Fitch Ratings has maintained FLNG Liquefaction 3, LLC (FLIQ3) on Rating Watch Negative (RWN).

FLIQ2's Operational Bank Facility (OBF) and five outstanding series of senior secured notes are rated 'BBB-'.

RATING RATIONALE

Fitch placed FLIQ3 on RWN on June 24, 2022 following an extensive outage caused by an incident that occurred at the Freeport LNG liquefaction plant. The incident resulted from an overpressure and rupture of a segment of an LNG transfer line, leading to the rapid flashing of LNG followed by a fire at the facility.

Fitch has maintained the RWN following further delays to the reinstatement of operations. The RWN will be resolved if a full completion of repairs and a return to full operations at the plant can be accomplished by the end of Q1 2023.

FLIQ3's ratings reflect the stable cash flow profile supported by revenues from tolling-style agreements with off-takers that bear all-natural gas supply and most cost risks. Proven equipment, experienced operators, and excess capacity help mitigate operating risk. FLIQ3 can pass-through nearly all liquefaction-related power costs but the project is exposed to potential increases to other operating costs.

The project's rating is constrained by the credit quality of its key counterparties given the high level of dependency on the revenue contracts for cash generation. The financial profile under the Fitch rating case, which includes sensitivities to liquefied natural gas (LNG) production levels and operational costs, is supportive of the rating with debt service coverage ratios (DSCR) averaging 1.60x (based on $4.5 billion of total rated project debt).

KEY RATING DRIVERS

Stable Contracted Revenues (Revenue Risk: Stronger)

FLIQ3 operates under long-term tolling agreements (LTAs) with two third-party off-takers. Each LTA is structured to provide revenue from a capacity payment that is paid regardless of the LNG volumes lifted and covers the project's fixed costs. Variable costs associated with lifting are reimbursed by the off-taker, effectively as a pass-through payment. FLIQ3's performance requirements are consistent with design parameters, so the risk that the seller triggers a contract termination option is low. The LTA originally signed with a subsidiary of Toshiba Corp. is now backed by a strong guarantee from a subsidiary of Total SA. The LTA with SK E&S LNG, LLC (SK E&S) is backed by a solid parent guarantee from SK Holdings Inc.

Stable Expected Operational Profile (Operation Risk: Midrange)

Operating performance risk is mitigated by the application of proven technology, which includes numerous installations worldwide. Excess production capacity above contracted levels and equipment redundancy achieved through the integrated operations of the site's three LNG trains reduce the impact of potential unplanned outages. O&M expenses are expected to be stable regardless of off-taker lifting patterns, as the associated variable power costs are nearly all absorbed by the off-takers. The project retains exposure to potential increases to fixed costs (over 50% of the total cost profile) but demonstrates substantial resilience to such increases under various stress scenarios.

No Feedstock Gas Risk (Supply Risk: Stronger)

FLIQ3's LTAs are structured as tolling-style agreements, in which the off-takers bear the risk of gas procurement and cost. FLIQ3 has no exposure to the potential variability in feedstock supply or cost.

Fixed and Hedged Debt Structure (Debt Structure: Midrange)

A combination of fixed rates on outstanding notes and hedging on the OBF mitigates interest rate risk on the project's debt. The senior notes and assumed refinanced OBF will mature with a one-year tail remaining on the LTAs. Equity distribution tests and dedicated reserves are consistent with typical investment grade project finance features. Fitch's financial analysis is based on total debt of about $4.5 billion, though provisions in the bond indenture permit the incurrence of supplement debt subject to a historical and projected coverage test at 1.4x and ratings affirmation.

Financial Profile

Fitch's financial analysis considers sensitivities to LNG production levels, operational costs, and a higher asset risk premium upon refinancing the OBF. The resulting cash flows produce a Fitch rating case DSCR profile averaging 1.60x, with a minimum of 1.56x. The rating also considers the 1.40x DSCR threshold allowable for supplemental debt.

PEER GROUP

Cameron LNG, LLC's higher rating (A-/Stable) is driven by stronger average rating case DSCRs (close to 2.5x) and more highly rated off-takers. FLIQ2 (BBB/RWN) shares common facilities with FLIQ3, has the same tolling-style revenue structure, facing some refinance risk, and demonstrates similar rating case coverages (1.54x average). In contrast, FLIQ2's rating is not constrained by counterparties. Sabine Pass Liquefaction, LLC (SPL; BBB-/Positive) has six operational LNG trains, and primarily earns revenue through sale and purchase agreements with investment grade off-takers. SPL's rating case coverage is around 2x, and Positive Outlook indicates current forecasts of financial performance may be adequate for a higher rating.

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to negative rating action/downgrade:

Failure to resolve the outage within the indicated time-frame;

Failure to continue receiving proceeds under the business interruption or property damage insurance policies;

Erosion in credit quality of the LTA off-takers or guarantors;

Weak operational performance or materially higher costs that reduce rating case DSCRs below 1.3x;

Issuance of additional debt that results in a Fitch rating case DSCR profile of less than 1.3x.

Factors that could, individually or collectively, lead to positive rating action/upgrade:

Resolution of the outage and return to normal operating profile within the indicated time frame;

Improvement in the credit quality of the LTA off-takers or guarantors;

Proven operating profile that justifies lower operational cost or higher LNG production assumptions.

Best/Worst Case Rating Scenario

International scale credit ratings of Sovereigns, Public Finance and Infrastructure issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of three notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

CREDIT UPDATE

The maintenance of the RWN is driven by delays to the reinstatement of operations as a result of an incident that occurred at the Freeport LNG liquefaction plant on June 8, 2022. The incident resulted from an overpressure and rupture of a segment of an LNG transfer line, leading to the rapid flashing of LNG followed by a fire at the facility. There were no injuries, no damage to the liquefaction trains, LNG storage tanks, dock facilities, or LNG process areas, and no threats to the surrounding area.

A third-party root cause analysis concluded in November 2022, with management implementing various improvements as they move towards the resumption of operations. The investigation has noted the involvement of operator error which will result in liquidated damages under off-take agreements.

A majority of construction work needed for operations was completed at the end of November 2022. With delays to the timeline, currently driven by regulatory challenges, management believes partial operations can start in January 2023, with a return to full operations at the plant by the end of Q1 2023. The management team anticipated earlier receipt of regulatory approvals required to proceed with reconstruction and repair work necessary for the reinstatement of operations, and regulatory delays remain a risk to the schedule.

Despite these risk factors, Freeport LNG maintains a sufficient amount of liquidity to pay debt service and expenses for the near-term. FLIQ3 has a partially undrawn debt service reserve account and working capital facility. Freeport LNG maintains sizable business interruption insurance that can be accessed by FLIQ3. Approximately 25% of the total insurance policy has been utilized. Further delays can erode Freeport LNG's liquidity position.

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

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This 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. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.

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