S&P affirms long-term credit ratings of National company KazMunayGaz and KazMunaiGas Exploration Production at level “ВВ+”; outlook “Negative”

July 1. KASE. Standard & Poor’s. Moscow

S&P affirms long-term credit ratings of National company KazMunayGaz and KazMunaiGas Exploration Production at level "ВВ+"; outlook "Negative"Standard & Poor’s Ratings Services today affirmed its ‘BB+’ long-term corporate credit rating on Kazakhstan-government-controlled vertically integrated oil company KazMunayGas NC JSC (KMG) and its core subsidiary KazMunaiGas Exploration Production JSC (KMG EP). The outlook is negative.

We also affirmed our ‘kzAA-‘ Kazakhstan national scale rating on KMG. The affirmation reflects our view that KMG’s various efforts to reduce debt should be sufficient to avoid weakening in its credit metrics and liquidity.

KMG’s majority shareholder, state-owned Samruk-Kazyna, has reportedly agreed to buy KMG’s 50% stake in Kazakhstan’s largest offshore oilfield, Kashagan, for $4.7 billion. We understand that KMG plans to use the proceeds from the asset sale to repay debt, which should enable the company to preserve its credit metrics, improve liquidity, and avoid covenant breaches on its bonds. We understand that the company is working on a few other transactions that should also support credit metrics and liquidity in the current low oil price environment. These efforts could further strengthen liquidity, which we currently assess as “less than adequate”.

In our current base-case scenario, we expect KMG’s adjusted ratios of debt to EBITDA at 3-3.5x and funds from operations (FFO) to debt in the 15%-20% range in 2015-2016, which should remain commensurate with the rating and our ‘b’ assessment of the group’s stand-alone credit profile.

KMG is a 100% government-owned national oil company, with stakes in essentially all of Kazakhstan’s oil-related assets and priority access to new assets that also benefit from vertical integration into pipelines. It is one of the country’s largest exporters and taxpayers and has some social mandates, such as supplying the local market with fuel at fairly low prices and investing in socially important projects. Still, KMG is responsible for only about 28% of the country’s oil production (12% when including only majority-owned operations).

In the current environment of lower oil prices, during which most oil companies strongly cut their capital expenditures (capex), KMG is increasing its capex compared with 2014’s because many of its assets require investments. Most of KMG’s majority-owned oil production assets are mature and lack growth prospects, its refineries are relatively old, and the company only has minority stakes in the country’s most profitable and young oil projects (such as 20% in Tengiz Chevroil and 10% in Karachaganak).

In our base case, we assume:

– A Brent crude oil price of $55 per barrel (/bbl) in 2015, $65/bbl in 2016, and $75/bbl from 2017.

– High capex, including refinery modernization, pipeline construction, and KMG’s portion of additional spending to put Kashagan on stream in first-half 2015.

– Stable dividends from the company’s affiliate Tengiz Chevroil, which we expect to be about $500 million-$700 million per year in 2015-2016.

Based on these assumptions, we arrive at the following credit measures for KazMunayGas:

– Funds from operations to debt of 15%-20% in 2015-2016.

– Negative free operating cash flow generation.

The rating on KMG reflects our expectation of a “very high” likelihood of government support, based on the company’s “very important” role and “very strong” link with the government.

The negative outlook on KMG mirrors the outlook on Kazakhstan.

If we lower our ratings on Kazakhstan, we would likely lower the ratings on KMG. This is because of the uplift we include in the long-term rating on KMG to reflect our expectation of the “very high” likelihood of government support for the company, if needed.

We could also lower the rating if KMG’s SACP weakens to ‘b-‘ from ‘b’. However, this would likely follow deteriorating liquidity, which we do not expect in our base-case scenario.

We would likely revise our outlook on KMG to stable following a similar outlook revision the sovereign rating.

We could consider upgrading KMG if we revised up the SACP to ‘bb-‘. However, we regard this scenario as remote, because it would follow improvement of FFO to debt to at least 30%, which we view as tough to achieve given the current oil price.