RPT-Fitch affirms Russia's Alliance Oil at 'B', outlook stable
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Aug 22 (Reuters) - (The following statement was released by the rating agency)
Fitch Ratings has affirmed Alliance Oil Company Ltd.'s (AOIL) Long-Term foreign currency Issuer Default Rating (IDR) at 'B'. The Outlook is Stable. A full list of rating actions is at the end of this release.
AOIL's ratings reflect the company's limited scale, concentrated business model skewed towards downstream operations, and potential increase in capital intensity and leverage to pursue its growth strategy. We recognise the company's progress in upgrading its Khabarovsk refinery and launch of the gas business in Q113, but note that its growth strategy may be challenged by the recent production decline at the Kolvinskoye field in Timano-Pechora. AOIL is one of Russia's second-tier integrated oil companies, accounting for 0.5% of crude production and for 1.5% of oil refining in the country.
KEY RATING DRIVERS
Upstream Scale Limits Upgrade
We expect that AOIL will achieve a moderate increase in total hydrocarbon production in 2013, due to stable or slightly lower crude output and the launch of natural gas production in Q113. AOIL aims for double-digit growth of oil and gas production in 2013-2015, but even if this growth strategy is successful, its ratings are likely to be limited to the 'B' category, given its limited scale and concentration on Russia. AOIL's upstream production in H113 averaged 58.7 thousand barrels of oil equivalent per day (mbbl/d), up 9% compared with the 2012 average, including natural gas and condensate production of 5.3mbbl/d.
Corporate Governance, Country Risk
AOIL's ratings include a one-notch discount for weaker corporate governance typical for Russian corporates and for higher country risks inherent to Russia - including the risks of evolving legal and tax environment. The tax regime has a direct influence on the sector's profitability through industry-specific taxes and although it is not our base case scenario, we cannot exclude that the regime might be revised at some stage. This unpredictability is incorporated in AOIL's ratings via the discount.
Timano-Pechora is Key
AOIL's ability to implement its upstream growth strategy in the Timano-Pechora region is still important for maintaining and increasing its production, although its significance has declined since AOIL launched its gas business in the Tomsk region. At end-2012, Timano-Pechora accounted for 42% of the company's proved oil and gas reserves. The lower-than-expected production potential of Kolvinskoye, AOIL's largest field, launched in September 2011, resulted in upstream production falling to 52.3 thousand barrels per day (mbbl/d) in Q412 from 62.4mbbl/d in Q411.
More Reliance On Downstream
Progress on the Khabarovsk refinery upgrade, increasing AOIL's primary refining capacity to 90mbbl/d, supports the current ratings. Average daily refining volumes at the Khabarovsk refinery totalled 85.9mbbl/d in H113, 12% yoy. The company intends to further increase its refining capacity to 100mbbl/d by end-2013, and to connect the refinery to Transneft's ESPO oil pipeline in 2014, significantly reducing the company's transport costs. We expect that lower transport costs will offset the negative effect from the expiration of most AOIL's oil production tax breaks in 2015, leading to greater reliance on downstream in generation of operating cash flows from 2016.
Material Contribution to JV
In 2012 AOIL contributed its Volga-Urals upstream assets operated by Tatnefteotdacha and Saneco to its joint venture (JV) with Repsol, S.A. (BBB-/Stable), which was set up in 2011. The assets accounted for 35% of AOIL's proved reserves at end-2012, and for 38% of its upstream production in 2012. We expect AOIL to retain significant control over these assets, but estimate that the cash flows effectively available to service AOIL's debt in the medium term will reduce as a result of the transaction, because 49% of Saneco and Tatnefteotdacha's potential dividends will be allocated to Repsol, and a part of the JV's operating cash flows may be used to finance JV capex.
No Deleveraging Expected
At end-2012 AOIL's funds from operations (FFO) Fitch-adjusted gross leverage was 3.2x, and we expect it to average 3x-4x in 2013-2017. In 2012, the company's FFO interest coverage was 4.2x, including capitalised interest, and this could be around 3x-4x over 2013-2017. We consider these figures adequate for the current rating level. AOIL might be able to deleverage moderately if crude prices were higher than in Fitch's conservative Brent price deck: USD103/bbl in 2013, USD96/bbl in 2014, USD88.5/bbl in 2015 and USD80/bbl in the long term.
The Amur River Flooding:
The management says that the Amur river flooding in the east of Russia does not affect the operations of AOIL's Khabarovsk refinery at the moment. We do not expect that the flooding will materially affect the company's operating cash flow and modernization of the refinery. However, we will continue to monitor the situation and might take a negative rating action in case of potential serious disruption or material capex overruns caused by the flooding.
Stronger Upstream, Stabilised Debt
Positive rating action could follow if the company increases the scale of upstream and downstream operations, including hydrocarbon production expanding to 80-100 thousand barrels of oil equivalent per day, consistently achieves positive free cash flow (FCF), and maintains mid-cycle funds from operations FFO adjusted leverage at or less than 4x and interest cover above 4x.
Lower Production, Rising Leverage
Declining hydrocarbon production (eg stemming from an inability to stabilise the production at Timano-Pechora), and higher capex or non-zero dividends to ordinary shareholders resulting in mid-cycle FFO adjusted leverage rising above 5x and interest cover falling below 3x could lead to negative rating action.
LIQUIDITY AND DEBT STRUCTURE
We view AOIL's liquidity position as adequate for the current ratings but challenged overall. Organic sources of liquidity are the most constrained due to high capex resulting in negative FCF generation. At end-H113, AOIL had USD398m of cash compared with short-term debt of USD384m. In H113, AOIL improved its debt maturity profile by issuing a USD500m Eurobond due 2020 and preferred stock for the equivalent of USD100m.
Balanced Debt Portfolio
AOIL's consolidated debt portfolio is well balanced by maturities and instruments. During 2008-H113 it issued Eurobonds, convertible bonds, Russian rouble domestic bonds and preferred stock totalling around USD2bn. In addition, in 2010 Vnesheconombank (BBB/Stable) opened a long-term credit line of more than USD750m with AOIL aimed at the Khabarovsk refinery upgrade due 2022. Around 25% of the company's consolidated debt is secured, including the Vnesheconombank loan.
Approach to Preferred Stock
Under Fitch's 'Treatment and Notching of Hybrids in Nonfinancial Corporate and REIT Credit Analysis', we allocate AOIL's cumulative preferred shares 50-50 between debt and equity; they therefore affect the company's leverage ratios. We also include 100% of the projected preferred dividends in our forecasts for interest coverage. AOIL has issued preference shares equivalent to around USD300m so far.
FULL LIST OF RATING ACTIONS
Alliance Oil Company Ltd.
Long-Term foreign currency IDR: affirmed at 'B'; Outlook Stable
Long-Term local currency IDR: affirmed at 'B'; Outlook Stable
Short-Term foreign currency IDR: affirmed at 'B'
Short-Term local currency IDR: affirmed at 'B'
Foreign currency senior unsecured rating: affirmed at 'B'/'RR4'
National Long-Term Rating: affirmed at 'BBB(rus)'; Outlook Stable
OJSC Alliance Oil Company
Local currency senior unsecured rating: affirmed at 'B' /RR4
National senior unsecured rating: affirmed at 'BBB(rus)'