OREANDA-NEWS. Fitch Ratings has assigned Kunlun Energy Company Limited (Kunlun) a Long-Term Foreign-Currency Issuer Default Rating (IDR) of 'A', with a Stable Outlook, as well as a senior unsecured rating of 'A'. Fitch has also assigned Kunlun's proposed US dollar senior unsecured notes an 'A(EXP)' expected rating.

Kunlun's ratings are closely aligned with the credit profile of its ultimate parent China National Petroleum Corporation (CNPC; A+/Stable), in line with Fitch's parent and subsidiary rating linkage methodology. Kunlun is rated one notch below CNPC's rating due to the close strategic and operational linkages, and the significant support Kunlun has received from CNPC and its subsidiary PetroChina Company Limited (PetroChina; A+/Stable). Kunlun's strong standalone credit profile, at 'A-', reflects predictable cash flow generated from its strategic Shaanxi-Beijing Line, as well as robust credit metrics.

KEY RATING DRIVERS

Credit Linked with Parent: Kunlun is 58.4%-owned by PetroChina, while its ultimate parent CNPC also has a direct stake of 3.43%. Kunlun's operational linkage with its parent is highlighted by the substantial related-party sales and purchases. Kunlun also relies on funding from PetroChina. At end-2014, 89% of Kunlun's loans were extended by PetroChina group companies. This ratio would drop as Kunlun starts to tap more external funding, but such a commercially driven funding approach is not viewed by Fitch as a weakening in linkage.

Ownership of Strategic Asset: Kunlun owns 60% of the Shaanxi-Beijing Line, which is the only natural gas pipeline supplying Beijing, and which satisfies the bulk of the capital city's gas demand. This asset, contributing about 60% of Kunlun's EBITDA, provides highly predictable cash flow as the gas supplier and off-taker are both part of the PetroChina group. Transmission income has been stable historically, at a yearly average of CNY0.36/cubic metre in 2012-2014.

Robust Credit Metrics: Kunlun's financial metrics are conservative, despite undergoing an investment phase over the last five years, as its investments have been funded by both debt and equity. The company also enjoys strong cash flow from the Shaanxi-Jing line, with annual EBITDA of around HKD8bn-9bn. FFO net leverage averaged 1.2x in 2012-2014, and would remain conservative in the next few years, as capex intensity would decline with completion of the Shaanxi-Beijing Line IV.

Kunlun only owns 60% of the Shaanxi-Beijing Line, while any risk of structural subordination should be balanced by the low debt leverage at the subsidiary holding this asset. Fitch's calculation of FFO for Kunlun also excludes dividends attributed to minority interests of the subsidiary.

LNG Business Developing: Kunlun has made substantial investments in liquefied natural gas (LNG), in line with its parent's strategy. This business is less stable than Kunlun's core pipeline segment, as the market is more competitive. Demand for LNG in China, still emerging, is highly linked to oil price cycles and the government's gas price reforms.

Potential Acquisitions and Reorganisation: Kunlun has boosted scale through asset injections by PetroChina. This trend could continue - for growth, or as a result of the parent's reorganisation of its mid-to-downstream gas business. Fitch expects Kunlun to conduct any future acquisition in a financially prudent manner, which has been the company's traditional practice. The current rating also assumes that Kunlun would continue playing a significant role in CNPC's overall gas strategy.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for the issuer include:
- Pipeline utilisation at 70% in 2015 and 2016, and to drop to below 60% in 2017 as construction of the Shaanxi-Beijing Line IV completes
- Overall EBITDA margin to shrink to 25%-30% 2015-2017 due to a mild reduction in transmission fee and upstream E&P margin pressures
- Average yearly capex of below HKD10bn in 2015-2017

RATING SENSITIVITIES

Negative: Developments that may, individually or collectively, result in negative rating action include:
- Evidence of weakening linkages between CNPC and Kunlun
- Negative rating action on CNPC.

Positive: Developments that may, individually or collectively, result in positive rating action include:
- Positive rating action on CNPC, provided the linkages between Kunlun and CNPC remain intact
- Development of closer linkages with CNPC.

For the rating of CNPC, the following sensitivities were outlined by Fitch in its Rating Action Commentary of 28 October 2014:

Negative: CNPC's ratings are currently equalised with those of China. Negative rating action could result from a downgrade in the sovereign rating.

Positive: Positive rating action on the sovereign would lead to positive rating action on CNPC, as its ratings are currently constrained by the sovereign. In such an event, the ratings of PetroChina would also benefit - provided the rating linkages remain intact.