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Rating Action:

MOODY'S ASSIGNS Ba3 TO PREMCOR'S SENIOR UNSECURED NOTES; Ba2 TO SENIOR SECURED BANK FACILITY; OUTLOOK STABLE

23 Jan 2003
MOODY'S ASSIGNS Ba3 TO PREMCOR'S SENIOR UNSECURED NOTES; Ba2 TO SENIOR SECURED BANK FACILITY; OUTLOOK STABLE

$2.068 Billion of Premcor USA, Premcor Refining, & Port Arthur Debt Securities and Bank Facilities Affected ($1.786 Billion Pro-Forma)

New York, January 23, 2003 -- Moody's rated Premcor, Inc.'s (PI) debt offerings, ending a review for upgrade begun November 27 upon PI's now $515 million pending acquisition of Williams' 190,000 barrel per day capacity (170,000 bpd throughput) Memphis refinery. PI will pay $315 million for the refinery, terminals, and storage assets, and roughly $200 million for inventory at current oil and products prices. Up to $75 million of earnout payments are also due over 7 years if market margin benchmarks exceed certain levels.

Anticipating ample equity funding from the pending offering, Moody's:

1) Assigned a Ba2 rating to Premcor Refining Group's (PRG) proposed amended and restated $750 million senior secured three-year working capital bank facilities.

2) Assigned a Ba3 to PRG's proposed $400 million senior unsecured notes due 2010 and 2013.

3) Confirmed all ratings for Premcor USA (PUSA), PRG, and Port Arthur Finance (PAF).

Note proceeds, new equity, and roughly $200 million of off-balance sheet Memphis inventory funding will fund the acquisition, redeem $42.4 million of PUSA notes, and repay $240 million of PRG floating rate notes due 2003 and 2004. Moody's anticipates equity proceeds at the high end of expectations for the pendingcurrent offering. Year-end 2002 gross Effective Debt/Capital was 59% (pro-forma 58.6%). PI will carry some $220 of debt per complexity barrel and $2,245 of debt per expected throughput barrel. Neither an exercise of the equity underwriters' overallotment provision, nor a larger offering, would immediately affect the ratings. On the other hand, in need, PI's backup equity plan would likely support the ratings.

The ratings are supported by a number of factors. Though vulnerable, and softening again in 1Q03, sector margin drivers firmed in 4Q02 after a four-quarter bottom and still point to far firmer 2003 results. Also, the Memphis acquisition and debt and equity fundings put PI's asset and funding base in the soundest condition in PI's history. As well, management has a long history of executing realistic, compatible growth and funding strategies, and assimilating acquisitions. The Memphis refinery, PI's early 2002 IPO, PI's Port Arthur coker project, and its other acquisitions, divestitures, and refinery closures in 1995 through 2002 replaced a relatively weak and highly leveraged asset base (a marginal retail system and two small marginal refineries, all divested) with one world-scale deep conversion refinery at Port Arthur, Texas, the two large Memphis, Tennessee and Lima, Ohio refineries, and a reasonable capital and liquidity base.

However, still-high effective leverage and other factors delay an upgrade. Sustained up-cycle results are needed to internally fund a heavy capital budget and reduce leverage. Ever-volatile margins softened in 1Q03, the shut-in of Venezuelan mostly heavy oil production restrains crude oil differentials, PI faces a high $700 million of low sulfur fuels and MACT capital spending through 2007 (up to $1.5 billion of total capex), high oil prices drive high letter of credit and working capital needs, and acquisition event risk (though in historically quite able hands) is high. There are no assurances the next acquisition can be funded with ample equity.

Furthermore, the bank rating is exposed to a high mix of commodity inventory in the borrowing base, a full 80% advance on inventories, oil prices in steep backwardation, the fact that part of inventory is in transit, and an expanded cash draw sublimit. Moody's also estimates PI's maximum exposure to its lease guarantees on divested Clark retail assets (now bankrupt) to be roughly $35 million a year, though we expect realized gross and net exposure to be far less. Also, tremendous 2001 coker margins from abnormally wide crude oil differentials pushed Port Arthur's coker margin stabilization agreement with Pemex into surplus (now $70 million). Thus, as in 2002, PI is naked to narrow crude oil price differentials until the surplus is consumed.

Moody's estimates pro-forma cash operating and gross interest expense per throughput barrel of $3.10 and $0.61, respectively. Allowing for scheduled and a degree of unscheduled downtime, the present geopolitical and market forces cause Moody's to be prepared for 2003 EBITDA of $350 million to $450 million, versus roughly $110 million in gross interest and $220 million in cash capex. We expect cash capex of at least $350 in 2004, or $450 million if margins are sufficiently strong. In up-cycle crack spread environments, and with at least average crude oil differentials, Moody's believes PI could generate $600 million to $680 million of pro-forma EBITDA.

An upgrade could come from some combination of the following factors:

= Memphis operationally performs as expected and its regional margins retain historic spreads over Gulf Coast benchmarks. PI would avoid material unscheduled downtime.

= Margins, driven by sector crack spreads and average or better crude oil price differentials, would need to return to mid-cycle or better for the bulk of 2003, and not collapse in 2004. The risk of liquidity-straining oil price spikes would have diminished.

= PI would complete its equity offering at a scale towards the high end of its estimates.

= PI's next acquisition, which may be substantial, would be funded 50% with common equity, and associated low sulfur fuels capex would be manageable.

= PI's final guarantee exposure to its divested retail assets would not be material to the rating.

Effective debt totaled $1.010 billion at year-end 2002, including roughly $85 million due to Morgan Stanley under the Lima refinery's crude oil line-fill inventory (2.7 million barrels) monetization. Assuming $250 million of equity is raised, pro-forma debt after the acquisition would be roughly $1.330 billion, including the Lima line-fill funding and now roughly $200 million of off-balance sheet inventory funding for Memphis. In lieu of the off-balance sheet funding, PRG would have to borrow some $285 million to fund the line-fill and inventory.

In a serious down-cycle, and facing high natural gas costs, PI's adjusted 2002 EBITDA was $173 million before writedowns, versus an adjusted $635 million in 2001. Fourth quarter 2002 EBITDA was $97.6 million whereas fourth quarter 2001 EBITDA was a negative $1 million. Fourth quarter 2002 benefited from wider crack spreads and crude oil differentials generally, and very strong Chicago region crack spreads over $6/barrel. Had Memphis been owned in 2002, Moody's conservatively estimates pro-forma 2002 EBITDA of roughly $250 million.

Memphis adds a vital third leg to PI's refining portfolio, strengthens its light sweet crude oil sourcing and logistics for Lima and Memphis, strengthen its regional refined product logistics, adds to PI's capacity to capitalize on regional margin spikes, and may postpone by one year PI's heavy low sulfur gasoline capital spending at Lima. Roughly 120,000 BPD of Memphis' throughput is sold within its local region, with 50,000 BPD shipped north into the Midwest for sale. The acquisition boosts PI's effective throughput capacity to roughly 570,000 barrels/day.

The Memphis acquisition appears to be competitive if regional margin differentials are retained. Excluding earnout payments, inventory, and low sulfur capex, the $315 million price equates to $270 per daily complexity barrel and $1,853 per throughput barrel. Memphis is a light sweet cracking refinery with a low Nelson complexity rating of 6.9. It needs roughly $180 million of capex to configure it for low sulfur fuels. On the other hand, Williams had invested some $400 million in Memphis since 1997, improving its process economics.

Memphis has rated capacity of 190,000 bpd but it runs 170,000 bpd due to local market light product demand constraints and to avoid producing larger volumes of fuel oil than the region needs. Also, transportation costs to, and the supply/demand balance of, other markets restrains higher Memphis production. Memphis' regional wholesale infrastructure comes with three regionally very important terminals, including a 70,000 barrel/day truck rack terminal in East Memphis, a 25,000 barrel/day terminal in West Memphis, and a 25,000 barrel/day jet fuel terminal serving the Memphis air transportation hub. All terminals are located within five miles of the refinery. The acquisition includes 3.8 million barrels of liquids storage capacity.

At 90% utilization, 170,000 bpd of crude oil throughput, at 2002 energy costs, and at mid-cycle Gulf Coast 2-1-1 crack spreads of $3.25/barrel plus transportation differential, Moody's reasonably believes Memphis can generate $105 million in mid-cycle EBITDA. PI believes it will generate higher mid-cycle results, on light sweet crude oil purchasing synergies with Lima and product marketing synergies with PI's Midwest wholesale terminal complex. It will take several quarters of operating and market conditions to assess what PI can do with Memphis.

Moody's notes that four recent and likely refined product pipeline expansions will increase competing Gulf Coast refined product volumes in the southern and northern Midwest. The impact on Lima and Memphis does not seem material in the long run due to recent and potential refinery shutdowns and regional demand growth. Nevertheless, these expansions underscore regional margin risks inherent to the evolution of the U.S. refining infrastructure.

PI's controlling shareholders (The Blackstone Group, Occidental Petroleum, and CEO Tom O'Malley) agreed to take up to $65 million of the equity offering. Under the refinery purchase and sale agreement, PI is not obligated to buy Memphis if the equity market is not sufficiently receptive to PI's pending offering. In that event, the acquisition may still proceed if William's exercises its option to accept up to $100 million of PI equity as partial payment.

Ratings confirmed include: PI's Ba3 senior implied rating; PAF's Ba3 $251 million of 12.5% senior secured notes due 2009; PUSA's B2 $42 million of 11.5% subordinated notes due 2009; PRG's Ba3 $110 million of 8.625% senior unsecured notes due 2008, $100 million of 8.375% senior unsecured notes due 2007, and $240 million floating rate term loan due November 15, 2003 and 2004; and PRG's B2 $175 million of 8.875% senior subordinated notes due 2007.

Premcor Inc. is headquartered in Old Greenwich, Connecticut.

New York
Steven Oman
Senior Vice President
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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