Kazakh Oil Producer Tengizchevroil ‘BBB’ Rating Affirmed On Steady Expansion Progress And Performance; Outlook Negative

Kazakhstan: Credit Rating

MOSCOW (S&P Global Ratings) July 20, 2017–S&P Global Ratings today affirmed
its ‘BBB’ corporate credit rating on Kazakhstan-based oil producer
Tengizchevroil LLP (TCO). The outlook is negative. We also affirmed our
‘kzAA+’ national scale rating on TCO.

At the same time, we affirmed our ‘BBB’ issue rating on Tengizchevroil Finance
International Ltd.’s senior secured bond, which is guaranteed by TCO.

The affirmation reflects our view that TCO’s operating and financial
performances remain generally in line with our base-case scenario, as the
company progresses with its expansion project, which aims to increase
production by 2022.

The ratings on TCO reflect our view that the strengths of TCO’s underlying
business will carry the company through its major investment project, despite
our expectation of strongly negative free operating cash flow in the next
several years. We also take into account our view that the availability of
financing for the full amount of the project, the very long-term nature of
TCO’s debt, and ongoing shareholder support via a cash-call mechanism further
enhance TCO’s credit profile.

TCO is developing one of the major Kazakh oil fields, Tengiz, and accounts for
about 34% of total hydrocarbon liquids produced in Kazakhstan and 29% of its
oil reserves. TCO produces about 784,000 barrels of oil equivalent per day
(boepd) of light sweet crude oil, and it targets increasing production to more
than 1.0 million boepd following the completion of its major expansion
project. The total value of the expansion plan is about $41.2 billion and will
be financed via $21.5 billion of debt (a bond issue, loans from commercial
banks, and senior pari passu loans from shareholders) as well as operating
cash flows.

Our assessment of TCO’s business risk profile reflects our view of the
company’s low-cost production, which allows it to generate meaningful positive
free cash flow even under low oil prices (before the expansion project). At
the same time, we consider the company’s exposure to high country risk in
Kazakhstan, where all TCO’s assets are located, alongside limited diversity in
terms of products and geography. An additional constraint on TCO’s business,
in our view, is its reliance on Caspian Pipeline Consortium as a low-cost
means of transportation, which currently supports profitability at
above-average levels.

Our assessment of TCO’s financial risk profile reflects our expectation that
the expansion project will materially increase leverage, with an anticipated
peak in 2020-2021 followed by a gradual reduction. Given the expected hike in
debt leverage and high capital expenditure (capex) requirement, our analysis
focuses primarily on future credit metrics, particularly our projections for
2018-2022. We expect TCO to maintain funds from operations (FFO) to debt of
above 25%, which would support the current assessment.

At the same time, we acknowledge that TCO’s debt has a very long-term nature,
similar to project finance transactions, with no debt repayments until 2024.
In our view, this partially mitigates our expectations of materially negative
free cash flow generation and somewhat relaxes the leverage tolerance levels
compared with some of TCO’s peers. Besides, the presence of a cash-call
mechanism–which requires shareholders to cover cash shortfalls due to cost
overruns or lower oil prices until 2022–mitigates the risk of lower oil
prices.

We assume that this important enhancement of the transaction structure will
not be triggered under our current price assumptions. However, we positively
reflect the cash-call mechanism in our comparison of TCO with its peers, since
it represents meaningful protection against a potential downside scenario,
notably if oil prices were to protractedly weaken to below $40 per barrel
(/bbl).

We believe TCO is moderately strategic to its parent companies, particularly
Chevron, its largest shareholder with a 50% stake in TCO since its
establishment. Chevron and TCO’s shareholders committed to providing the bulk
of financing for TCO’s expansion projects. That said, TCO itself accounts for
only a small percentage of consolidated production. We also note that TCO is
located in a country with unstable regulation. Therefore, we think that
further support to TCO is possible but not guaranteed in all scenarios,
including in the event of deterioration of the sovereign’s credit quality.

Accordingly, because we do not consider parental support toward a moderately
strategic subsidiary as a basis for rating the subsidiary above the sovereign
foreign currency rating, we should not have adjusted the rating on TCO by one
notch for possible support in our prior analysis. Such adjustment constituted
a misapplication of criteria, which today’s action corrects.

Although our current corrected analysis results in a different stand-alone
credit profile, it has no effect on the rating on TCO. This is because we
factored in the contractual shareholder support of the project into our
analysis of the financial risk profile, which we reassessed to intermediate
from significant. This primarily reflected our views that we would not adjust
our assessment of TCO’s financial risk profile for negative free cash flow,
which we usually do for TCO’s peers, because the majority of TCO’s debt is
provided by the parent companies, and because of the existence of the
cash-call mechanism.

The rating on TCO is one notch above the long-term foreign currency rating on
Kazakhstan (foreign currency: BBB-/Negative/A-3). We stress tested TCO under a
sovereign default scenario in Kazakhstan since 100% of TCO’s revenues and
EBITDA are generated in this country. Generally, we think that TCO is exposed
to sovereign-related risks more than some other oil companies, including the
main risk of regulation change. That said, as we do not expect TCO to have any
debt maturities until 2024, we think the company could sustain a hypothetical
sovereign default. But given TCO’s 100% exposure to Kazakhstan, our rating on
the company can only exceed the transfer and convertibility (T&C) assessment
on Kazakhstan by one notch.

The negative outlook on TCO solely reflects the outlook on the sovereign
rating. Generally, we believe that TCO should be able to maintain headroom
against the long-term rating target of debt to EBITDA of 3x on average. We
think that the short-term oil price volatility alone is unlikely to drive a
rating change, as the long-term evolution of credit metrics would largely
depend upon the long-term oil price, which is currently $55/bbl.

We would lower our long-term rating on TCO if we lowered our long-term foreign
currency rating on Kazakhstan or revised down our T&C assessment on the
country by one notch. We could also downgrade TCO if we revised our long-term
oil price assumption to below $40 and if debt to EBITDA exceeded 3.0x on
average or materially above 3.5x at any point in time. Other factors that
could negatively affect the rating include a worsening of country risk in
Kazakhstan, for instance due to a substantial revision of the local tax
regulation or major disruptions to the Caspian pipeline, which we currently do
not expect.

We could also lower the rating if we observed less support from Chevron and
other shareholders than we currently factor in, adversely affecting TCO’s
capital structure.

We could revise the outlook on TCO to stable if we took a similar action on
the sovereign.

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