Fitch Affirms Oil India at 'BBB-'; Outlook Stable
KEY RATING DRIVERS
Strong Linkages With State: OIL's rating are equalised with that of its 68% owner - the Indian sovereign ('BBB-'/Stable) - in line with Fitch's Parent and Subsidiary Linkage methodology. Fitch views the strategic, operational and financial links to be sufficiently strong to warrant equalisation. The state oversees the company's operations, appoints senior managers and requires OIL to bear part of the domestic fuel subsidy burden. Fitch expects OIL to be part of the state's efforts to improve India's energy security.
Currently, OIL's standalone rating is at the same level as the sovereign's. Should the standalone rating be revised down, OIL's IDR would receive an uplift. This is because Fitch equates it to India's rating based on a top-down rating approach, providing linkages with the state remain intact.
Small Reserves, High Concentration: OIL's relatively small reserves and their concentration constrain its standalone rating. OIL's proven reserves were 372 million barrels of oil equivalent (boe) at end-March 2015; with production of around 110,000 boe per day. OIL's peers rated in the 'BBB' category have median reserves of 2 billion to 3 billion boe and production of around 500,000 boe per day. Assam, a state in north-eastern India prone to unrest accounts for 96% of OIL's production and 98% of reserves. Fitch believes OIL's production profile will continue to be concentrated in Assam over the next three-to-four years, and therefore its earnings would be at risk from any disturbance in the state.
While OIL's natural gas production has been rising steadily over the last four years, oil production at some of its mature fields has been declining over this period. OIL plans to arrest this decline to increase oil production from the financial year ending 31 March 2017 (FY17).
Increasing Effort of Diversification: OIL aims to diversify and enhance its reserves through overseas acquisitions and exploring domestic acreage outside Assam. In 2014 OIL acquired a stake in fields in Mozambique and Russia.
OIL is also in the process of acquiring a 29.9% joint stake with Indian Oil Corporation Ltd (BBB-/Stable) and Bharat Petro Resources Limited (100% subsidiary of Bharat Petroleum Corporation Limited (BBB-/Stable)), in LLC Taas-Yuryakh Neftegazodobycha - a step-down subsidiary of Rosneft, Russia's national oil company that owns the Taas Yuriakh fields. This consortium has also signed an initial agreement to evaluate a 23.9% stake in Vankor fields of Rosneft, which if finalised, may result in additional investments by OIL.
Robust Financial Profile: OIL's has a net cash position and strong liquidity. Fitch, however, expects OIL's net debt to rise in the near to medium term, mainly due to acquisitions. Fitch expects OIL's financial profile to remain comfortable for its current rating. Also, all acquisitions currently being considered are in producing fields or under-development fields close to production, reducing the normal uncertainties associated with such acquisitions.
Fitch expects OIL's adjusted net debt to EBITDA (net leverage) to remain below 2x and its EBITDA-based fixed charge cover to remain above 6x, even after accounting for its acquisition of a stake in Rosneft's fields. Fitch says the acquisitions are, however, likely to significantly reduce the headroom for OIL's current standalone rating.
Low Production Costs: OIL has low finding and development (F&D) costs of around USD6/boe, as most of its fields are onshore. It expects F&D costs to rise to around USD7/boe over the next few years, which would still remain low by industry standards. Costs associated with bringing oil to the surface are around USD8.5boe, which translates into strong field economics. However, the government levies and discounts to state-owned refiners reduce the benefits, resulting in a lower EBITDA/boe of around USD16 to USD20 in the last four years.
Contingent Liabilities: OIL has claims worth INR85.7bn from the Assam government related to taxes on its sharing of under-recoveries with downstream oil companies. The company has challenged the demand, saying it had followed regulations, and the matter is before the courts. Fitch estimates that if OIL is directed to pay dues and change its tax calculation method, its net leverage is likely to increase by around 1x.
Fitch's key assumptions within the rating case for OIL include:
- oil production to increase by around 3% (FY15: -2%) and gas production by around 5% (FY15: 4%) annually over the medium-term
- oil prices as per Fitch's price deck (USD35 per barrel (bbl) in the financial year ending 31 March 2017 (FY17), USD45/bbl in FY18 and USD55/bbl in FY19), with no under recoveries during FY17 and FY18
- natural gas prices for its production in India, based on the reference price formula in line with Fitch's price deck
- capex of around USD600m per annum over the next three years
- acquisition of a stake in Taas Yuriakh fields of Rosneft in FY17
Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- an upgrade of the sovereign rating, provided 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 and asset diversity, 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 its net leverage increases to over 2.0x, gross debt/proved reserves exceeds USD5/boe (FY15: USD3.9/boe; FY14: USD4.0/boe) or EBITDA-based fixed charge coverage reduces below 6x (FY16E:12x; FY15:12x) on a sustained basis. However, OIL's IDRs will continue to be equated to that of India, provided linkages with the state remain intact.
For the sovereign rating of India, the following sensitivities were outlined by Fitch in its Rating Action Commentary of 7 December 2015.
The main factors that individually or collectively could lead to positive rating action are:
- Fiscal consolidation or fiscal reforms that would cause the general government debt burden to fall more rapidly than expected in the medium term
- An improved business environment resulting from implemented reforms and persistently contained inflation, which would support higher investment and real GDP growth
The main factors that individually or collectively could lead to negative rating action are:
- Deviation from the fiscal consolidation path, causing the already high public debt burden to deviate further from the median, or greater-than-expected deterioration in the banking sector's asset quality that would prompt large-scale financial support from the sovereign
- Loose macroeconomic policy settings that cause a return of persistently high inflation levels and a widening current account deficit, which would increase the risk of external funding stress