OREANDA-NEWS. Fitch Ratings has affirmed the Long-Term Foreign - and Local-Currency Issuer Default Ratings (IDRs) on China National Petroleum Corporation (CNPC), CNPC Finance (HK) Limited (CPFHK) and PetroChina Company Limited (Petrochina) at 'A+'. The Outlooks on the IDRs are Stable. A full list of rating actions is at the end of this commentary.

Under Fitch's Parent and Subsidiary Linkage criteria, CNPC's ratings are equalised with those of China (A+/Stable). Similarly, the ratings of PetroChina and CPFHK are equalised with the ratings of their parent, CNPC, based on their strong overall legal, operational and strategic ties.

Lower oil prices have led to a significant weakening of CNPC's credit metrics and substantially reduced the headroom under the company's standalone credit profile, which we still assess at 'AA-'. We expect CNPC's credit metrics to remain weak for this rating level through 2018.

However, Fitch expects CNPC to gradually restore its credit metrics to levels appropriate for a 'AA-' profile by 2018 or 2019. This is based on the company's cost reduction programme, reduced capex and dividend discipline, as well as a recovery in oil prices over the long term under the Fitch oil price deck, and provided the company does not engage in aggressive M&A. Fitch's base rating case forecast does not factor in potential disposal proceeds resulting from any re-organisation of CNPC's business units.

KEY RATING DRIVERS

Large Integrated Company: CNPC's scale is one of the largest among Fitch-rated energy companies globally. It benefits from an integrated business profile, with its own crude output accounting for around 80% of its mid - and down-stream processing requirements in 2015. In addition, the company has large petroleum marketing, petrochemical and gas mid-stream operations, which were more profitable in 2015. This helped to offset the impact of lower crude prices on the cash generation of its upstream operations.

Upstream Cash Preservation: CNPC has focused on profitability and cash preservation in its upstream business. Lifting cost of its main operating entity, PetroChina (86% owned by CNPC), fell 6% and all-in costs declined 29% in 2015 due to lower tax and levies, cost deflation in the sector and higher efficiencies. Domestic hydrocarbon production, however, declined 1% in 2015 and Fitch expects it to fall further as the company cut production at ageing, high-cost oil fields.

CNPC's capex dropped 31% in 2015. CNPC's reserve replacement was affected by large reserve write-downs in 2015 due to low oil prices, but its proved reserve life still compares well with peers rated in the 'AA' and 'A' categories. Petrochina, which accounts for the majority of group reserves, had a proved reserve life of 14.4 years in 2015. CNPC's large reserve base provides a significant degree of flexibility in an environment of low oil prices.

Gas Drives Growth: Fitch expects CNPC to raise gas production and sales volumes to make up for lower oil production amid weak oil prices and capex cuts. Profitability of CNPC's mid-stream gas business unit trended down from a peak in 3Q15 after city-gate gas prices were cut in November 2015. However, Fitch expects profit in this business unit to remain stable because of higher sales volume and lower costs of gas imported via pipelines and in liquefied form.

Refining Margin to Normalise: Refining and chemical margins reached record highs in 1Q16 after China switched to a new pricing mechanism for refined products, as higher-margin products made up a bigger share of CNPC's product mix, and due to strong gasoline demand and cracking margins. However, competition in the refining segment has intensified after independent refining companies were granted crude import and usage rights. Utilisation for CNPC's refineries will continue to trend down as a result of some market-share loss. Fitch expects the refining margin to decline from the 1Q16 level, but still remain healthy.

Weakened Credit Metrics: Low oil prices and a large working-capital outflow have led to a weakening of credit metrics; CNPC's FFO-adjusted net leverage rose to 2.1x in 2015 from 1.6x in 2014. CNPC, along with other Chinese majors, has significantly benefitted from changes to the special oil gain levy, which reduced the negative impact on cash generation from low oil prices. However, low oil prices will continue to put pressure on CNPC's credit metrics in 2016. However, based on our price deck for Brent, we expect the company's credit profile to gradually start improving from 2017. The company has demonstrated a commitment to protecting its financial profile with not only capex cuts but also lower dividends. In our base case, no major acquisitions or disposals are included.

Strategic Importance to State: CNPC is an integral part of the country's energy supply chain. The company is China's largest oil and gas producer, accounting for about 52% and 73% of China's total crude oil and natural gas production respectively, and about 50% of China's proved oil and gas reserves by Fitch's estimate. CNPC's operating activities are subject to extensive regulations and controls by the Chinese government, including those on refinery gate prices for fuels and natural gas, which have led to losses or weak profitability in these operations in the past.

CNPC is also responsible for securing adequate energy resources for the country. Related investments to maintain strong reserve replacement and growth, including M&A, also placed a significant burden on the company's net cash flow generation. However, the state has continued to support CNPC, including via favourable policies, sizeable annual capital injections and other forms of capital support.

State Linkage Intact Despite Reforms: Fitch believes that CNPC is likely to retain control over the most strategic assets that the state may choose to open to private-sector participation. We believe the goal of reforms of state-owned enterprises is to diversify funding sources, enhance corporate governance, and improve operational efficiency and capital returns, while maintaining state control over strategic operations and assets. Fitch expects CNPC's importance in national energy security and strategy to remain unchanged, and linkage with the state to remain strong.

Consolidated Approach for PetroChina: Fitch has taken a consolidated view of the financial and operating profiles of CNPC and PetroChina, because CNPC owns 86% of PetroChina and PetroChina accounts for the majority of the CNPC group's total proven oil and gas reserves and over 80% of CNPC's EBITDA.

Consolidated Approach for CPFHK: China Petroleum Finance Limited (CPF) and CPFHK together function as the sole treasury centre for the CNPC group, centralising settlements, debt financing and cash management. CNPC appoints all of CPF's board members and senior management members, and CPF appoints all of CPFHK's board members directly. CPF and CPFHK's board members appoint all of CPFHK's senior managers. CPF's consolidated budget and business plans are approved by CNPC.

For the benefit of note holders, CNPC and CPF have executed keepwell agreements with CPFHK. These agreements, while not guarantees, benefit note holders because they ensure that CPF and CPFHK have sufficient resources to meet their financial obligations. However, in Fitch's view, equalising CPFHK's rating with CNPC's is not primarily dependent on these agreements, but is based on their overall legal, operational and strategic ties.

KEY ASSUMPTIONS

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

- Fitch oil and gas price rating case assumptions for Brent: USD35 a barrel (bbl) in 2016; USD45/bbl in 2017, USD55/bbl in 2018 and USD 65/bbl in the long term

- Oil and gas production to decline 3% in 2016, and remain broadly flat thereafter

- Flat refining throughput in 2016-2019

- 2016 capex at around CNY220bn, and change with oil price thereafter

- No acquisitions or sales proceeds from any asset disposals

RATING SENSITIVITIES

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

- A negative rating action on the sovereign

- CNPC's 'AA-' stand-alone profile may be lowered if its FFO-adjusted net leverage is over 2x and FFO fixed-charge cover is under 8.0x, on a sustained basis; or significant negative free cash flow generation from 2018 onwards

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

- A positive action on the sovereign, provided the rating linkages between the state and CNPC remain intact or CNPC's standalone credit profile remains at 'AA-'.

Ratings on PetroChina and CPFHK will move in tandem with any change in CNPC's ratings, provided the rating linkages remain intact

For the sovereign rating of China, the following sensitivities were outlined by Fitch in its

Rating Action Commentary of 26 November 2015:

Positive

- Increased evidence that the economy can adjust smoothly while rebalancing without experiencing a disruptive "hard landing"

- Greater confidence that the debt problem in the broader economy can be resolved without a material negative impact on growth or financial stability

- Widespread adoption of the renminbi as a reserve currency globally

Negative

- A sharper growth slowdown than currently anticipated, leading to a materialisation of risks to financial and/or social stability

- A rise in estimated general government indebtedness well above Fitch's current estimate

- Sustained capital outflows sufficient to erode China's external balance-sheet strengths, or undermine financial stability

- A change in policy direction that signalled decreased willingness to tackle the economy's imbalances and vulnerabilities, thereby increasing the risk of an eventual disorderly adjustment

FULL LIST OF RATING ACTIONS

CNPC:

- Long-Term Foreign-Currency IDR affirmed at 'A+'; Outlook Stable

- Foreign-currency senior unsecured rating affirmed at 'A+'

- Long-Term Local-Currency IDR affirmed at 'A+'; Outlook Stable

- Local-currency senior unsecured rating affirmed at 'A+'

CPFHK:

- Long-Term Foreign-Currency IDR affirmed at 'A+'; Outlook Stable

- Foreign-currency senior unsecured rating affirmed at 'A+'

- Long-Term Local-Currency IDR affirmed at 'A+'; Outlook Stable

- Local-currency senior unsecured rating affirmed at 'A+'

Debt issuance by CPFHK's guaranteed SPVs:

- CNPC (HK) Overseas Capital Ltd affirmed at 'A+'

- CNPC General Capital Ltd affirmed at 'A+'

PetroChina:

- Long-Term Foreign-Currency IDR affirmed at 'A+'; Outlook Stable

- Foreign-currency senior unsecured rating affirmed at 'A+'

- Long-Term Local-Currency IDR affirmed at 'A+'; Outlook Stable

- Local-currency senior unsecured rating affirmed at 'A+';

- Short-Term Foreign-Currency IDR affirmed at 'F1'

- Short-Term Local-Currency IDR affirmed at 'F1'