OREANDA-NEWS. April 13, 2015. Fitch Ratings has affirmed Korea National Oil Corporation's (KNOC) Long-Term Foreign Currency Issuer Default Rating (IDR) and foreign currency senior unsecured rating at 'AA-'. Its Short-Term Foreign Currency IDR is also affirmed at 'F1+'. The Outlook on the IDR is Stable.

KNOC's ratings and Stable Outlook reflect the company's strong ties with the South Korean government, and its status as a key vehicle in the execution of Korea's energy policy.

KEY RATING DRIVERS
Ratings Equalised with Sovereign: The ratings of KNOC are equalised with Korea's (AA-/Stable) due to the company's strong strategic and operational ties with the state. KNOC is a key vehicle in the execution of Korea's energy policy. Its role entails the acquisition of oil and gas reserves, exploration and production activities to improve the country's self-sufficiency, and managing the country's strategic oil reserves. Its operations are closely aligned with the government's energy plan and monitored by the government.

Strong Continuous Government Support: KNOC undertakes substantial investments that require considerable financial assistance from the government. The government provides capital injections to support KNOC's policy objectives and operational targets. The government's capital injections into the company totalled KRW10.1trn as of December 2014, equivalent to nearly 40% of its total assets. The KNOC Act also states that the government may provide financial guarantees to KNOC, although there are no explicit guarantees to date.

Operations Affected by Lower Oil Prices: KNOC's revenue fell 17% and EBITDA declined by more than 20% in 2014 due to the sharp decline in oil prices during 4Q14. Fitch expects the deterioration to be more significant in 2015 because oil prices in the year to date are averaging below USD60/barrel (bbl), compared with nearly USD100/bbl in 2014, and our assumption is that prices will stay at these levels throughout the year. Some of KNOC's upstream assets such as the Dana Petroleum operations are more vulnerable to oil price declines because of high production costs.

Measures to Improve Financial Profile: With the new administration's push to reduce debt at Korean state-owned entities (SOEs), KNOC has been shifting its strategy towards a more conservative investment and operational target, and towards improving its financial position. As such, we believe it will be unlikely that the company will make major acquisitions in the near term. The company has also been restructuring its asset portfolio to improve its financial profile by selling overseas upstream and downstream assets and domestic real estate properties.

Standalone Credit Profile to Weaken Further: The company's standalone credit profile remains weak for its rating levels due to major debt-funded acquisitions in recent years. At current oil price levels, we expect the company to continue to post negative free cash flow, which would put further pressure on the company's credit profile. As such we expect the company's FFO adjusted net leverage to increase to above 10x in 2015 (2014: 5.5x) but to improve gradually from 2016 onwards, reflecting slightly improved oil price assumptions.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Oil prices in line with Fitch's base case price deck as outlined in the "Fitch Oil and Gas Assumptions Summary", dated 11 February 2015
- Production volume to remain nearly flat in 2015
- Capex of KRW3.5trn in 2015 and KRW3trn in 2016

RATING SENSITIVITIES
The issuer's rating is currently equalised with that of Korea.

Negative: Future developments that may, individually or collectively, lead to a negative rating action include:
- A negative rating action on the sovereign.
- The government's inability to curtail the rate of increase in public-sector entities' debt, resulting in deterioration in the state's ability to provide timely and adequate support to key public-sector entities.
- Weakening of linkages with the state.

Positive: Future developments that may, individually or collectively, lead to a positive rating action include:
- A positive rating action on the sovereign, provided that the rating linkages between KNOC and the state remain intact and that the state's ability to support key state-owned entities remains strong.

For the sovereign rating of Korea, the following sensitivities were outlined by Fitch in its Rating Action Commentary of 19 August 2014:

The main factors that, individually or collectively, could trigger positive rating action are:

-A significant reduction in general government indebtedness
-A sustainable decrease over time in the indebtedness of state-linked enterprises
-Evidence that the economy can grow over time, thereby narrowing the income gap with rating peers, without an ongoing rise in household indebtedness

The main factors that, individually or collectively, could trigger negative rating action are:

-A change of policy on the broader public sector's finances leading to tolerance for sustained rises in general government debt or broader public sector debt
-Crystallisation of risks in the financial sector leading to disruption of economic and financial stability, such as a sharp pick-up in defaults among households