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Rating Action:

Moody's rates Alon Refining Krotz Spring's new notes B2

01 Oct 2009

Approximately $655 million of debt affected

New York, October 01, 2009 -- Moody's Investors Service assigned a B2 (LGD3, 45%) rating to Alon Refining Krotz Springs, Inc.'s (ARKS) proposed senior secured notes offering. Moody's also assigned a B2 Corporate Family Rating (CFR). The outlook for ARKS is positive.

In conjunction with the assigned ratings for ARKS, Moody's affirmed Alon USA Energy, Inc.'s (Alon USA) B2 CFR, its B1 (though changing to LGD3, 43% from LGD2, 23%) senior secured term loan rating, and raised its Probability of Default Rating (PDR) to B2. The outlook for Alon USA remains positive.

ARKS is an indirectly owned subsidiary of Alon USA, which owns and operates the Krotz Springs refinery located in central Louisiana. The proceeds of the notes offering will be used to repay ARKS's existing term loan ($163 million) and to provide funding for a cash collateral account that will be used to support crack spread hedges to be put in place upon closing of the transaction.

The B2 CFR for ARKS reflects its strategic importance to Alon USA. This was validated by the support Alon USA and its parent, Alon Israel Oil Company Ltd. (Alon Israel) provided to Krotz in conjunction with its amendments earlier this year. Despite the non-recourse structure of the ARKS debt, Alon USA put $25 million of new equity into ARKS and Alon Israel provided additional L/C support of $25 million. These actions support our view that Krotz remains strategic to Alon USA and will likely be supported in the future if needed.

Under Moody's Loss Given Default Methodology (LGD), the ARKS notes are rated equal to its new B2 CFR. Although the new bonds will have the same collateral package that the existing term loan lenders have, the new capital structure warrants a 50% family recovery rate given that it lacks the same covenant protection as the existing term loan. Although the company must offer to buy the notes at par with 50% of excess cashflow, there are no maintenance covenants that offer protection similar to those in the term loan. As a result of this change in the capital structure, the new notes are rated B2, which is the same as the CFR. The Alon USA consolidated liabilities are not included (and have not historically been) in the ARKS liability waterfall given the non-recourse nature to Alon USA.

The positive outlook for ARKS reflects our expectation that it will remain a critical part of Alon USA's overall strategy and will continue to be supported by Alon USA. Given that Alon USA's outlook remains positive, the outlook for ARKS is also positive and could be upgraded if Alon USA's ratings were to be upgraded in the future. However, given the single asset nature of ARKS, the ratings for ARKS would likely be limited to a B1 rating even if Alon USA were to move further up the ratings scale.

The B2 CFR for ARKS also reflects the single asset risk that bondholders face at that entity. The Krotz refinery is a low complexity, 83,100 barrels per day of throughput capacity unit that processes light sweet crude. The refinery currently produces gasoline and jet fuel, but a high proportion of its product slate is low value light cycle oil and high sulfur diesel. As a result, ARKS significantly relies on a 5-year off-take agreement with Valero Energy Corp. for all of its high sulfur diesel and light cycle oil and to help its profitability and cashflows until Alon USA elects to make an investment that will enable Krotz to produce ultra low sulfur diesel. However, if Alon USA elects to take advantage of the more flexible capital structure of ARKS and starts to take distributions in the future, the ratings for ARKS could be de-coupled from Alon USA's ratings and have limited upside if ARKS is left with higher leverage.

These risks are mitigated by ARKS's lower leverage after Q2' 09 debt reduction associated with an April 2009 amendment to its term loan agreement. This resulted in the reduction of about $240 million of debt, bringing leverage to $308 per complexity barrel from over $800 per complexity barrel at the beginning of the year. Although the company is increasing its debt with this notes offering, the increase will be used to provide support for a new crack spread hedge and the pro forma leverage (approximately $392 per complexity barrel) still compares favorably with the B2 peers. In addition, the B2 reflects the refinery's high conversion rate (approximately 101.5% liquids yield) and location to multiple crude supply sources and the Colonial pipeline which takes its gasoline and jet fuel production to attractive markets. In addition, the off-take agreement in place with Valero for the next four years provides ARKS a firm buyer for the high sulfur diesel and light cycle oil.

While ARKS plans to enter into a heating oil crack spread hedge for approximately 50% of its diesel production at about $12.50/bbl, the hedge will not cover diesel volumes until after the Krotz refinery undergoes a major turnaround currently scheduled for January 2010. In the meantime, crack spreads have declined significantly over the past few months, having gone from an average of over $8.00/bbl for the first half of 2009 to approximately $4.00/bbl. This drop in margins will put pressure on the company's cash flows over the near-term and may even result in negative cash flow for a period of time until margins improve. However, Krotz is a low cost refinery and was generating positive cashflow even as crack spreads fell during the year (though at current levels, it is not expected to stay cash flow positive). Furthermore, when the crack spread hedge is in effect, it will provide some cash flow protection even in the face of extremely volatile refining margins.

Alon USA's B2 CFR reflects the company's set of refining assets that offers good diversification in terms of markets and products it offers. With its current configuration of essentially three refineries and a network of over 1,020 retail sites in the southwest, Alon USA is spread across multiple markets, providing cushion against the volatility of any one market having too great of an impact on the company's earnings and cash flows.

The positive outlook for Alon USA continues to reflect an improved financial profile that puts the company in-line with higher rated peers as well as an expectation of a sufficient recovery of refining margins in 2010. This improved profile ($614 pro forma debt/complexity barrel) along with currently strong asphalt margins provides some cushion against current weak refining margins However, if refining margins remain at their currently weak levels and results in materially weaker than expected earnings and cashflows, the outlook could be changed to stable.

The last rating action for Alon USA was on 5/7/09, when we confirmed the ratings with a positive outlook.

The principal methodology used in rating both Alon USA and ARKS was the Global Independent Refining and Marketing Rating Methodology, which can be found at www.moodys.com in the Credit Policy & Methodologies directory, in the Ratings Methodologies subdirectory. Other methodologies and factors that may have been considered in the process of rating this issuer can also be found in the Credit Policy & Methodologies directory.

Alon USA Energy, Inc., headquartered in Dallas, Texas, is an independent refiner and marketer of petroleum products and owner and operator of convenience stores in the Southwestern and South Central U.S.

Alon Refining Krotz Springs, Inc. is an indirectly owned subsidiary of Alon USA Energy Inc., which owns and operates the Krotz Springs refinery located in central Louisiana.

New York
Thomas S. Coleman
Senior Vice President
Corporate Finance Group
Moody's Investors Service
JOURNALISTS: 212-553-0376
SUBSCRIBERS: 212-553-1653

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

Moody's rates Alon Refining Krotz Spring's new notes B2
No Related Data.
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