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Rating Action:

MOODY'S ASSIGNS B3 RATING TO CHENIERE ENERGY'S SENIOR UNSECURED NOTES; STABLE OUTLOOK

15 Apr 2005
MOODY'S ASSIGNS B3 RATING TO CHENIERE ENERGY'S SENIOR UNSECURED NOTES; STABLE OUTLOOK

Approximately $500 Million of Debt Securities Affected

New York, April 15, 2005 -- Moody's assigned a B3 rating to Cheniere Energy, Inc.'s pending $500 million of ten year senior unsecured notes, a B1 senior implied rating, and an SGL-2 liquidity rating. The rating outlook is stable.

STRUCTURAL AND FUNDAMENTAL OVERVIEW

Note proceeds will increase parent company cash. Pro-forma year-end 2004 cash would then approximate $800 million, though substantial first quarter 2005 project outlays and overhead have significantly reduced cash balances by mid-April 2005.

The first six coupon payments will be escrowed. Remaining cash will principally fund Cheniere's substantial project development costs and front-end owner equity for up to three wholly-owned leveraged liquefied natural gas (LNG) import and regasification projects. For example, front-end equity for Cheniere's Sabine Pass LNG L.P. project is approximately $216 million. Moody's expects Cheniere's first material operating cash flow to begin in second half 2008. Relying on cash flow from tolling contracts alone, Moody's expects first free cash flow after capital spending to occur no earlier than 2009, assuming timely successful completion of at least one LNG project. Any subsidiary project financing debt would have first claim on that cash flow for debt reduction.

The note indenture provides minimal restrictions on the use of note proceeds or other protections for note holders. No subsidiaries, including the LNG project subsidiaries, are required to, or are likely to, guarantee the notes. It is likely that virtually all operating assets and cash flow will be at the subsidiary level. Any project financing is likely to restrict each project's ability to upstream cash to the parent due to project debt covenants.

Partly supported by $286 million of net proceeds from a December 2004 common equity offering, Cheniere is creating a capital intensive, largely project financed, downstream LNG regasification business to participate in rapid world and U.S. LNG market growth. It seeks to build 10 bcf/day to 12 bcf/day of LNG regasification capacity by 2009 to 2010 at a cost to Cheniere of $2.3 billion to $2.6 billion excluding interest expense. Moody's believes that interest expense could push that to $2.5 billion to $2.7 billion though this figure would be lower to the degree Cheniere issues common equity or does not pursue three projects.

To put Cheniere's undertaking into perspective, its capacity goal equates to roughly two-thirds of 2003 world LNG consumption and LNG liquefaction capacity and roughly one third to one-fourth of expected world capacity by 2008 to 2010. Notably, the offsetting world natural gas production, LNG liquefaction, and LNG tanker investments necessary to deliver a sufficient volume of LNG to a new regasification plant is at least 11 times the unit capital cost of a regasification plant's capacity. The evolution of the LNG market may not proceed in a balanced linear path.

However, while considerable market and market structure risk lies ahead, Cheniere has successfully developed two world-scale regasification projects that have attracted major participants, full project funding, and investment grade offtake counterparties for the majority of capacity. It just received FERC approval for a third project and is well into developing a fourth project.

RATING RATIONALES

In spite of high consolidated leverage and no cash flow until late 2008, the B1 senior implied rating reflects the sensitized potential long-term earnings power of Cheniere's well-sited and reasonably structured LNG projects. The projects are supported by long-term tolling agreements, assuming stipulated construction and operating performance by Cheniere. The projects will be built under major engineering, construction, and procurement (EPC) contracts with major general contractors (Bechtel and Technip, so far). The lump sum turnkey contracts cover the majority of project costs (a $647 million Sabine contract with Bechtel). Regasification technology is generally well established and eventual cash flow is substantially supported by attractive tolling agreements with investment grade counterparties.

However, the B1 consolidated rating is restrained by Cheniere's very high consolidated and project leverage, its early stage of formation relative to the management and operating challenges ahead; no free cash flow for at least 3 and one-half years; and potential project construction delay, cost overrun, and performance risk. Furthermore, leveraged Cheniere has notably wide indenture latitude to invest in a very wide array of capital intensive business, directly or indirectly through affiliates, within a very broadly defined energy sector.

Importantly too, Moody's observes significant risks and uncertainties associated with the pace, scale, and upstream versus downstream balance by which the world and U.S. LNG market expands over the next five to ten years. Rising regasification competition may hamper Cheniere's ability to win attractive tolling contracts for Corpus Christi and Creole Trail at the same blended $0.32/mcf capacity and operating fees built into the Sabine Pass contracts. We also note that a degree of cost overrun risk is borne by Cheniere. A partial mitigation may be recent trends that suggest inflationary pressures in certain materials markets are abating. Moody's also notes a potential imbalance in Cheniere's bargaining leverage over very large Bechtel as Cheniere's front-end equity funding is down-streamed into Sabine Pass LNG.

Cheniere is exposed to follow-on financing risk, future contract risk, commodity risk somewhat mitigated by long-term tolling agreements, the risk of an uneven pace of growth and upstream versus downstream balance within the world LNG market, and competition from expected rapid U.S. regasification growth. It is exposed to major competitors and general contractors far larger and more experienced than Cheniere.

We favorably note that the $822 million Sabine Pass LNG project financing package appears to have been satisfactorily structured and reviewed by a seasoned third party engineer. Overall, the Sabine financing is led by experienced project lenders, it is tightly documented, change orders exceeding $5 million, or $15 million in aggregate require bank approval, a third party project documentation and engineering review was conducted at the behest of the banks by experienced Stone and Webster, and it was syndicated to 47 banks.

The B3 senior unsecured note rating reflects the note's weak position within the corporate and financial structure. Indenture protections are weak and, with no upstream guarantees, the notes are structurally and effectively subordinated to high levels of structured project finance debt per project and would be effectively subordinated to up to $350 million of parent senior secured debt should that eventually be arranged. It is likely that virtually all operating assets and cash flow are likely to be at the subsidiary level and project debt would also restrict the upstreaming of cash once operations commence. Furthermore, relative to its leverage and cash flow timing, the note indenture carveouts permits significant restricted payments latitude.

The SGL-2 rating reflects good liquidity cover of visible obligations over the next 4 quarters. Cheniere has very high initial balance sheet liquidity, tempered by outlays over the next four quarters for project and overhead costs, a highly opportunistic business investment posture, and note indenture language permitting cash to be used for virtually any investment purpose within a notably broadly defined energy sector. Still, while there are negligible indenture restraints on the use of liquidity, Cheniere's initial pro-forma liquidity appears to reside in sound territory over the next four quarters, amply covering parent company overhead and Cheniere's owner's share of project costs.

OVERVIEW OF CHENIERE

Lacking a specific operating track record to date, Cheniere is building an able management team, will now begin building a track record in project construction management, in running a rapidly growing highly leveraged business of considerable scale, and running a world scale LNG business. Cheniere is a small leveraged business in a sector dominated by major deeply capitalized international operators. It faces inherent construction and completion risk and uncertainty over whether world LNG liquefaction capacity will grow sufficiently fast to keep pace with LNG regasification capacity and provide a highly liquid spot market by the time Cheniere's projects come on line.

Overall, Cheniere is well into its project development phase, very early in the project construction phase, and is staffing up for its project construction management and eventual operating needs. It has been developing four potentially very attractive LNG import and regasification terminals along the U.S. Gulf Coast. It intends to operate the three currently wholly-owned projects. Sabine Pass LNG (100%), Freeport LNG (30%), Corpus Christy LNG (100%), and Creole Trail LNG (100%), are well situated along the U.S. Gulf Coast.

Sabine Pass has arranged its non-recourse secured project financings and construction of both Freeport and Sabine Pass has already commenced. Corpus Christy received its pivotal FERC (Federal Energy Regulatory Commission) approval this week to proceed and may commence construction in second half 2005. Cheniere hopes for Creole Trail's FERC approval next year and may commence construction in first half 2006.

Cheniere is making an important contribution to the major expansion of U.S. LNG import capacity, hoping to capitalize on rising U.S. natural gas import requirements and rapid growth in the world LNG market. There is no assurance that the rapid expansion of U.S. LNG import facilities will be matched by expansion of foreign LNG liquefaction capacity and LNG tanker tonnage sufficient to feed both the rapid U.S. and world expansions in LNG demand. While the secular demand trends for the highly competitive world LNG market are strong, LNG supply and the competition for that supply will be intense on a world scale.

Uncertainties and risks remain along the way to the LNG's market's full regional and world development that will affect LNG shippers' willingness to commit to term tolling contracts; the pricing of such commitments; the eventual scale of the world spot LNG market; the ability of regasification terminals to consistently compete for spot cargoes in that market, given the intense price shopping on a world scale by holders of spot cargoes; the uncertain risks and inexperienced Cheniere's eventual skill at profiting from a merchant energy role in the spot market; and the rapid U.S. expansion of competing regasification terminals.

A key concern is whether the pace of U.S. and international growth in regasification capacity outpaces the growth of extremely capital intensive LNG liquefaction and LNG tanker capacity needed to supply LNG to regasification terminals.

Moody's also sees a risk to natural gas economics in the event that oil prices moderate to levels that, through fuels cross-competition, reduces natural gas sufficiently to slow the pace of growth in regasification capacity.

To the degree that LNG market growth and liquefaction capacity is being driven by major producers that have also sponsored or are minority investors in downstream regasification capacity, Moody's believes that Cheniere's ability to compete for those LNG producers committed and spot volumes would be reduced.

Cheniere Energy, Inc. is headquartered in Houston, Texas.

New York
John Diaz
Managing Director
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

New York
Andrew Oram
VP - Senior Credit Officer
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

No Related Data.
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