MOODY'S PROVISIONALLY ASSIGNS (P) Ba3 TO PORT ARTHUR FINANCE CO.'S SR. SEC. DEBT; CONFIRMS CLARK USA & CLARK R&M RATINGS
Based on information received to-date, Moody's provisionally assigned (P) Ba3 ratings to Port Arthur Finance Corp.'s (PAF) $325 million of senior secured notes, $325 million of senior secured bank term loans, and $75 million secured working capital revolver. PAF provides debt funding for Port Arthur Coker Co.'s (PACC) $765 million share in Clark Refining & Marketing's (CRM) $833 million coker project ($958 million with a third-party hydrogen plant included) within CRM's flagship Port Arthur, Texas refinery (PA). Moody's also confirms Clark USA's (CUSA) B3 and CRM's Ba3 senior unsecured notes, and CRM's B2 senior sub notes and Ba2 senior secured bank debt. Clark's senior implied rating is Ba3 with negative outlook pending sector recovery and negotiations on a large acquisition.
PACC, affiliate CUSA, and CUSA's subsidiary CRM are controlled by Clark Refining Holdings (CRH), 81%-owned by private equity funds run by The Blackstone Group (unrated; $4 billion of equity commitments) and 18% by Occidental Petroleum (Oxy, Baa3). Blackstone ($104 million) and Oxy ($11 million) provide $115 million of delayed equity to PACC. At closing, PAF will repay CRM for $174 million of prior project outlays, firming CRM's liquidity.
OVERVIEW OF PROJECT RATINGS AND CLARK RATINGS OUTLOOK:
PACC's and CUSA/CRM's ratings are linked, recognizing (1) ultimately inseparable operating and economic mutual interests between CRM, PACC, and Blackstone, (2) the value and strategic importance of a successful PACC to CRM and to Blackstone's exit strategy, and (3) support gained from a large degree of risk shifting through PACC's third-party contracts. Clark is leveraged in a volatile demanding sector and its ratings outlook is negative, subject to sector recovery and acquisition and funding terms on Equilon's 295,000 bpd Wood River, Ill. refinery. PACC leases CRM's PA distillation towers and 3 hydrotreaters to enable it to process crude and, with its owned assets, generate cash flow sufficient to support the desired project debt level. Clark debt is structurally subordinated to PACC debt on key assets and contracts but a successful PACC strengthens CRM.
Pro-forma for PACC, Blackstone will have invested $239 million and Oxy $131 million in Clark and PACC. Material degrees of PACC/Clark ratings support is given to Blackstone's self-interest in preserving its investment during downturns and in completing PACC. Pro-forma, Purvin & Gertz, Inc. (PG) states it believes PA would rank as a top five refinery in the extremely competitive U.S. Gulf Coast refining corridor in terms of complexity and earnings potential.
Project completion is a key element in Blackstone's grooming of Clark for an IPO or other strategic event to execute its exit strategy. Absent a completion guarantee, the CUSA/CRM and PACC ratings benefit from Blackstone's vested interest in completing PACC. PACC's cash flow and debt service coverage projections depend heavily on the margin stabilization formula in the PMI crude contract; loss of the contract would be negative for the ratings and default event.
The CUSA/CRM ratings outlooks may be raised to stable if CRM acquires Wood River in a manner preserving bondholder protection, and a sustained refining recovery occurs. Separately, the CUSA/CRM outlook (and perhaps ratings after a period of de-leveraging) could independently benefit from timely PACC completion and performance to specifications.
In the meantime, Clark/Blackstone contend with high leverage and an ever-challenging refining sector. Refining margins were exceedingly weak in 1H99, and remain seasonally weak in mid-1999. Margins are driven globally and regionally by: refining capex and capacity; crude supply, cost, and cost differentials; global and regional inventory levels and storage capacity; regional crude pipeline logistics; and product demand trends. After 15 years of decline, U.S. crude distillation capacity resumed growth in 1995 and will have jumped a combined 6% in 1998 and full-year 1999 from 1997 levels. Below the distillation trend, crude conversion capacity has been growing for many years. Combined, this outpaces near-term transportation fuels growth.
PROJECT RATINGS RATIONALE:
PACC's reason for existence and ability to meet projections are tied to integrated operations in a fully-functioning PA refinery. The project appears to be technically sound. If PACC avoids excessive change orders, completes in timely fashion, and operates to design specifications with its crude supply contract intact, PACC adds substantially to PA's earnings potential. And, while the PMI margin stabilization mechanism smoothes accounting earnings margins, cash margins are not smoothed to the same degree. Still, the crude contract is a strong justification for CRM to undertake the project, though loss of the contract while Clark/PACC remain leveraged would be negative for the ratings. PACC completion risk is substantially reduced, but not eliminated, by a $544 million lump-sum date-certain turnkey contract from Foster Wheeler USA (parent is rated Baa3), incorporating material liquidated damages coverage (discussed below).
PACC may have substantial protection against involuntary consolidation with Clark in bankruptcy, but this is not certain and voluntary consolidation cannot be ruled out in the event PA needs to be sold out of bankruptcy. The sanctity of transfer prices, costs, and terms in the CRM and PACC contracts are less clear in CRM distress/bankruptcy scenarios. If CRM became distressed, PACC may face negotiations to modify contract terms with CRM. And, regardless of financial distress, a refinery's inherently extreme operating conditions require CRM to consistently fund its share of minimum refinery maintenance capex.
A substantial portion of PACC's margins (under the base case and all but one sensitivity case) is generated under the assumption that CRM's portion of PA is running and purchasing PACC unfinished feeds for upgrade and blending in CRM downstream PA units. Operation of PACC without CRM's PA upstream units (distillation towers leased to PACC) is problematic. PACC's margin is supported through a key 8-year coker margin support formula within a 10-year heavy sour (Maya) crude supply contract from P.M.I. Commercio Internacional, S.A. de C.V. (unrated) and guaranteed by Petroleos Mexicanos (Pemex, rated Ba2, review for upgrade).
Restricted payments language appears to be adequate. No distributions are permitted until completion, all reserve accounts are funded, the bank loan 75% cash sweep for the period is paid, and the debt service coverage exceeds 1.6x on both trailing and forward twelve months bases.
The payments waterfall provisions enforce a rigorous application of cash flow after operating and debt service requirements, to fund all reserve accounts and cash sweep obligations before any restricted payments are permitted. However, to the degree upcycle free cash flow can be and is paid out the partners, there is no claw back mechanism on these outflows and only the funds in the reserve accounts would be available to fund sustained downturns.
Events of default are numerous, including (1) failure of contract parties to perform (PMI under the crude supply contract, FW under the construction contract, and CRM under its services and supply, product purchase, and lease agreements with PACC); (2) failure of PACC to achieve mechanical completion by March 2001, or October 2001 if project debt continues to be serviced and completion can still be reasonably pursued, and failure of PACC to achieve substantial reliability by October 2001; (3) and failure of hydrogen plant completion by December 2000.
In addition to successful PACC completion, in order for PACC to run the pro-forma crude slate and attain its projected earnings: (1) CRM must first complete $96 million of upgrade work to its distillation towers and hydrotreaters leased to PACC; (2) due to extreme operating conditions, CRM must also consistently fund its share of reinvestment in PA to minimize downtime; (3) and CRM must be able to honor key CRM contracts with PACC.
Thus, though CRM must both honor its PACC contracts and fund maintenance of the rest of the refinery for PACC to meet base case and all but one sensitivity case earnings, PACC may have a strong position in negotiations with a distressed Clark. Assuming its crude contract is intact, PACC could control the heart of PA's enhanced earnings power. Still, PACC needs CRM's PA units, and PACC's value is only fully derived if operated or sold with PA. PACC and Clark have common owners but almost $1 billion of CUSA/CRM debt controls PA's disposition in a CRM distress scenario.
PACC-owned assets cannot directly process crude oil. PACC leases the crude distillation units from CRM to process crude, retain its favorable PMI/Pemex contract, and have business mass sufficient to qualify for the desired project debt level. PACC is not a loss payee on CRM's casualty insurance for the distillation units and other leased units but states it will arrange this coverage, and business interruption insurance, as conditions precedent to financial close. This insurance is needed to ensure independent funding if a PA casualty event coincides with a period of CRM distress. Major casualty events are not uncommon in refining.
If, for any reason, the PA refinery is not operating, but PACC retains use of the leased distillation towers, PACC could likely retain its crude contract but would need to arrange third parties to operate its owned and leased units, arrange for crude procurement and handling, and directly sell unfinished product streams at discount. PG reflects this condition in its suboptimal "stand-alone" projections that assume the distillation towers take crude but PACC sells its streams externally at materially reduced margins. But actual realized margins will be a function of both the degree of resulting structural disruption to relatively thin raw intermediate markets and market conditions at the time. Such margins could be below PG estimates.
In the event of severe fire or explosion in the distillation towers, until rebuilt (as long as one year, or more), true stand-alone cash flow can not cover debt service. PACC believes business interruption insurance covers debt service until casualty insurance proceeds rebuild the towers. PACC could not run crude and would need third-party diluted vacuum resid as feed to run its delayed coker at materially reduced volume. Pemex would redirect its Maya crude in this case.
Volatility in PACC earnings margins would be reduced by the crude contract, but cash flow volatility is not be reduced as much as earnings volatility and, under certain market scenarios, the stabilization formula may generate working capital funding needs (below). And, though PACC's inherent highly volatile coker margins should be stabilized by PACC's crude supply contract, such protection is contracted to last 8 years if start-up is achieved by July 2001.
The ratings recognize PACC's exposure under its take-and-pay offtake contract with Air Products & Chemicals (A2, review downgrade) which is building a vital $125 million hydrogen plant. PACC is exposed to substantial unsecured claims if it can not meet its obligations to APC. PACC has a $54 million buy-out option on the later of 10 years or plant senior debt retirement.
CLARK REFINING & MARKETING RATINGS RATIONALE:
As a private, leveraged, independent merchant (no retail) refiner, Clark needs high liquidity to ride sharp cash flow, working capital, and financial market swings inherent to the sector. In downturns, CUSA/CRM consumes liquidity as EBITDA can fall far below interest expense, mandatory capex must be funded, and seasonal working capital surges can be exacerbated by crude oil cost surges. CRM's 3 Midwest refineries generated 1H99 losses and PA was down sharply. PA is by far Clark's most valuable unit. Within limits, Blackstone is bridging Clark's capital structure during downcycles and business expansion until a strategic de-leveraging event. Blackstone appears to be taking reasonable business steps to groom Clark for an IPO.
Excluding PACC debt, pro-forma total CUSA and CRM debt approximates $1 billion, plus $375 million of letters of credit. CUSA/CRM generated negative 1Q99 EBITDA (before inventory profit) of $33 million, versus $19 million of CRM cash interest expense, $5 million of CUSA coupon, $980 million of total debt, and about $375 million of letters of credit. Moody's believes CUSA/CRM generated break-even EBITDA (before inventory profit) in 2Q99. CRM estimates that its total non-discretionary refining capex will average about $90 million each year in each of 1999 through 2001. Pro-forma for asset sales, pending project outlays, and PAF reimbursement, CRM's cash approximates $400 million.
PROTECT COMPLETION RISK:
Construction and performance risks are significantly mitigated but not eliminated by the FW turnkey contract. FW will build and integrate delayed coker, hydrocracker, and desulfurization units under a $544 million fixed price date-certain design, engineering, procurement, and construction contract. Under a separate contract with CRM, FW performs the upgrade work on key CRM units vital to PACC's ability to operate. FW is a world leader in delayed coker technology, design and construction. The contract calls for liquidated damages due to delays in mechanical completion or guaranteed reliability is established that are capped at $70 million once and, once guaranteed reliability is established, up to another $75 million in debt buy-down to the degree the PACC units underperform. This augments interest coverage in the event of construction delays and reduces debt to match PACC's debt burden to performance potential.
THE COKER PROJECT, ASSETS, CONTRACTS, AND PROCESS DESCRIPTION:
CRM seeks to substantially increase the complexity and earnings potential of PA. The $957 million project (hard and soft costs, and hydrogen plant) would boost to 80% of distillation capacity (from 20%) PA's ability to run cheaper heavy sour crudes without increasing low value heavy sour resid yields. Assisted by the coker margin formula, CRM believes PACC coker will to generate the majority of PA's earnings. PACC will own and CRM will manage construction of an 80,000 bpd delayed coker, a 35,000 bpd vacuum gas oil hydrocracker, and a 417 long ton per day desulfurization unit. CRM will upgrade/increase PA's atmospheric distillation capacity from 232,000 bpd to 250,000 bpd, its vacuum distillation capacity to about 130,000 bpd, and upgrade one naphtha and two distillate hyrdotreaters.
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