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April 2 (The following statement was released by the rating agency)
Fitch Ratings has assigned India-based Oil India Ltd's (OIL; BBB-/Stable) proposed US dollar notes an expected rating of 'BBB-(EXP)'.
The notes are rated at the same level as OIL's Issuer Default Rating (IDR) of 'BBB-' as they will constitute direct, unconditional, unsubordinated and unsecured obligations of the company. The final rating is contingent upon the receipt of final documents conforming to information already received.
KEY RATING DRIVERS
Standalone Profile and State Linkages: Fitch assesses the linkages between OIL and its 67.6% owner - the Indian sovereign (BBB-/Stable) - to be strong, based on the agency's Parent and Subsidiary Linkage methodology, especially its strategic and operational linkages. Currently, OIL's standalone rating is at the same level as the sovereign's. Should the standalone rating be revised down to below that of the sovereign, OIL's IDR would receive an uplift to equate it to India's rating based on a top-down rating approach.
Strong Operational Profile but Small Scale: OIL has strong operating experience of around 50 years. The rating benefits from OIL's low cost ratios, especially its very low finding and development costs of USD5.4 per barrel. The company's production cost of around USD8.5 per barrel (excluding levies) is in line with rating peers, although this is expected to increase over the medium-term. OIL has a healthy reserve replacement ratio of above 150%, largely organic.
OIL's proven reserves were 460m barrels of oil equivalent (boe) at end-March 2013, with proven developed reserves of 84%. OIL's reserves and current production are much smaller than that of its peers rated in the 'BBB' category, whose median reserves are at around 2bn boe and median production at 500,000 boe per day. OIL's profitability per boe is diminished by the large subsidies it provides to local refiners - currently USD56 per barrel of oil. This fixed dollar obligation impacts the company adversely, especially when crude prices are falling. However, Fitch expects this subsidy burden to shrink over time.
Concentration of Operations: OIL's rating also factors in the concentration of its current reserves and production in northeastern Assam state. Further, out of its 17 producing fields, the crude production is concentrated in the Greater Hapjan (38%) and Greater Chandmari (18%) fields. The natural gas production is slightly less concentrated, with the top three fields accounting for around 50% of the production. OIL through its pipeline supplies crude oil to four refineries (total capacity of about 50m barrels) in northeastern India. The pipeline is also connected to another refinery west of Assam that has capacity of about 30m barrels. This provides the company some flexibility in diverting its production in case any customer encounters operating difficulty. We expect OIL's geographical diversity to improve over time, although production will continue to be concentrated in Assam in the medium-term.
Mozambique Asset Stake Purchase: OIL has acquired a 4% stake in a gas asset in the Rovuma basin in Mozambique for USD1bn. The stake will be increased by an additional 1%. This asset is considered to be one of the largest natural gas finds, with gas initially in place of 62.6-112.5 trillion cubic feet. Gas production is likely to start from the fiscal year ending March 2019. If executed successfully, this will diversify OIL's production and add to its reserves. The project is at a very early stage, and entails execution risks inherent to projects of this nature, although the risks are mitigated by the strong sponsors and operator of the project. Fitch also believes OIL will continue to expand via other acquisitions.
Solid Credit Metrics: The company has strong credit metrics and liquidity due to low indebtedness and large cash balances. Fitch's decision to rate OIL at investment grade on a standalone basis, despite its small scale, is largely driven by OIL's strong balance sheet. At end FY13, OIL had cash and equivalents of INR121bn (around USD2bn), and debt of INR12.6bn. The gross debt/EBITDA was 0.3x with gross debt/ proved reserves of USD0.5 per barrel.
While these metrics will weaken after the Mozambique acquisition and its related capex - which will be largely debt funded - they remain adequate for the ratings assigned. Fitch expects gross debt/ EBITDA to increase to around 1.5x and gross debt/proved reserves to about USD2.8 per barrel over the next two years. We expect OIL will be able to maintain its comfortable liquidity position with a negative net debt position over the near term. While, Fitch expects OIL to use some of its cash balances for future M&A, it is likely to maintain strong cash balances.
The government asked OIL and the largest state-owned upstream player, Oil & Natural Gas Corporation Limited (ONGC), to jointly acquire a 10% stake in Indian Oil Corporation Ltd (IOC; BBB-/Stable), which the state was looking to divest. OIL and ONGC each paid INR26.7bn to acquire the stake in March 2014. Fitch does not expect this to have a major effect on OIL's standalone credit profile.
Positive Regulatory Developments: The government had announced that gas prices will be linked to market prices from April 2014, which is likely to lead to a doubling of OIL's gas prices to USD8.4/mmbtu from the current regulated price of USD4.2/mmbtu. This measure has been deferred by the Election Commission of India till the model code of conduct (for pre-election practices) related to the general election scheduled for April/May 2014 is lifted. When this measure is implemented, the gas price increase will boost OIL's EBITDA substantially - in FY13, gas accounted for more than 40% of its total annual production of 44.9 mboe.
In addition, in October 2013 a government appointed committee recommended that the discount that oil producers provide to state-owned refiners be retained at USD56 in FY14. The report stated that in the future, the discount should be calibrated based on global crude oil prices and be percentage based rather than an absolute amount. If implemented, this would benefit OIL and other state-owned upstream companies in India.
Positive: Future developments that may, individually or collectively, lead to positive rating action include
- An upgrade of the sovereign rating provided the rating linkages with the state remain intact.
- OIL's standalone credit profile of 'BBB-' may be upgraded if it addresses the current constraints on its scale, asset diversity and profitability, while maintaining its strong balance sheet position.
Negative: Future developments that may, individually or collectively, lead to negative rating action include
- A downgrade of the sovereign rating
- A downgrade of OIL's standalone credit profile may result if gross adjusted debt to EBITDA increases to over 3.0x, gross debt/ proved reserves exceeds USD5 per boe and/ or fixed charge coverage reduces below 6x on a sustained basis.