Fitch Affirms Russia's Gazprom Neft at 'BBB-'; Outlook Negative
GPN's 'BBB-' rating reflects the company's strong business profile with growing upstream production and strong downstream operations, and low volatility of earnings compared with international peers due to progressive taxation and flexibility of the rouble exchange rate. On the other hand, GPN's financial leverage is set to increase on the back of its ambitious capex programme; and the company will have to rely primarily on domestic banks to finance its negative free cash flow (FCF) because of the US/EU sanctions and limited access to external funding. GPN's rating and Outlook are capped by those of Russia (BBB-/Negative), and PJSC Gazprom (BBB-/Negative), its immediate parent.
GPN is one of Russia's major oil producers. In 2014 the company's hydrocarbon production (excluding joint ventures (JVs), including joint operations) amounted to 1,083 thousand barrels of oil equivalent per day (mbpd), of which 80% was liquids. GPN is controlled by PJSC Gazprom.
KEY RATING DRIVERS
Lower Earnings Volatility
The earnings of Russian oil and gas companies, including GPN, are less volatile than most of their international peers, primarily due to progressive taxation in upstream activity and flexibility of the exchange rate. In 1H15 GPN's dollar-denominated upstream EBITDA per barrel of oil produced declined 21% yoy while Brent collapsed by 48%. In rouble terms, GPN's upstream EBITDA per barrel increased 29% yoy. The hike in oil taxation in Russia announced in October 2015 will have only a moderate impact on the company due to its high exposure to downstream operations, and hence lower exposure to export duties. The negative effect should not exceed 5%-7% of GPN's 2016 EBITDA.
A possible full-length revision of taxation aimed at increasing the government's stake in oil and gas revenues presents some risks, though we view this scenario as unlikely at this stage.
Rising Upstream Production
We positively view the company's efforts to increase its upstream production in Russia through developing and ramping up greenfields and stabilising production decline at brownfields, though its ambitious capex programme will put pressure on FCF, especially in 2016-17. In 2014 GPN's upstream production, excluding JVs, amounted to 1,083mbpd, and we expect it to exceed 1,300mbpd by 2017; showing growth of 8% yoy in 2016 and 10% yoy in 2017. The growth should mainly result from ramping-up operations at the company's large Novoport and Prirazlomnoye fields. There should be additional upside from GPN's JVs, such as Arcticgaz, Messoyakha and Northgas, though we tend to put less emphasis on non-consolidated production in our analysis as JV's cash flows may not be immediately available to service an issuer's debt.
Russian Oil Major
In 2014 GPN's hydrocarbon production amounted to 1,083 mbpd (excluding JVs), which Fitch classifies as 'medium' in scale and which places the company between Russia's largest oil producers, such as OJSC OC Rosneft and PJSC Lukoil (BBB-/Negative), on the one hand, and smaller regional producers, such as PAO Tatneft (BBB-/Negative) and PJSOC Bashneft (BB+/Stable), on the other. Globally, GPN's production level is close to that of such peers as ConocoPhillips (A/Negative), Occidental Petroleum Corp. (A/Stable) and Anadarko Petroleum Corp (BBB/Stable).
Competitive Reserves and Costs
GPN's proved oil reserves of 7.2 billion barrels at end-2014 (as per PRMS; excluding JVs) imply a 18-year reserve life, in line with that of its larger Russian oil and gas peers. Its 1H15 lifting costs decreased to USD2.7 per barrel of oil equivalent, down 38% yoy, on the rouble depreciation, and is much below that of most international peers.
Stabilising Downstream Performance
Oil refining in Russia underperformed in 1Q15 as domestic prices on refined oil products remained significantly below the export netback (export price minus export duty and transportation costs). This resulted from a combination of several factors, including the 'tax manoeuvre' undertaken by the Russian government, the rouble depreciation, and reluctance of Russian oil companies to raise oil product prices due to political considerations. Performance started to improve in 2Q, and we expect that GPN's refining and retail margins will stabilise in 3Q-4Q. However, they will remain lower than in 2014 due to changes in taxation.
Strong Ties with Gazprom
GPN's ties with PJSC Gazprom remain strong. The company enjoys operational autonomy and management overlap is limited; however, from strategic and legal perspectives the companies are closely related because GPN is subject to cross-default provisions in Gazprom's eurobond documentation. According to the parent's oil strategy, all Gazprom's oil assets are consolidated under GPN's umbrella. GPN is classified as Gazprom's principal subsidiary under Gazprom's eurobond terms and conditions. We expect Gazprom should support GPN in financial distress. Available sources of direct support may be limited, because of western sanctions against GPN, but could include lower dividends from the subsidiary, for example.
Leverage to Rise Further
GPN's financial leverage increased in 2014 on the back of the rouble devaluation, and we expect it to further rise on the company's ambitious capex programme. However, we expect it to be below our negative rating action trigger. GPN's funds from operations (FFO) adjusted net leverage is likely to fluctuate around 2.25x in 2015-17; up from 1.7x in 2014 and 0.8x in 2013. In its turn, GPN's interest coverage will decrease as international borrowings will be gradually replaced by more expensive Russian loans, and may fall below Fitch's current negative rating action trigger. However, this alone should not result in a negative rating action.
In our view, there is also a possibility that GPN may scale back its capex programme, in case oil prices remain lower than expected and/or if the company finds it difficult to attract new funds to finance its negative FCF. This could impact GPN's medium-term production.
Sanctions
GPN was added to the list of sanctioned entities by both US and EU in September 2014. The US Office of Foreign Assets Control has included GPN on the Sectoral Sanctions Identifications List, which prohibits US persons to provide new finance above 90 days to the company, as well as to provide equipment and technology for greenfield deepwater, Arctic offshore and shale oil projects in Russia. Similarly, the Council of the European Union has prohibited EU nationals to provide new finance above 30 days, and to provide equipment and technology needed for greenfield deepwater, Arctic or shale oil projects in Russia.
We believe the sanctions may affect the company in the long term, if they remain in place, but they have no immediate effect on GPN's creditworthiness. First, GPN is now effectively barred from western capital markets, both eurobonds and syndicated loans, which it had relied on in the past as a primary source of finance. This will have no short-term implications given available and potential liquidity sources, primarily Russian state banks. Second, GPN may find it more difficult to develop some of its unconventional resources, including tight oil, without western partners and technologies. However, we believe GPN has enough conventional reserves to proceed with its growth strategy at least in the next three to four years.
KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Oil price deck for Brent: USD55/bbl in 2015 and 2016; USD65/bbl in 2017, USD70/bbl in 2018 and USD75/bbl thereafter;
- USD/RUB exchange rate: 60 in 2015 and 2016; 55 thereafter;
- Russian progressive taxation cushioning the effect of declining oil prices on GPN's EBITDA;
- Upstream production rising to around 1,300Mbpd by 2017 (excluding JVs);
- Negative FCF and repayment of upcoming maturities mainly financed by loans from the Russian state banks.
RATING SENSITIVITIES
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Negative rating action on Russia (BBB-/Negative) and/or PJSC Gazprom (BBB-/Negative), as GPN's rating and Outlook are capped by both the rating of the sovereign and its immediate parent. Negative rating action on Russia may stem from weakening in the sovereign balance sheet, failure to recover from recession, rise in geopolitical tensions and new sanctions (see Fitch Affirms Russia at 'BBB-'; Outlook Negative 16 October 2015 on www.fitchratings.com);
- New sanctions targeted at GPN or more general sanctions;
- Worsened financial metrics, possibly from high-than-expected capex or dividends or falling production, making GPN's FFO-adjusted net leverage rise above 2.5x (2015E: 2.1x) and FFO interest cover fall below 10x (2015E: 10x) on a sustained basis;
Positive: An upgrade is unlikely given the current sovereign rating but future developments that could lead to the Outlook being revised to Stable include a similar rating action on Russia and Gazprom.
LIQUIDITY AND DEBT STRUCTURE
Adequate Liquidity
At 30 June 2015 the company's short term debt amounted to RUB96bn and was fully covered by a cash balance of RUB53bn and short-term deposits of RUB66bn plus committed credit lines from Russian banks for a total amount of RUB27.5bn.
GPN's negative FCF and repayments will put pressure on its liquidity in 2016. We expect that GPN should be able to attract finance primarily from the Russian state banks and possibly through placing domestic bonds. In case of necessity GPN should also be able to scale back its capex programme, or receive liquidity support from Gazprom.
FULL LIST OF RATING ACTIONS
PJSC Gazprom Neft
Long-term foreign and local currency IDRs affirmed at 'BBB-'; Outlook Negative
National Long-term rating affirmed at 'AA+(rus)'; Outlook Stable
Short-term foreign currency IDR affirmed at 'F3'
Senior unsecured rating affirmed at 'BBB-' (the affirmation applies to all debt issued prior to 1 September 2014)
GPN Capital S.A.
Senior unsecured rating affirmed at 'BBB-' (the affirmation applies to all debt issued prior to 1 September 2014)
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