SAN FRANCISCO--(BUSINESS WIRE)--Fitch Ratings has affirmed 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) at 'BB-'. The Rating Outlook is revised to Negative from Stable.
KEY RATING DRIVERS
The affirmation reflects a projected financial profile that remains consistent with the rating, including forthcoming additional pari passu leverage required to fund project completion. The Negative Outlook reflects the heightened probability of continuing construction cost overruns, completion delays, and a significant increase in projected operating costs, which could further decrease financial cushion to levels consistent with a lower rating.
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 with a strike price of $6 and $6.50 per mmBtu to moderate gas price risk. In addition, the project will fund from operations, over seven years, an annual $25.8 million reserve requirement to provide liquidity and help mitigate price risk during the non-hedging period. Alternatively, IFCo can enter into call swaptions at a $7 per mmBtu strike price during part or all of the final three years of the debt term. Fitch believes that the call swaptions and hedging reserve moderate natural gas price risk, and estimates that DSCRs change by 0.10x - 0.15x for every $1 per mmBtu change in gas prices.
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.
Construction Significantly Over Budget
Although the engineering, procurement, and construction (EPC) agreement is a fixed-price contract, fully-wrapped by an experienced contractor, substantial change orders led to a 15% increase in EPC project costs. The project will fully exhaust its contingency and an additional $100 million of senior debt and sponsor equity will be required to complete the facility. EPC progress was 88% complete as of the end of 1Q 2015 and is slightly behind schedule.
Additional Debt Permitted
Provisions under the original financing permit supplemental pari passu debt up to 5% of original principal. IFCo will exercise this provision to fund cost overruns and complete the project. Relatively high equity distribution triggers and a cash-funded debt service reserve equivalent to six months of senior bond payments support debt repayment during potential periods of low operating cash flow. Operating and major maintenance reserves help shield the project from issues during the operational phase.
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 expected 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 is vulnerable to changes in project economics.
Project Construction - Negative: Further increase in completion costs or a delay in completion. Positive: Completion of the project on schedule and within the revised budget.
Margin Risk - Negative: Fundamental shift in the supply-demand balance that results in a materially worse nitrogen market pricing environment than forecasted. Higher natural gas market prices sustained over a long period.
Operations - Negative: Inability to effectively manage operating costs or failure to reach and sustain projected capacity and utilization rates.
In November 2014, IFCo issued a disclosure stating that the total cost to complete the project has increased by approx. $100 million, from $1.8 billion to $1.9 billion. The project's original financing included a $105.5 million contingency reserve, but total project costs are now expected to increase to approximately $1.9 billion, including full use of the contingency reserve. The project's EPC agreement is a fixed-cost, turn-key arrangement, but change orders for items outside the original scope of work drove the increased project cost. There have been 22 change orders submitted, totalling an increase of $115.6 million through the end of 2014, with further change orders anticipated. The bulk of the costs are due to additional required piling work ($55.4 million) and an off-site water supply facility ($27.6 million) that was not originally planned.
To fund the revised project cost, IFCo will issue $59.7 million of additional debt, pari passu to the rated senior bonds, as permitted under the terms of the indenture. IFCo has not finalized the terms of the new loan and has only provided some general assumptions to Fitch regarding the repayment schedule and interest rate. Fitch has incorporated the assumed repayment terms of this pari passu obligation into its rating of the senior bonds. Parent OCI Fertilizer also deposited $40 million of equity, through the project company and trustee, into the construction fund account in January 2015.
Along with increased costs, the project's construction is also marginally behind schedule. Construction work fell behind schedule due to severe weather in late 2013 and early 2014 as well as a shortage of skilled labor. Late delivery of equipment has put procurement slightly behind schedule as well. A heat exchanger failed in initial testing due to tube leaks, and any further issue with the repaired equipment could delay commissioning of the ammonia plant (scheduled for August 2015). In the event of a delay, EPC contractor Orascom E&C USA will owe delay damages to the project. However, the credit quality of parent OCI Construction Holding, the guarantor backing delay payments, is considered too weak for the project to rely on collection of these damages. This counterparty risk is largely mitigated by the advanced stage of project completion.
The project company has also revised its long-term expectation for several major operating expenses, including labor, maintenance, and other feedstock costs. In particular, management increased its assumptions for market labor rates and the estimated number of plant employees. The project's unproven cost profile increases the potential volatility of long-term financial performance.
Fitch's financial analysis incorporates management's revision to the long-term non-feedstock cost profile as well as IFCo's forthcoming additional pari passu debt. Fitch's base case expectation for long-term performance assumes capacity and conversion yields in line with management expectations but uses more conservative assumptions for nitrogen fertilizer and natural gas prices. Under the Fitch base case, IFCo's financial metrics appear strong with DSCRs averaging 2.61x, with a minimum of 2.17x.
Fitch's rating case applies more stringent assumptions to fertilizer and gas prices to reflect the exposure to and volatility of market prices on both the feedstock and product sides. Additionally, the rating case includes a 2.5% reduction in the utilization rate and a 10% increase to O&M costs (excluding natural gas) to reflect the impact of potential operational issues. Under the Fitch rating case, DSCRs are speculative grade, averaging 1.15x, including breakeven coverage in the first four years of operations during which time the project will repay the additional debt issued to complete the project.
Additional information is available at 'www.fitchratings.com'
Applicable Criteria and Related Research:
--'Rating Criteria for Infrastructure and Project Finance' (July 11, 2012).
Applicable Criteria and Related Research:
Rating Criteria for Infrastructure and Project Finance