Fitch Affirms SOCAR at 'BBB-'; Outlook Stable
SOCAR is a wholly state-owned national oil company of Azerbaijan (BBB-/Stable). Its ratings are aligned with the sovereign's. SOCAR is a mid-size integrated oil company with 2014 hydrocarbon production of 253 thousand barrels of oil equivalent per day (mboepd) and a number of assets in midstream, downstream, chemicals and retail.
SOCAR controls Petkim, Turkey's only chemical producer, and is constructing a 10 million ton capacity STAR refinery in Turkey. It is also a party to several production-sharing agreements (PSAs) in Azerbaijan and receives specified volumes of oil, natural gas and gas condensate free of charge.
We expect that SOCAR's leverage metrics may come under pressure in 2015-2016 under our oil price deck. We forecast funds from operations (FFO) net leverage will increase to 2.9x in 2015 from 1.9x in 2014.
KEY RATING DRIVERS
Ratings Aligned with Sovereign
SOCAR's ratings are aligned with Azerbaijan's, as it represents the state's interests in the strategically important oil and gas industry. SOCAR maintains close ties with the government and the State Oil Fund of the Republic of Azerbaijan (SOFAZ) to make financial and investment decisions.
Funding of SOCAR's Projects
According to a decree by the President of Azerbaijan signed in 2014, SOCAR set up a joint venture (JV), Southern Gas Corridor CJSC (SGC). SOCAR holds a 49% share in SGC, with the remainder held by the Ministry of Economy and Industry of Azerbaijan. The purpose of the JV is to implement key Azeri gas projects including the development of the Shah Deniz gas field, expansion of the South Caucasus Pipeline (SCP), construction of Trans-Anatolian and Trans Adriatic gas pipelines (TANAP and TAP).
Funding of SGC's operations in 2014 was carried out mainly with bonds issued by SGC and subscribed by SOFAZ. In 2015, funding is expected to have come mainly from the Ministry of Economy and Industry of Azerbaijan and SOCAR, which expects to receive its share of funding from the government. In light of the large scale of investments, we view the creation of the JV as well as SOFAZ's and the government's active participation in its funding as positive for SOCAR's ratings. This also underlines the strong ties between SOCAR and its sole owner underpinning the company's ratings.
STAR Refinery Under Construction
In May 2014, SOCAR agreed funding for the 10 million ton, USD5.7bn STAR refinery in Turkey. The USD3.3bn project finance debt package has maturity of 18 and 15 years with a four year grace period. The refinery is expected to come online in 2019 and supply the Turkish market mainly with diesel and jet fuel. We view the planned cooperation between the refinery and Petkim, SOCAR's Turkish petrochemical subsidiary as positive for the project's profitability. We consider SOCAR's funding requirements manageable, especially as part of the financing is expected to come from the Azeri government. SOCAR issued a USD750m bond in 2015, which was mainly used to fund STAR development.
Speculative Grade Standalone Profile
Fitch views SOCAR's standalone profile as commensurate with a speculative grade rating, reflecting its limited reserves, declining production, aged refineries, but also an extensive domestic pipeline network, expanding international downstream and retail portfolio, and adequate credit metrics. In 2014, SOCAR's total hydrocarbon output (excluding equity stakes) was 253 thousand barrels of oil equivalent per day (mboepd), 1% down yoy. In 1H15 production was 246mboepd, 5.6% lower than in 1H14. While SOCAR's upstream is weaker and its lifting costs are higher than that of 'BB' rated Russian peers, this is partially compensated by profits from its midstream and downstream operations.
Gas Replaces Oil
Under our base rating case, we expect Azerbaijan oil production to decline gradually from the depletion of existing brownfields At the same time, we forecast higher natural gas production from Azerbaijan's PSAs, in particular the Stage 2 of the Shah Deniz PSA. In December 2013, the Shah Deniz Stage 2 partners approved the final investment decision with a USD28bn cost estimate, including the South Caucasus Pipeline expansion. Once completed, the project aims to increase production by 16 billion cubic metres of gas and 4 million tons of gas condensate starting from late 2018.
We assume that SOCAR's EBITDA will decrease by 28% in 2015 yoy improving gradually in line with our oil price assumptions. We further assume that SOCAR will spend over AZN5bn on capex in 2015-2017. This will lead to an increase in FFO adjusted net leverage to 2.9x in 2015, up from 1.9x in 2014.
Over 80% of SOCAR's debt is denominated in US dollars, but at the same time the vast majority of revenues and trade receivables are also USD-linked, which will neutralise the impact of a 33.5% manat devaluation introduced in February 2015 on leverage ratios. The devaluation, and corresponding increase in manat-denominated revenues, will provide a cushion for a decline in oil prices as a significant portion of SOCAR's costs is in manat. However, the positive impact on financial performance may be hindered in the medium term if wage and cost inflation pressures increase.
Fitch's key assumptions within our rating case for the issuer include:
- Brent prices of USD55/bbl in 2015, recovering to USD65/bbl in 2016, USD75/bbl in 2017 and USD80/bbl thereafter
- Overall flat upstream production over the rating horizon
- Capital expenditure of AZN1.6bn in 2015 and AZN1.7bn in 2016
- Distributions to government kept flat at AZN400m over the rating horizon, largely in line with historical average distribution
- FX USD/AZN of 1.05 over the rating horizon
Positive: Future developments that may result in positive rating action include:
- Fitch would require government guarantees for a large portion of the company's debt to maintain rating alignment in case of a sovereign rating upgrade
Negative: Future developments that may result in negative rating action include:
-Weakening state support
-An aggressive investment programme and/or acquisitions resulting in a significant and sustained deterioration of standalone credit metrics
LIQUIDITY AND DEBT STRUCTURE
We view SOCAR's liquidity position as adequate. As of 30 June 2015, the group's liquidity position comprised AZN2.9bn of cash and cash equivalents, of which AZN2.4bn (81%) was in USD-denominated bank balances and AZN140m (5%) was in EUR-denominated bank balances. This is sufficient to cover SOCAR's short-term borrowings of AZN2.7bn, 74% of which was short-term facilities in USD. The company issued USD750m notes in March 2015, which strengthened its liquidity position.
As of 30 June 2015, 86% of SOCAR's debt was USD-denominated and 40% of all debt had floating rates. Compared with end-2014, long-term debt has increased to AZN5.8bn from AZN3.6bn over six months. Stripping the effect of the USD750m notes, issued in March 2015, the increase in gross debt is 38%, which is close to the percentage depreciation of the Azerbaijani manat versus the US dollar.