Fitch Affirms National Company KazMunayGas at ‘BBB-‘; Outlook Stable
Fitch Ratings-Moscow-28 June 2017: Fitch Ratings has affirmed JSC National Company KazMunayGas’s (NC KMG or the group) Long-Term Foreign-Currency Issuer Default Rating (IDR) at ‘BBB-‘ with a Stable Outlook. Fitch has also affirmed KazMunaiGaz Finance Sub B.V.’s foreign-currency senior unsecured rating at ‘BBB-‘. A full list of rating actions is at the end of this release.
KEY RATING DRIVERS
Links with State: We rate NC KMG on a top-down basis, one notch below Kazakhstan (BBB/Stable), reflecting their strong strategic and operational links. The support factored into NC KMG’s rating includes an expectation that over the medium term the state will manage NC KMG with a financial profile that gives it some standalone resilience to oil price shocks.
Expected Reduction in Leverage: We forecast that in 2017-2020 NC KMG’s funds from operations (FFO) adjusted gross leverage will gradually decline from 7.3x at end-2016 to around 5x. Today’s rating affirmation reflects this expected deleveraging path. Should the company fail to achieve meaningful deleveraging or obtain tangible state support to reduce gross debt, we may widen the notching between the state and NC KMG.
Notched-Down Ratings Approach: NC KMG is Kazakhstan’s national oil and gas company, with medium-scale hydrocarbon production and refining, and is the owner of trunk oil and gas pipelines. It accounts for about 27% of domestic oil production, including its share of production in joint ventures (JVs), and it owns most of the refining capacity in the country. The absence of an explicit state guarantee for a significant portion of NC KMG’s debt prevents full alignment of the group’s rating with Kazakhstan’s.
NC KMG is discussing with JSC Sovereign Wealth Fund Samruk-Kazyna (BBB/Stable) an extension of the call option for the latter’s stake in the Kashagan oilfield. We view this potential call extension as another example of state support to the group. We do not expect NC KMG to repurchase the stake over the medium term due to insufficient funds, unless the terms of the deal are materially different from the original in favour of the group.
Improved 2016 Performance: NC KMG’s results improved in 2016, despite the weak oil price, due to the tenge depreciation and cost optimisation. Its FFO increased to KZT464 billion from KZT390 billion in 2015, while its free cash flow (FCF) was up by KZT83 billion yoy, though it remained negative. Fitch-calculated NC KMG’s FFO adjusted gross leverage was 7.3x at end-2016, lower than our earlier forecasts.
JSC KazMunaiGas Exploration Production (KMG EP), NC KMG’s key 63% owned upstream subsidiary, fared better in 2016. Its FFO improved to KZT178 billion from negative KZT5 billion in 2015 on average lifting costs of USD9.3 per barrel (bbl), down 30% yoy, and average netback of USD21.3/bbl. In addition, KMG EP’s effective oil-related taxes plunged to USD14.7/bbl in 2016 from USD40.7/bbl in 2015. Progressive taxation should continue cushioning KMG EP’s future profitability.
Greater Upstream Efficiency: The group has launched an upstream transformation programme to streamline and modernise operations, maintain production volumes by using hydraulic fracturing (fracking) and improve its cost structure. If successful, this programme should make the group more resilient to oil price volatility.
Lower Expected JV Dividends: In 2016 NC KMG received KZT119 billion in dividends from JVs and associates, down 31% yoy. Following an announced USD37 billion expansion, Chevron Corp.-led TengizChevroil LLP (TCO), in which NC KMG has a 20% stake, paid nil dividends to NC KMG in 2016, down from KZT89 billion in 2015. We expect that the group’s cash dividends in 2017-2019 will remain at low levels compared to historical amounts.
On 1 November 2016 Kazakhstan’s giant Kashagan field began commercial oil production. NC KMG expects Kashagan crude production to more than double by end-2017 from about 180 thousand barrels of oil per day (mbopd) currently. We forecast no dividends from Kashagan to the group over the rating period as KMG Kashagan B.V., NC KMG’s 50% associate holding 16.88% interest in the project, will continue repaying its USD1.6 billion outstanding debt related to the Kashagan acquisition.
Domestic Refinery Upgrades, Tariffs: The group is continuing to upgrade Atyrau, Pavlodar and Shymkent (a JV) refineries to ensure compliance with Euro-4 and Euro-5 emission standards by end-2017 for the first two assets and mid-2018 for Shymkent. NC KMG estimates its total domestic downstream capex at KZT253 billion in 2017, and a sharp decline to a mere KZT10 billion per annum starting in 2018.
Consolidated Approach to Downstream Assets: In our rating case, we continue to consolidate the group’s downstream assets, ie, KMG International NV (KMGI, B+/Rating Watch Negative) and domestic Kazakh refineries, despite the announced disposal plans for these assets, as we believe it may take longer to close the sale. The domestic refining tariffs have been deregulated from 1 January 2017, and we expect the profitability of the group’s domestic refining asset to gradually improve over time.
NC KMG is Kazakhstan’s national oil and gas production and refining company and the owner of trunk oil and gas pipelines. With 2016 production of nearly 250mboepd, or 580mboepd including its share in JVs, it fares well against such peers as PJSOC Bashneft (BBB-/Stable, 430mboepd), State Oil Company of the Azerbaijan Republic (SOCAR, BB+/Negative; 250mboepd including JVs) and Repsol, S.A. (BBB/Negative; 680mboepd including JVs).
NC KMG’s gross leverage is significantly higher than that of similarly rated EMEA peers, but is similar to that of some other national oil companies, eg, Korea National Oil Corporation (AA-/Stable) and Mexico’s Petroleos Mexicanos S.A. (Pemex, BBB+/Negative).
NC KMG’s rating is notched down one notch from the sovereign rating due to strong strategic and operational ties on the one hand and weak legal ties, eg, the absence of state guarantees for the group’s debt, on the other. Among its local peers, Kazakhstan Electricity Grid Operating Company (BBB-/Stable) is also rated down one notch from the sovereign due to strong operational and strategic links but legal ties insufficient for rating alignment.
Fitch’s key assumptions within our rating case for the issuers include:
– Brent oil price of USD52.5/bbl in 2017, USD55/bbl in 2018, USD60/bbl in 2019 and USD65/bbl thereafter;
– average exchange rate of KZT324 per 1 USD in 2017 and 310 thereafter;
– flat or moderately declining oil and gas production and no dividends from Kashagan in 2017-2020;
– broadly stable financial performance of midstream segment;
– improving profitability of downstream segment;
– capex averaging KZT380 billion per annum in 2017-2020;
– no significant asset disposals in 2017-2020.
Developments that may, individually or collectively, result in positive rating action include:
– A sovereign upgrade
Developments that may, individually or collectively, result in negative rating action include:
– a sovereign downgrade;
– failure to improve FFO adjusted gross leverage to below 7x over the medium term;
– evidence of weakening state support, ie, the state’s failure to provide timely tangible financial support to the group.
For the sovereign rating of Kazakhstan, Fitch outlined the sensitivities listed below in the rating action commentary of 24 April 2017.
The following risk factors individually, or collectively, could trigger negative rating action:
– a further weakening in the sovereign external balance sheet;
– materialisation of significant contingent liabilities above those already identified from the banking sector on the sovereign balance sheet;
– policies that hamper fiscal consolidation or undermine monetary policy credibility.
The following factors, individually or collectively, could result in positive rating action:
– a sustained recovery in external and fiscal buffers;
– steps to reduce the vulnerability of the public finances to future oil price shocks, for example by reducing the non-oil deficit;
– a sustained recovery in the economy supported by substantial improvements in the business environment and governance and greater diversification;
– substantial improvement in the performance of the banking sector.
Manageable Maturities, FX Debt: At 31 March 2017, the group’s short-term debt of KZT700 billion, including the short-term portion of oil supply prepayment, was fully covered by cash of KZT444 billion and short-term investments of KZT1,557 billion, excluding cash attributable to discontinued operations. In April 2017, NC KMG issued Eurobonds totalling USD2.75 billion (about KZT863 billion), the proceeds from which will be used to repay its obligations. At end-2016, 89% of the company’s cash and deposits and 94% of the group’s debt was denominated in US dollars. Of the total cash and short-term investments, KZT1.1 trillion or 56% was at KMG EP at end-2016.
We rate NC KMG on a gross leverage basis because we do not consider the group’s significant cash balance, including short-term deposits, as being able to fully offset its high leverage. Historically, the group relied on external debt financing for capex funding. Fitch treats a USD3 billion oil supply prepayment received by NC KMG from Vitol as debt.
FULL LIST OF RATING ACTIONS
Long-Term Foreign-Currency IDR: affirmed at ‘BBB-‘; Outlook Stable
Long-Term Local-Currency IDR: affirmed at ‘BBB-‘; Outlook Stable
Short-Term Foreign-Currency IDR: affirmed at ‘F3’
Foreign-currency senior unsecured rating: affirmed at ‘BBB-‘
Local-currency senior unsecured rating: affirmed at ‘BBB-‘
KazMunaiGaz Finance Sub B.V.
Foreign currency senior unsecured rating: affirmed at ‘BBB-‘
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Summary of Financial Statement Adjustments
– KMGI consolidation: Fitch added back KMGI’s income statement and balance sheet items into NC KMG’s financials. As a result, NC KMG’s end-2016 debt increased by KZT202 billion and its 2016 EBIT improved by KZT390 billion, while NC KMG’s cash flows were unaffected.
– Prepayments for oil deliveries: Fitch treats the long-term prepayments for oil deliveries from Vitol as debt. As a result, NC KMG’s adjusted debt increased by KZT989 billion at end-2016. Associated interest payments are added to NC KMG’s interest charge.
– Guarantee for Beineu-Shymkent pipeline: Fitch included the full amount of USD720 million loan guarantee provided to Beineu-Shymkent Pipeline LLP, NC KMG’s JV, in debt at end-2016.
– Operating leases: Fitch adjusted NC KMG’s debt by adding 6x the annual operating lease expense of KZT14.3 billion in 2016.
– Not readily available cash: Fitch estimates that NC KMG will need to keep KZT30 billion of cash on balance for various corporate needs and removes this amount from its end-2016 readily available cash. Additionally, Fitch deducted KZT109 billion of cash pledged as loan collateral.
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