Fitch Ratings has upgraded Energean plc's Long-Term Issuer Default Rating (IDR) to 'BB-' from 'B+'.

The Outlook is Stable. Fitch has also upgraded Energean's senior secured notes to 'BB' from 'B+'. The Recovery Rating is 'RR3'.

The upgrade reflects Energean's enlarged output from a ramp-up of production in the Karish field. It also reflects our expectation that EBITDA net leverage will decline to below 2x by 2025 from 6.3x in 2022.

Energean's 'B+' Long-Term IDR reflects its strong gas-weighted growth prospects in Israel, some additional growth potential in existing producing assets, reserve life of over 20 years on a 2P basis and a large share of contracted sales under long-term take-or-pay agreements that will provide more visibility to its cash flows.

We view potential short-term material disruptions or a shut-down in production in Israel due to the ongoing conflict between Israel and Hamas to be manageable, given the company's solid credit metrics, liquidity sources and staggered debt maturity profile. If further escalation affects Energean's ability to produce from its highly cash-generative assets in Israel on a more protracted basis we would treat it as an event risk.

Key Rating Drivers

Project Completion Drives Upgrade: Energean nearly tripled its production during 1H23, driven by the successful ramp-up of the Karish field. The company is the sole indirect owner and operator of the offshore Karish, Karish North, and Tanin gas developments in Israel. We expect 2023 production contribution from Karish will be around 85kboe/d, increasing above 150kboe/d next year as Karish North comes onstream and a full year of run-rate production is realised.

Severe Shock to Operating Environment: The conflict between Israel and Hamas remains a shock and a heightened risk for Energean's operation in Israel. Since the start of the military conflict, the Karish field has been operating at full capacity with no disruption to its operations. It is uncertain how the conflict will develop and while not our base case, a large-scale escalation of military confrontations will be an event risk to Energean's rating. We expect the company to have sufficient strength of the balance sheet and liquidity to withstand six months of lost production in Israel.

Clear Path to Deleveraging: We expect Energean's Fitch-calculated EBITDA net leverage, on a consolidated basis and including operating company-level project-finance debt, to decline in 2023 to 3.3x under Fitch's base-case commodity-price assumptions and assessment of cash flows from the Israeli assets based on the floor price. We expect the metric to decline further to 2.8x in 2024, before it normalises at 1.5x-2.0x as its Israeli assets fully ramp up production.

Defined Dividend Policy: Energean is expected to pay dividends of at least USD50 million per quarter. This will rise in line with its medium-term production and revenue targets to at least USD100 million per quarter, as fully sanctioned and funded developments come onstream in the medium term.

Consolidated Profile: Energean's holding company notes are structurally subordinated to debt located at operating companies, which mainly consist of USD2.6 billion project-finance notes at its 100% opco Energean Israel Limited (EISL) secured by its assets. However, we analyse Energean on a consolidated basis, due to cross-default provisions in its notes' documentation.

Senior Secured Rating: We rate the senior secured notes using a generic approach for 'BB' category issuers, which reflects the relative instrument ranking in the capital structure. Given a large share of debt ranking more senior to notes, the Recovery Rating for the notes is 'RR3' to reflect a lower relative call on EV. This results in the senior secured rating being notched up once from the IDR.

Israel-Focused Gas Producer: Over 70% of Energean's production comes from Israel. Energean assets outside of Israel have a run-rate working interest production base of around 40-60kboe/d. Non-Israeli producing assets are primarily located in Egypt and Italy. Energean operates the majority of its portfolio, and maintains a gas-to-oil production ratio of over 70% from its producing assets. While the company's gas-focused production mix is supportive of strong long-term demand given relative undersupply in the region, we note that the company's credit profile is highly dependent on cash flows from Israel.

Low Re-contracting Risk: Fitch expects Energean would be able to replace customers in the event of a contract termination or other unforeseen event, given high demand in Israel, access to international markets, and the favourable cost position of the Karish, Karish North and Tanin projects. We view the company's record of customer replacement during 2022 as well as production ramp-up at the Karish field as substantially mitigating contract termination and re-contracting risks.

Improving Cost of Production: Energean's cost structure has significantly fallen to USD12.1/boe as of 1H23 from USD19/boe as of 1H22 and is expected to decline further to the USD9-12/boe range. This is driven by the Israeli assets, which are low-cost, with favourable unit economics and a primarily gas-weighted production mix. These assets are Energean's key value driver, contributing around 77% of current 2P reserves and run-rate production of around 140kboe/d, bringing consolidated production to around 200kboe/d by 2024 under our assumptions.

Derivation Summary

Fitch rates Energean one notch lower than Harbour Energy PLC (BB/Negative). Energean has longer reserve life, and is expected to have similar production of around 200kboe/d by 2024. This is partially offset by Harbour's lower leverage.

We rate Energean one notch above Kosmos Energy Ltd. (B+/Stable). Energean's longer reserve life, larger production base including initial contributions from the Karish field, more stable cash flows owing to long-term contracted sales volumes, and better geographic mix support the one-notch difference.

Key Assumptions

Key Assumptions Within Our Rating Case for the Issuer:

Oil and gas prices to 2027 in line with our base case price deck

Production from Karish field for 2024 at 76kboe/d, taking into account a hypothetical operational disruption resulting in six months of lost production

Consolidated production volumes of 120kboe/d in 2023, 116kboe/d in 2024 and peaking at around 185-190kboe/d in 2025

Capex averaging around USD464 million a year between 2023 and 2027

No insurance proceeds

Karish North coming online in late 2023

Israeli gas sold at contractual floor price of USD4.5/mmbtu through 2027

Dividend payments of USD200 million in 2023, no dividend payments in 2024, followed by USD200 million in 2025-2027

RATING SENSITIVITIES

Factors That Could, Individually or Collectively, Lead to Positive Rating Action/Upgrade:

De-escalation of geopolitical risk will be a pre-requisite for positive rating action

Maintaining EBITDA net leverage below 1.0x on a sustained basis

Continued prudent financial management at EISL, ensuring sound distributable cash flow generation

Increasing 1P reserve levels

Factors That Could, Individually or Collectively, Lead to Negative Rating Action/Downgrade:

Significant escalation of the conflict that will lead to material reduction in production due to closure of Israeli fields and/or damage to EISL's operations on a protracted basis

EBITDA net leverage rising above 2.0x on a sustained basis

Significant gas sales contract terminations at EISL

Negative post-dividend free cash flow on a sustained basis, due to capex overruns, production delays or high dividend payments

Liquidity and Debt Structure

Comfortable Liquidity: Energean does not have any immediate external funding needs and liquidity is strong, with no maturities until 2026. At end-1H23 Energean's liquidity was USD658 million, including cash and cash equivalents (USD358 million) and an unused revolving credit facility of USD300 million.

Issuer Profile

Energean is an international independent gas-focused oil and gas company focused on the exploration, development and production of gas and oil assets in the Mediterranean.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

ESG Considerations

The highest level of ESG credit relevance is a score of '3', unless otherwise disclosed in this section. A score of '3' means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. Fitch's ESG Relevance Scores are not inputs in the rating process; they are an observation on the relevance and materiality of ESG factors in the rating decision. For more information on Fitch's ESG Relevance Scores, visit https://www.fitchratings.com/topics/esg/products#esg-relevance-scores.

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