long-term price uncertainty, and reserve accounts help to mitigate the impact of short-term price fluctuations, but the cash flow cushion remains vulnerable to changes in project economics.
Peer Analysis: IFCo's peer group includes merchant project financings in which product sales are susceptible to the inherent volatility of commodity markets. Merchant projects that have achieved ratings in the 'BB' category have demonstrated some combination of long-term feedstock price certainty, materially low leverage, structural enhancements, or a proven, quasi-monopolistic competitive advantage. Merchant projects in the 'B' rating category typically are exposed to price and volume risk and operate in a business environment with highly volatile margins.
Negative - Further Construction Obstacles: Further increase in completion costs or delay in completion beyond current expectations.
Positive - Project Completion: Completion of the project and commencement of operations as currently scheduled, resolution of all outstanding contractor claims, and replenishment of the debt service reserve.
Negative - Margin Risk: A fundamental shift in the supply-demand balance that results in materially lower operating margins expected to persist over a long period.
Negative - Operational Cost Overruns: Inability to effectively manage operating costs or failure to reach and sustain projected capacity and utilization rates.
SUMMARY OF CREDIT
Since Fitch's last review in April 2015, construction of the plant has fallen further behind schedule and costs have continued to escalate through change orders for activities outside of the scope of the EPC contract. In its fourth quarter 2015 Construction Monitoring Report, independent engineer Nexant reported 33 change orders totalling nearly $200 million. This is an increase of approximately $85 million from a total of $115 million of approved change orders one year ago. The bulk of the increase is a $66.3 million charge related to severe winter weather. Management has indicated that remaining obligations can be met through a combination of funds remaining in the equity construction account (including the June 2015 $100 million of additional funding), a new $150 million LOC-backed subordinated loan facility, and operating cash flow following mechanical completion.
The project schedule has been pushed back further and management's latest expectation is that ammonia production will begin in the September/October 2016 timeframe with downstream production expected to commence one to two months later. This represents roughly a one year delay in construction. Under the terms of the EPC agreement, Orascom E&C USA (OEC) owes delay damages for failure to meet the original mechanical and provisional acceptance dates of August and November 2015, respectively. These damages are capped at 10% of the EPC contract and Fitch expects damages owed will amount to approximately $130 million.
In early March 2016, contractor OEC submitted an additional notice summarizing contract price and time claims that would further increase IFCo's overall construction costs beyond approved change orders to date. The initial claim totals $416.2 million, though IFCo is still reviewing the validity of these claims and believes several major items will be invalidated.
IFCo's first payments on its senior bonds are due June 1 and Dec. 1 of 2016. The combined senior principal and interest obligations, additional pari-passu loan obligations, and required hedge premium payments amount to an estimated $168.3 million. Construction progress, the status of OEC's claims, and market fertilizer prices over the next few months will further inform the likelihood that IFCo can meet its obligations relying only on projected sources of funds available to the project company.
Additional information is available on www.fitchratings.com
Rating Criteria for Infrastructure and Project Finance (pub. 28 Sep 2015)
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