OREANDA-NEWS. Fitch Ratings has affirmed PT Pertamina (Persero)'s (Pertamina) Long-Term Foreign-Currency IDR at 'BBB-' with a Stable Outlook. Its senior unsecured rating, USD10bn global medium-term note programme and existing senior unsecured notes have also been affirmed at 'BBB-'.

KEY RATING DRIVERS

Rating Equalised with Sovereign: Pertamina's ratings are equalised with that of its parent, the Republic of Indonesia (BBB-/Stable), as per Fitch's Parent and Subsidiary Linkage methodology. This reflects the strong operational and strategic linkages between the parent and the company. Pertamina is the sole refiner in Indonesia and the dominant retailer of petroleum products. It remains one of the most important state-owned entities in executing Indonesia's national energy policy. Fitch assesses its standalone credit profile at 'BBB-'.

Public Service Obligations: Pertamina performs a public service obligation (PSO) by selling certain petroleum products below market prices. The government makes up the shortfall via subsidies to ensure Pertamina receives a predetermined margin on the products sold under the PSO. These subsidies are important for Pertamina to operate as a profitable entity, particularly because its downstream operations accounted for about 43% of EBITDA in 2015, up from from just 6% a year earlier. We expect subsidies to comprise over half of Pertamina's EBITDA over the next three years and an absence of the subsidies can make it challenging for Pertamina to continue with its planned investments.

Risk from Subsidy Reforms: Pertamina's subsidy requirement fell during 2015 due to the fuel price reforms undertaken by the Indonesian government, along with the fall in crude oil prices. The company received a subsidy of USD3.3bn in 2015 (2014: USD12.5bn). The state removed subsidies on gasoline in January 2015, and changed the subsidy mechanism for diesel, with the subsidies now being fixed in nature, rather than variable. However, the fixed diesel subsidy formula can increase the risk that Pertamina does not recover its costs, if retail prices of fuels are not revised adequately or at regular intervals.

The government had initially planned to revise fuel prices at least once a month, but has gradually moved to a policy of revising fuel prices every three months. The government also continues to set the prices for gasoline despite the removal of related subsidies, highlighting the sensitive nature of fuel prices in Indonesia, which has a history of social unrest in response to fuel price increases. Fitch will closely monitor developments in the reforms, particularly if fuel will continue to be sold at commercial prices in a high price environment.

Large Capex and Investments: Pertamina expects to spend around USD17bn over the next three years on capex for increasing its oil and gas production and expanding its refining capacity. The high capex is likely to result in a significant increase in Pertamina's debt levels, which along with weaker profitability due to low oil prices, is likely to drive up its leverage. Pertamina externally sources around 40%-50% of its net crude requirement for its refineries and about 45% of its refined products. Increasing Pertamina's upstream production and refinery capacity augmentation and improvement remain important to improving the company's profitability and containing the state's potential subsidy expenses. We expect Pertamina's oil and gas production to continue to rise by over 15% over the next three years supported by these investments (2015:11%).

Weakening Credit Metrics: We expect Pertamina's FFO-adjusted net leverage to increase to around 4x in 2016 (2015: 2.0x) and remain around this level till 2018, driven by weak profitability and high capex. Fitch expects Pertamina's free cash flows (FCF) to turn negative in 2016 (2015: positive USD4bn; 2014: negative USD1.5bn) and continue to remain negative in 2017 and 2018. The fall in Pertamina's working capital requirement due to low oil prices during 2015 supported its positive FCF and lower net debt levels (2015: USD10.5bn; 2014: USD13.9bn).

Strong Liquidity: Pertamina's liquidity remains strong with cash balance of USD3.1bn as of end-2015 (2014: USD3.6bn) and strong access to funding. Fitch believes that Pertamina will continue to have strong access to bank and bond markets given its state linkages and that it will be able to meet its debt obligations in this period and obtain funding for expansion.

Standalone Profile: Pertamina's standalone credit strength reflects its vertically integrated operations, large scale and dominant position in Indonesia's retail fuel market. However, its operating strengths are offset by its short upstream production position, small mid-stream capacity relative to its overall petroleum product sales, and weakening in its credit metrics. Pertamina is one of Indonesia's largest producers of crude oil, accounting for over 20% of the country's crude output. Overall, Fitch considers Pertamina's standalone credit profile to be a weak 'BBB'.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

- Oil prices (Brent) to average USD40 a barrel in 2016, USD45 a barrel in 2017, USD55 a barrel in 2018 and USD65 a barrel in the long term, in line with the Fitch oil and gas price deck

- Present subsidy formulas for diesel, kerosene and LPG to continue

- Downstream volume growth of 2% a year in 2016 improving to around 3%-4% thereafter

- Growth in oil production of over 25% in 2016 and around 15% each in 2017 and 2018

- Total capex and acquisition spend of USD16.5bn between 2016 and 2018

RATING SENSITIVITIES

Positive: Future developments that may, individually or collectively, lead to positive rating action include:

- Positive rating action on Indonesia's sovereign rating, provided there is no weakening of the company's legal, operational and strategic ties with the government

Negative: Future developments that may, individually or collectively, lead to negative rating action include:

- Negative rating action on the sovereign, provided the company's standalone profile also weakens. Fitch would lower the company's standalone profile if FFO-adjusted net leverage is sustained above 4.0x due to higher capex, large M&A or if Pertamina is not fully compensated under the subsidy formula

- Weakening of links with the state, although Fitch considers this to be unlikely in the medium term.

For the sovereign rating of Indonesia, the following sensitivities were outlined by Fitch in its Rating Action Commentary of 23 May 2016:

The main factors that, individually or collectively, could trigger positive rating action are:

- A strengthening of the external balances, making Indonesia less vulnerable to sudden changes in foreign-investor sentiment, for instance through lower commodity export dependence or structurally higher foreign direct investment inflows.

- Evidence of higher sustainable GDP growth in the longer run, for instance resulting from structural reforms or infrastructure improvements.

The main factors that, individually or collectively, could trigger negative rating action are:

- A sharp and sustained external shock to foreign and/or domestic investors' confidence with the potential to cause external financing difficulties.

- A rise in the public debt burden, for example caused by breaching the budget-deficit ceiling.