DBRS Limited (DBRS Morningstar) downgraded the Issuer Rating and Senior Secured Bonds (the Bonds) issued by North West Redwater Partnership (NWR or the Issuer) to BBB (high) from A (low) and removed both ratings from Under Review with Negative Implications. All trends are Stable. NWR, a partnership between CNR (Redwater) Limited (CNR Redwater) and NWU LP (North West Upgrading), is responsible for the construction, ownership, and operation of a 50,000 barrel per day (b/d) upgrader bitumen refinery (the Project) in Alberta’s oil sands and refinery and pipeline hub. The Project will process 79,000 b/d of bitumen blend (feedstock) into a variety of refined products, notably diesel, capturing value-add in Alberta instead of shipping bitumen to U.S. refineries. The downgrade is due to negative rating actions on both the Project's toll payers (or their guarantors), and comes despite the project having completed a major milestone of Commercial Operations Date (COD) in May 2020, which DBRS Morningstar views as a significant positive.
The energy market disruption, which began in March 2020 due to both the impact of the Coronavirus Disease (COVID-19) pandemic on oil demand, as well as the price war between Saudi Arabia and Russia, had a significant impact on both the Province of Alberta (Alberta; whose agent, the Alberta Petroleum Marketing Commission (APMC), serves as the 75% toll payer to the project) and Canadian Natural Resources Limited (CNRL; the guarantor to CNR (Redwater)’s 25% toll payer obligation). In recognition of these impacts, DBRS Morningstar downgraded Alberta in March 2020 from AA to AA (low) with a Negative Trend, and changed the trend on CNRL from Stable to Negative in June 2020 after placing the credit Under Review, while maintaining its rating at BBB (high). Key drivers for these actions include CNRL's adverse exposure to the severe decline in crude oil prices, resulting in financial metrics which are well below the BBB (high) range, and the sensitivity of its cash flow to the heavy-light oil price differential and changes in the West Texas Intermediate (WTI) oil price. Alberta, meanwhile, has been affected by budget shortfalls and rising debt-to-GDP ratios even before the market disruptions in March of this year. DBRS Morningstar's current outlook for oil and natural gas prices, while cognizant of pricing support due to global production cuts agreed to in April, gradual lifting of lockdown measures, and return of some economic activity, remain constrained by high oil inventories and weak demand. Three-year base case price projections remain roughly half to two-thirds the level of prepandemic projections, meaning that CNRL, as a producer and marketer of crude, and Alberta, whose economy depends on the health of the oil sector, will remain adversely affected over this time.
The credit ratings of CNRL and Alberta flow directly through to form the basis of the credit rating of NWR through the Debt Service Obligation (DSO) structure of the toll Processing Agreements (PAs) between the two toll payers and NWR. The DSO commits APMC and CNR (and/or their guarantors) to unconditionally ensure sufficient funds for debt service, on a 75%/25% split respectively, regardless of the operational or completion status of the Project. Both APMC and CNR have been fulfilling their obligation since the Toll Commencement Date in June 2018, despite the nearly two-year delay in commissioning, indicating continued support for fulfilling contract obligations, and insulating bondholders from the effects of the delay. This obligation to fund the DSO survives termination of the PAs; however, the obligations are several and not joint. A default by CNRL on CNR's 25% of DSO would theoretically lead to a default on the senior debt in the absence of any support. However, DBRS Morningstar believes that the APMC has potential incentives in the form of incremental revenues from sales of refined products to step in in the case that CNRL should default and keep the Project operational until a solution, such as a replacement toll payer, is secured, which adds additional support to the rating. As a result, DBRS Morningstar views the rating level as between the rating of CNRL and the Province. In this respect, DBRS Morningstar views a negative trend assigned to the rating of a toll payer as effectively putting the toll payer’s rating one notch below for the purposes of guaranteeing debt obligations.
NWR met final commissioning milestones in May 2020, and as a result was able to declare COD on June 1, 2020. DBRS Morningstar views this achievement positively and believes this to remove a major source of uncertainty overhanging the project to date. Attention now turns to the transition to full operations. NWR has indicated that over the next two to three months, the logistical steps required in this transition, including the toll payers fully assuming obligations for arranging feedstock supply and paying associated feedstock costs, will be phased in in a gradual manner. The criteria for reaching COD does not require the facility to have operated at full capacity, and NWR will now focus on ramping up production to a targeted 100%. DBRS Morningstar notes that the light oil refining units, which have been operating since the end of 2017, have been performing consistent with these targets; however, the Gasifier (the operation of which has been a factor behind much of commissioning delay) has not yet been ramped to these levels. Some post-COD residual risk therefore remains, and DBRS Morningstar will closely monitor the progress during ramp-up.
Concurrent with the declaration of COD, the toll payers have formally confirmed NWR as the agent dealing directly with market participants on their behalf, both for sourcing bitumen and marketing end product. DBRS Morningstar notes that NWR has been producing refined products such as ultra-low-sulfur diesel for sale on the open market since the end of 2017, thus establishing marketing relationships, which is a positive factor aiding the transition to operations. Furthermore, DBRS Morningstar believes that the facility's focus on diesel fuel as opposed to gasoline provides some level of mitigation against the current reduced levels of demand since diesel is a primary fuel for long-distance trucking and agriculture vehicles, both essential sectors in the current coronavirus pandemic.
After COD, the ratings are supported by the value of the bitumen feedstock and refined products underpinning APMC’s potential incentive to continue supporting the Project in the case of a CNRL default until an alternative solution is found. The ratings may be upgraded if improving visibility on economic conditions and increased confidence in price projections lead to a positive rating action on either the rating level or rating trend of the toll payers. Likewise, further negative rating actions on the toll payers could result in a downgrade of the ratings; however DBRS Morningstar believes that rating risks to the downside are currently limited unless toll payer ratings are further downgraded by two or more notches, or there are other significant negative developments.
A description of how DBRS Morningstar considers ESG factors within the DBRS Morningstar analytical framework and its methodologies can be found at: https://www.dbrsmorningstar.com/research/357792.
All figures are in Canadian dollars unless otherwise noted.
The principal methodologies is Rating Project Finance (August 2019) and DBRS Morningstar Criteria: Guarantees and Other Forms of Support, which can be found on dbrsmorningstar.com under Methodologies & Criteria.
For more information regarding rating methodologies and Coronavirus Disease (COVID-19), please see the following DBRS Morningstar press release: https://www.dbrsmorningstar.com/research/357883.
The rated entity or its related entities did participate in the rating process for this rating action. DBRS Morningstar had access to the accounts and other relevant internal documents of the rated entity or its related entities in connection with this rating action.
Generally, the conditions that lead to the assignment of a Negative or Positive trend are resolved within a 12-month period. DBRS Morningstar trends and ratings are under regular surveillance.
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