Fitch Affirms CNOOC Limited at 'A+'; Outlook Stable
The IDRs of CNL reflect its standalone rating of 'A' and rating uplift to 'A+' on account of its linkages with and support from China (A+/Stable). The company's standalone credit profile reflects its relatively strong operating and financial profile, and its higher business risk as a pure upstream operator, relative to integrated oil and gas companies globally. CNL's financial metrics have weakened over the last 18 months, hit by the market downturn. In assessing CNL's standalone credit profile, Fitch considers the consolidated credit profile of its parent, China National Offshore Oil Corporation (CNOOC), which owns 64.4% of CNL; the consolidated financial profile of CNOOC is somewhat stronger. Fitch expects CNL's cash flow metrics to recover only gradually through 2018 as per Fitch's oil price assumptions.
CNL's credit profile also incorporates favourable regulations for the company, state endorsement of CNL as the dominant company in China's offshore oil and gas sector, and the increasing importance of China's offshore oil and gas production to its energy security.
KEY RATING DRIVERS
Linkages with the State: The rating uplift reflects the strategic importance of CNL and its parent, CNOOC, to the state. CNOOC is wholly owned by the State-owned Assets Supervision and Administration Commission of the State Council of China. CNL is China's largest offshore oil and gas exploration company and it has been responsible for a large share of the overseas oil and gas resource acquisitions made by China's national oil companies. In addition, CNOOC's mid-stream assets, particularly its liquefied natural gas (LNG) importation infrastructure that accounts for over 80% of China's LNG import capacity, are strategically important to the state.
Strong Upstream Profile: CNL is one of the largest oil exploration and production companies globally. In 2015, CNL's production and proved reserves stood at 1.35 million barrels of oil equivalent (boe) per day and 3.996 billion boe, respectively, excluding equity affiliates. Its production cost of USD7.42/boe in 1H16 is at the lower end of those of its 'A' rated peers. Its gross debt to proved reserves of USD6.47/boe also sits comfortably in the 'A' category. Nonetheless, the company's developed reserves only accounted for 40% of total proved reserves at end-2015, translating to a short proved developed reserve life of 3.5 years (down from an average of around four years historically). This implies potentially higher capex requirement in 2017 and beyond for reserve replenishment. CNL's reserve life based on its total proved reserves, however, is still healthy at around eight years.
Effective Cost Controls: CNL cut lifting costs by 23% in 1H16, much more than the 10% for PetroChina Company Limited (A+/Stable) and China Petroleum & Chemical Corporation (Sinopec) (A+/Stable). CNL's cost cuts also outpaced those of its peers in 2015 following the sharp fall in oil prices in 2H14. The cost reductions were achieved through supply-chain management, streamlining processes and lower contribution from high-cost production areas. In addition, CNL and other Chinese operators significantly benefitted from lower special oil gain levy on domestic production due to both the drop in oil prices and a higher taxable threshold introduced by China to support the upstream producers in a low oil price environment. CNL paid special gain levies of only CNY59m in 2015 compared with CNY19.1bn in 2014. This provided a significant cushion against the fall in operating cash generation from lower realised oil prices.
Capex Flexibility May Diminish: To preserve cash in the current low oil price environment, CNL cut its capex by 29% in 2015 and budgeted another 10% cut for 2016 to CNY60bn. However, Fitch believes there is a limit to CNL's capex flexibility because the company's proved developed reserve life is low. Of the company's capex, nearly 64% is earmarked for development activities. Nevertheless, the company would need to invest to replenish its reserves and to improve the developed reserve life to ensure stable production in the medium term, though Fitch notes that CNL has historically been able to consistently deliver on its production targets and achieved production growth over the last five years. The company's production grew by 19% in 2015. With the cut in capex, and focus on more economic fields, we expect the company's production to be around 480 million boe in 2016.
CNL and CNOOC Profiles Linked: Excluding CNL, CNOOC has substantial investments in mid-stream refining, LNG businesses, and others, including engineering and oilfield services, which are less profitable than CNL. Historically CNL accounted for over 75% of CNOOC's EBITDA, though the ratio dropped to 67% in 2015 due to the weaker profitability of the upstream E&P business. CNOOC exerts significant operational and financial influence on CNL.
Limited Standalone Rating Headroom: CNL's production is liquid-heavy and is highly exposed to oil price movements. The rapid drop in oil price caused CNL's leverage - as measured by FFO to net adjusted debt - to weaken to 1.5x in 2015 from 0.95x in 2014. The rise in leverage was also partly a result of CNL maintaining a considerable dividend payment, relative to its cash flow generation, in 2015.
Based on Fitch's oil and gas price deck assumptions, CNL's leverage would rise to about 2x in 2016, above what is comfortable for an 'A' rating. Despite a much-reduced all-in cost of USD34.86/boe for 1H16, CNL's profitability and credit metrics are unlikely to recover quickly while oil prices hover around USD40-45/boe. Continued substantial shareholders returns via dividends or larger-than-expected capex would also constrain the extent of any improvement in its credit metrics. That said, we estimate CNOOC's consolidated credit metrics will be broadly in line with levels that support a standalone rating of 'A', with leverage around 1.5x over the medium term. In any case, the IDRs of CNL have substantial headroom; in the event CNOOC's credit profile weakens, up to three notches of uplift are available. Currently, only one notch of uplift is applied, as with that, CNL's IDR reaches that of China.
Fitch's key assumptions within our rating case for the issuer include:
- Oil and gas prices move in line with Fitch's oil and gas price deck: Brent at USD42/bbl in 2016; USD45/bbl in 2017; USD55/bbl in 2018, and USD65/bbl in 2019 and thereafter
- Zero production growth in 2016, with a mild decline in 2017 and modest increase of 1%-2% in 2018-2019
- Operating expense per barrel to decline in 2016 due to low oil price, and rise with oil price increases thereafter
- 2016 capex at the company's budgeted level, and at 35%-40% of capex intensity (capex-to-revenue ) thereafter
- No major M&A
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- CNL's 'A' standalone rating could be lowered if, on a consolidated basis, CNOOC's leverage, as measured by FFO to net adjusted debt, is sustained at over 1.5x by 2018. However, in such an event, up to three notches of uplift will be available, arising from the group's linkages with China, provided these linkages with the state remain strong
- A downgrade of China's sovereign ratings
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- Fitch does not anticipate an upgrade of CNL's standalone rating in the medium term
- CNL's ratings may benefit if China's ratings are upgraded, provided linkages between CNOOC, CNL and the state remain strong