Fitch Affirms Russia's Gazprom Neft at 'BBB-'; Outlook Stable
30 Nov 2016 11:52 AM
Fitch Ratings-Moscow/London-30 November 2016: Fitch Ratings has affirmed PJSC Gazprom Neft's (GPN) Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) at 'BBB-', with a Stable Outlook. The affirmation applies to all debt issued by GPN and its subsidiary GPN Capital S.A. prior to 1 September 2014. A complete list of rating actions is available below.
GPN's 'BBB-' rating reflects the company's strong business profile with growing upstream production and substantial downstream operations. Russian oil and gas companies, including GPN, were less severely hit by low oil prices than international producers due to low lifting costs, a weaker rouble and progressive oil taxes. The prospect of adverse changes in taxation remains an issue for Fitch's view on Russian energy company ratings.
GPN's leverage will remain high because of its ambitious capex programme. The company will have to rely mainly on domestic banks to finance its negative free cash flow (FCF) because of US and EU sanctions. However, its leverage should normalise in 2018. The company's credit profile is supported by strong legal ties with its parent PJSC Gazprom (BBB-/Stable).
KEY RATING DRIVERS
Rising Upstream Production
We view positively GPN's efforts to increase its upstream production in Russia through developing and ramping up its Novoport and Prirazlomnoye greenfield projects and stabilising the production decline at brownfield sites. GPN's upstream production in 2015 was 1.1 million barrels of oil equivalent per day (mmboe/d), excluding joint ventures. We expect it to exceed 1.25 mmboe/d by 2017, a 7% increase coming after a 5% increase in 2016. However, this ambitious capex programme will put pressure on free cash flow in 2017-18.
Russia's potential deal with OPEC to freeze or cut oil production could force GPN to revise its production growth plans. However, we believe the measure, if implemented, will be temporary and will not have a significant effect on the company's medium-term business profile.
Joint Ventures Support Growth
There should be additional production volume upside from GPN's JVs, such as Arcticgas, Messoyakha and Northgas, 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.
Tax Risks Remain
Based on the preliminary federal budget parameters, we expect oil taxes in 2017 to remain broadly at the 2016 level. The Russian progressive taxation has so far alleviated the impact of low oil prices, but may be less helpful if oil prices retreat again and the state decides to increase its share of oil and gas revenues. These risks are one of the reasons we cap ratings of Russian oil and gas companies by that of the sovereign.
Weak Downstream Performance
Downstream margins in Russia have been plagued by the 'tax manoeuvre' undertaken by the Russian government, lower oil prices and a weaker rouble. In 2015, GPN's downstream margins halved to around USD7/bbl, and fell further by around 25% yoy to USD5/bbl in 1H16. We believe that refining margins will remain weak as further adverse tax changes will be partially offset by gradually recovering oil prices.
Strong Ties with Gazprom
GPN's ties with PJSC Gazprom are strong even though GPN enjoys operational autonomy and management overlap is limited. The companies are closely related from strategic and legal perspectives because GPN is subject to cross-default provisions in Gazprom's Eurobond documentation. GPN is classified as Gazprom's principal subsidiary under Gazprom's Eurobond terms and conditions. According to the parent's oil strategy, all Gazprom's oil assets are consolidated under GPN's umbrella.
We expect Gazprom would support GPN should the need arise. Available sources of direct support may be limited, because of western sanctions against GPN, but could include lower dividends from the subsidiary as was the case in 2016.
Capex Drives Leverage Higher
GPN's leverage is higher than that of other Fitch-rated oil and gas producers in Russia, such as PJSC Lukoil and PJSC Tatneft, but is adequate when compared to international companies. In 2015, FFO-adjusted net leverage was 2.6x. We expect this ratio to peak in 2017 at 2.7x on low oil prices and its massive capex programme before falling to 2.4x in 2018.
Sanctions Have Limited Impact
US and EU sanctions against GPN may affect the company in the long term, but should have no immediate effect on creditworthiness. GPN is effectively barred from western capital markets, which it had relied on in the past as a primary source of funding. This has no short-term implications given domestic liquidity sources, mainly Russian state banks.
We believe conventional reserves are sufficient for GPN to proceed with its growth strategy, though developing unconventional resources without western partners and technologies may prove difficult on the longer-term.
Fitch's key assumptions within our rating case for GPN include:
- Oil price deck for Brent: USD44/bbl in 2016, USD45/bbl in 2017, USD55/bbl in 2018, USD60/bbl in 2019 and USD65/bbl in the long term;
- USD/RUB exchange rate: RUB67 per 1 USD in 2016, RUB66 in 2017, RUB61 in 2018, RUB59 in 2019 and RUB58 in the long term;
- Russian progressive taxation cushioning the effect of declining oil prices on GPN's EBITDA;
- Upstream production rising by around 6% per year in 2016-2019 (excluding JVs);
- Capex averaging RUB330bn annually in 2016-2019;
- Negative FCF and repayment of upcoming maturities mainly financed by loans from the Russian banks.
Future developments that may, individually or collectively, lead to a negative rating action include:
- Negative rating action on Russia (BBB-/Stable) and/or PJSC Gazprom (BBB-/Stable), as GPN's rating and Outlook are capped by both the rating of the sovereign and its immediate parent.
- Worsened financial metrics, e.g. FFO-adjusted net leverage rising above 3x (2016E: 2.4x).
- A major oil tax increase.
- Sustainably negative FCF through the cycle.
Future developments that may, individually or collectively, lead to positive rating action include:
- A positive rating action on Russia and PJSC Gazprom would result in a positive rating action for GPN, unless its FFO-adjusted net leverage rises above 2.5x through the cycle.
Refinancing Critical for Liquidity
The company's RUB96bn short-term debt at 30 September 2016 was fully covered by a cash balance of RUB39bn and committed credit lines from Russian banks of about RUB120m.
GPN's negative FCF and repayments will put pressure on its liquidity in 2017 and 2018. We expect that GPN should be able to attract finance mainly from Russian state banks and possibly through placing domestic bonds. GPN should also be able to scale back its capex programme, if needed, 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 Stable
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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Summary of Financial Statement Adjustments
- Operating leases: Fitch adjusted GPN's end-2015 debt by adding 6x the annual operating lease expense of RUB12.1bn.
- Financial liability to Gazprom: Fitch includes RUB60.6bn of deferred consideration to PJSC Gazprom in GPN's debt. The amortising liability is expected to be repaid before end-2020.
- Not readily available cash: Fitch estimates that GPN will need to keep RUB10bn of cash on balance for various corporate needs and removes this amount from GPN's readily available cash.
- Mineral extraction and excise taxes: Fitch has subtracted RUB256.5bn of mineral extraction tax and RUB68.4bn of excise tax expense from GPN's 2015 revenue and operating costs to facilitate revenue comparability among Russian oil and gas producers and international peers.
Additional information is available on www.fitchratings.com. For regulatory purposes in various jurisdictions, the supervisory analyst named above is deemed to be the primary analyst for this issuer; the principal analyst is deemed to be the secondary.
Criteria for Rating Non-Financial Corporates (pub. 27 Sep 2016)
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