TEXT-S&P cuts Polish Oil & Gas to 'BBB-'; Outlook Stable

Wed Nov 28, 2012 4:23am EST

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(The following statement was released by the rating agency)

Nov 28 -

Overview

-- In our view the regulatory framework for Poland's gas market appears to prevent the Polish Oil & Gas Company (PGNiG) from passing on the price of natural gas imports to its end consumers, making the group highly vulnerable to volatility in commodity markets.

-- We believe the company's agreement with Gazprom on gas imports will stem the increase in gas trading losses and enhance profitability and liquidity. But key credit metrics will likely be significantly below previous guidance for 2012.

-- We are lowering our rating on PGNiG to 'BBB-' from 'BBB' and removing it from CreditWatch.

-- The stable outlook reflects our anticipation that PGNiG's fair business risk profile and significant financial risk profile will not weaken over the next two years.

Rating Action

On Nov. 28, 2012, Standard & Poor's Ratings Services lowered its long-term corporate credit rating on Polish Oil & Gas Company SA (PGNiG) to 'BBB-' from 'BBB'. We removed the rating from CreditWatch, where we placed it with negative implications on Sept. 5, 2012. The outlook is stable.

Rationale

The downgrade reflects our view that the Polish gas market regulatory framework does not support PGNiG's domestic gas supply operation. Furthermore, there was a steep decline in PGNiG's key credit ratios because of losses on oil-indexed and U.S. dollar-based imported natural gas in 2012 and high investment levels. PGNiG sells gas on the domestic market under regulated prices that are below its import costs. The regulator's refusal to allow timely pass-through of a significant increase in the cost of imported gas in 2012 resulted in unprecedented trading losses for the group.

We have revised our view of the group's business risk profile to fair from satisfactory and that on the financial risk profile to significant from intermediate, as defined in our criteria. The ratings also reflect our methodology for rating government-related entities and our opinion that there is a "moderately high" likelihood that the Republic of Poland (foreign currency A-/Stable/A-2, local currency A/Stable/A-1) would provide timely and sufficient extraordinary support to PGNiG in the event of financial distress. This is based on our view of PGNiG's "strong" link with, and "important" role for, the Polish government. As a result, the ratings currently benefit from a one-notch uplift from the stand-alone credit profile (SACP), which we now assess at 'bb+', down from 'bbb-'.

On Nov. 6, 2012, PGNiG announced a commercial agreement with OAO Gazprom amending the pricing formula for its gas imports under the important Yamal contract. The new pricing terms, which according to the group include European gas market-based pricing components, will in our view stop gas trading losses from increasing and help stabilize the group's financial performance and key credit metrics. Furthermore, the positive impact on profitability will help the group secure unrestricted access to its key domestic credit facilities, restricted by covenants, thereby improving liquidity, in our view. Our base-case scenario underlying the rating of the group includes significant improvement of key credit metrics from 2013, as reflected in the stable outlook for the rating.

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