OREANDA-NEWS. Fitch Ratings has assigned State Oil Company of the Azerbaijan Republic's (SOCAR; BBB-/Stable) proposed notes an expected foreign currency senior unsecured rating of 'BBB-(EXP)', in line with SOCAR's Long-term Issuer Default Rating.

The final rating is contingent upon the receipt of final documentation conforming materially to information already received and details regarding the amount, coupon rate and maturity. The proceeds from the notes issuance are expected to be partially used to fund the company's capex and other general corporate purposes.

KEY RATING DRIVERS
Ratings Aligned with Sovereign
SOCAR's ratings are aligned with Azerbaijan's (BBB-/Stable), as it represents the state's interests in the strategically important oil and gas industry. SOCAR maintains close ties with the government and the State Oil Fund of the Republic of Azerbaijan (SOFAZ) to make financial and investment decisions.

Funding of SOCAR's Projects
According to a decree by the President of Azerbaijan, SOFAZ and SOCAR will set up a joint venture (JV). SOCAR's cash contribution to the JV will be limited to AZN49m or 49% of JV's charter capital. SOCAR will also transfer to the JV its stakes in a number of ongoing projects, eg, a 10% stake in Shah Deniz PSA and related gas pipeline projects in 2023. Thereafter, SOFAZ will lend additional funds to the JV, which it will use to fund its share of investments in these projects.

Although there is no specific decision yet regarding the funding of SOCAR's other announced projects, eg, the oil-gas processing and petrochemical complex (OGPC) in Baku, we expect that these projects will also be funded mostly by SOFAZ. Fitch's sovereign analysts estimate that SOFAZ's assets totalled about USD40bn at end-2013 and expect further moderate growth in sovereign assets.

SOCAR has agreed funding for the 10 million ton STAR refinery in Turkey. Socar has received commitments to cover the unpaid equity portion equal to USD1.4bn of the USD5.6bn project from international banks, partially covered by Export Credit Agencies. SOCAR expects to make an additional USD800mn equity contribution related to its 60% stake in the project, which is scheduled to be completed in 2017.

'BB' Standalone Profile
Fitch views SOCAR's standalone profile as commensurate with the mid 'BB' category, reflecting its limited reserves, declining brownfield production, aged refineries, but also an extensive domestic pipeline network, an expanding international downstream and retail portfolio, and adequate credit metrics. In 2014, SOCAR's total hydrocarbon output was 297 thousand barrels of oil equivalent per day (mboepd), flat on previous year's levels. While SOCAR's upstream is weaker and its lifting costs are higher than that of 'BB' rated Russian peers, this is partially compensated by profits from its midstream and downstream operations.

Gas Replaces Oil
Under our base rating case, we expect SOCAR's own (excluding JVs) oil production to decline gradually to 2016 from the depletion of existing brownfields in Azerbaijan, SOCAR's only upstream region. At the same time, we forecast higher natural gas production from Azerbaijan's PSAs, in particular the Stage 2 of the Shah Deniz PSA. Once completed, the project aims to increase production by 16 billion cubic meters of gas and 4 million tons of gas condensate starting from late 2018.

Large Capex, Higher Leverage
We conservatively estimate that SOCAR will spend around USD2.2bn on capex in 2015-2016. The company has little capex flexibility as most funds are earmarked for its upstream business to arrest brownfield production decline, to meet its obligations under the PSAs and to complete projects that are already underway, including the construction of the STAR refinery. We forecast that under Fitch's oil price deck of USD55 per barrel of oil (bbl) in 2015 and USD65/bbl in 2016, SOCAR's FFO net leverage could exceed 2x.

KEY ASSUMPTIONS
- Flat foreign exchange rate (in line with Fitch's sovereign team's forecast for Azerbaijan)
- Stable production volumes in line with recent performance
- Declining price deck in 2015 and 2016 (per Fitch's price deck)
- EBITDA margins, dividends broadly stable
- 15-20% reduction in capex due to a lower oil price

RATING SENSITIVITES
Positive: Future developments that may result in positive rating action include:
-An increase in state support through eg, government guarantees for a large portion of the company's debt, or additional lending by SOFAZ, coupled with a sovereign rating upgrade.

Negative: Future developments that may result in negative rating action include:
-Weakening state support.
-An aggressive investment programme and/or acquisitions resulting in a significant and sustained deterioration of standalone credit metrics.
- Sovereign Downgrade

LIQUIDITY AND DEBT STRUCTURE
According to IFRS accounts, SOCAR had USD1.5bn of cash at 30 June 2014, which was insufficient to cover its short-term debt of USD2.2bn on that date. Of the total cash and restricted cash at mid-2014, about 50% was held at the state-owned International Bank of Azerbaijan (BB/Stable), a related party. SOCAR's short-term debt at mid-2014 accounted for 32% of its gross debt, up from 30% at end-2013.