OREANDA-NEWS. Fitch Ratings has affirmed CNOOC Limited's (CNL) Long-Term Foreign- and Local-Currency Issuer Default Ratings, senior unsecured rating and rating on its guaranteed notes at 'A+'. The Outlook is Stable. The agency has also affirmed the energy company's Short-Term Foreign- and Local-Currency IDRs at 'F1' and CNOOC Nexen Finance (2014) ULC's guaranteed senior unsecured notes at 'A+'.

The IDRs of CNL reflect its standalone rating of 'A' and rating uplift to 'A+' on account of strong linkages with and support from China (A+/Stable). The company's standalone credit profile reflects its relative strong financial and operating profiles and its higher business risk profile as a pure upstream operator relative to more integrated oil and gas companies. 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 off-shore 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, China National Offshore Oil Corporation (CNOOC), to the state. CNOOC is wholly owned by the State-owned Assets Supervision and Administration Commission of the State Council of China (SASAC), and it owns 64.44% of CNL. 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.

Leading Upstream Player: CNL is one of the largest oil exploration and production companies globally. At end-2014, CNL's production and proved reserves stood at 1.13 million barrels of oil equivalent (boe) per day and 4.16 billion boe respectively, excluding equity affiliates. These compare well with other 'A' rated international peers, such as BG Energy Holdings Ltd (A-/Rating Watch Positive), Eni SpA (A/Stable) and Occidental Petroleum Corp. (A/Stable), and 'BBB' category rated peers, such as Apache Corporation (BBB+/Stable) and Devon Energy Corporation (BBB+/Stable). Its production cost of USD12.2/boe is at the lower end among its 'A' rated peers, although its gross debt to proved reserve ratio of 6.0x is higher than that of 'A' peers, and more in line with those in the 'BBB' category.

Focused on Controlling Costs: CNL reduced lifting costs by 18.5% in 1H15, much more than the 2.8% for PetroChina (A+/Stable) and the 2.4% for Sinopec(A+/Stable), following the sharp fall in oil prices. 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 1H15 compared with CNY11.97bn in 1H14. This provided a significantly cushion against the fall in operating cash generation from lower realised oil prices.

Capex Reduced: To preserve cash amid the current low oil price environment, CNL has cut its budgeted capex for 2015 by 25%-35% from 2014 to CNY70bn-80bn.The decrease is largely driven by 38% drop in domestic capex. The company cut capex by 31% in 1H15, but there is a limit to its capex flexibility because CNL has a ratio of proved developed reserves to total reserves of 42% and a resultant low developed reserve life of only 4.3 years. The company has cut exploration capex by 30% and development capex by 34%, mainly through a 43% cut in development capex in China while development capex overseas remains high; its development capex now accounts for around 77% of total capex (against any average of 79% historically). CNL's proved reserve life of 10.1 years is, however, comparable with that of its peers rated in the 'A' category.

Near-Term Production Growth: CNL aims to increase production by 10% to 14% in 2015 (including equity affiliates). Fitch considers this level of production growth achievable given CNL's production increased 13.5% yoy in 1H15 (including equity affiliates). Five out of seven planned new projects successfully started operations in 1H15. Fitch expects the reduced capex to have limited impact on CNL's near-term production, though longer-term production and reserve life may be affected by the investment cutbacks.

Reduced Standalone Rating Headroom: The rapid drop in oil price has affected upstream oil and gas companies' credit metrics. CNL's leverage - as measured by net debt to FFO - has weakened slightly to 0.95x in 2014 from 0.93x in 2013, and is estimated at about 1.1x in 1H15. Using Fitch's oil and gas price deck assumptions, CNL's leverage is likely to increase to around 1x-1.5x in the next four years, which is still appropriate for its standalone credit profile of 'A'. Fitch expects FCF to remain negative over the rating horizon due to high capex needs. However, in the event CNL's standalone credit assessment is lowered, rating enhancement driven by linkages with the state as per Fitch's parent and subsidiary linkage methodology should still support its 'A+' IDRs.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:
- Fitch's oil and gas price deck: Brent at USD55/bbl in 2014; USD65/bbl in 2014; USD75/bbl in 2018 and USD80/bbl thereafter
- Production growth of 10% in 2015, 4.5% in 2016 and 1% in 2017 and 2018
- Operating expense per barrel to decline in 2015 due to low oil price, and rise with oil price increases thereafter
- 2015 capex at company's budgeted level, and to follow oil price movements thereafter
- No major M&A

RATING SENSITIVITIES

Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- CNL's 'A' standalone rating could be lowered if its leverage as measured by FFO to net adjusted debt is sustained at over 1.5x. However, in such an event, Fitch could provide additional rating uplift on account of state support, if 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.