Fitch Downgrades Russia's Rosneft to 'BBB-'; off RWN; Outlook Stable

Reuters

Oct 18 (Reuters) - (The following statement was released by the rating agency)

Fitch Ratings has downgraded Russia-based OJSC OC Rosneft's Long-term foreign andlocal currency Issuer Default Ratings (IDRs) to 'BBB-' from 'BBB' and removed them from RatingWatch Negative (RWN). The Outlook is Stable. A full list of rating actions is provided at theend of the rating action commentary.

The downgrade reflects Fitch's forecast that Rosneft's funds from operations (FFO) adjusted net leverage will increase sharply and fluctuate around 3x in 2013-2017. The 'BBB-' IDR incorporates our assessment of Rosneft's strategy, capex plans and funding options, and includes a one-notch uplift for support from the Russian Federation (BBB/Stable), Rosneft's majority shareholder.

Rosneft is the world's largest listed oil company with a 2012 hydrocarbon output of around 4.2 million barrels of oil equivalent per day (mmboe/d), excluding equity stakes. It controls almost 40% of crude output in Russia and aims to become a major natural gas producer.

KEY RATING DRIVERS

High Debt Burden

In 2012-2013, Rosneft raised USD37bn in debt, including syndicated loans for USD31bn and a USD3bn eurobond. Based on Fitch's Brent price assumption of USD103/bbl in 2013, USD96/bbl in 2014, USD88.5/bbl in 2015 and USD80/bbl in the long term, we forecast that Rosneft's FFO adjusted net leverage will fluctuate around 3x in 2013-2017, up from 1.5x in 2012, levels commensurate with a 'BB+' rating category.

In 2013, Rosneft signed a 25-year oil supply contract with China National Petroleum Corporation (CNPC; A+/Stable). According to CNPC, Rosneft will increase gradually its oil deliveries to China to 46m tons per annum from the current 15m tons, or over 900 thousand barrels of oil per day (mboe/d).

According to media reports, Rosneft may receive significant prepayments from CNPC for future oil supplies, in addition to USD11.5bn in prepayments it agreed with oil traders Vitol, Glencore and Trafigura under long-term supplycontracts to deliver up to 310mboe/d. We believe that Rosneft will use the funds, if and when obtained, to repay its USD38bn in debt maturing in 2013-2015, most of which is acquisition-related.

We classify all such prepayments that Rosneft has received or may receive in the future as debt-like and include them in Rosneft's gross leverage calculations, applying the 'substance over form' principle. We believe that in substance these prepayments are similar to a USD15bn loan that Rosneft raised in 2009 from CNPC that was secured on deliveries of 15m tons of oil per annum to CNPC. Furthermore, we classify all oil contract-linked prepayments as secured. Consequently, we may notch down Rosneft's senior unsecured obligations in the event that the ratio of secured borrowings to EBITDA exceeds 2x, to highlight the risk of subordination for unsecured creditors. We estimate this figure was close to 1x at end-2012.

'BB+' Standalone Profile

Rosneft's 'BB+' standalone profile reflects its strong operations, low earnings volatility typical for Russian oil majors and fairly high leverage, and is limited by country-specific corporate governance issues and its concentration of production in Russia.

Rosneft's operational profile has improved dramatically following the acquisition of TNK-BP completed in March 2013. Its post-acquisition hydrocarbon output places it ahead of such majors as Royal Dutch Shell plc (AA/Stable), BP plc (A/Stable) or ConocoPhillips (A/Stable). Rosneft controls 37% of Russia's crude production and 28% of its refining throughput. At end-2012, Rosneft's and TNK-BP's combined proved reserves were nearly 31bn barrels of oil equivalent. Rosneft's lifting costs of USD4/bbl in H113 were the lowest among Russian peers.

State Support Incorporated

We incorporate a one-notch uplift for support from the Russian Federation into Rosnet's rating. This is due to significant strategic and operational ties between the company and the sovereign. We view the endorsement of the latest acquisitions by Russian authorities, as well as the preferential treatment that Russian state-owned oil companies receive in offshore licence block allocation as evidence of support that Rosneft receives from the state. We also believe that the company has strong access to the Russian government.

On the other hand, Rosneft's operational scale is now so large that the state might find it challenging to support the company under a stress-case scenario, eg, if oil prices plummet significantly for a prolonged period of time, as the Russian government itself heavily depends on tax revenues from oil and gas companies. While we expect that the state would support Rosneft in an event of economic downturn, we believe that support may come indirectly in the form of loans from state-owned banks or targeted tax concessions.

Ambitious Capex, Opportunistic M&A

Rosneft has ambitious development plans, both in upstream and downstream. We believe that its capex will remain high, resulting in negative free cash flow (FCF) before dividends in 2014. Rosneft has, so far in 2013, announced natural gas M&A deals in Russia, including a USD3bn acquisition of its remaining 49% stake in Itera, an independent gas producer, a USD1.4bn acquisition of gas assets of OJSC ALROSA (BB-/RWP) and a USD1.8bn buyout of 19.6% in SeverEnergia from Enel S.p.A. (BBB+/RWN). Although these deals should help Rosneft to achieve its production goal of 100bn cubic meters by 2020, they further drain the company's cash.

Stable Operating Cash Flows

The lower earnings volatility of Russian oil companies compared with most international peers is credit-positive, which we take it into account in our forecasts. Three major factors contribute to it - a progressive tax regime, ie, the total tax burden borne by Russian oil and gas producers increases as oil prices rise, and vice versa; a relatively flexible exchange rate regime that implies that the rouble depreciates in response to falling oil prices, cushioning the impact of lower oil export revenues; and the regulation of domestic gas prices. The importance of these factors was demonstrated in 2009, when the EBITDA of the Russian oil and gas companies per barrel of oil equivalent declined less than that of most international peers.

RATING SENSITIVITES

Positive:

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

-FFO net adjusted leverage falling below 2.5x and FFO interest coverage exceeding 10x on a sustained basis, which may lead to a positive review of its standalone credit profile.

Because Rosneft's ratings are not capped by the sovereign ratings, a positive rating action on the Russian Federation is unlikely to be replicated in the company.

Negative:

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

-FFO net adjusted leverage rising above 3.5x and FFO interest coverage falling below 8x on a sustained basis due to higher capex or M&A

-Weaker ties between Rosneft and Russia

LIQUIDITY AND DEBT STRUCTURE

Taking into account the additional liquidity provided by the CNPC deal, we consider Rosneft's liquidity as adequate. At 30 June 2013, Rosneft reported RUB346bn (USD10.6bn) in cash and cash equivalents and RUB499bn (USD15.3bn) in short-term borrowings and finance lease obligations. Its gross unadjusted debt at 30 June 2013 amounted to RUB2,384bn (USD72.9bn), plus the prepayment of RUB258bn (USD7.9bn) received from Glencore and Vitol. In Q413 and 2014-2015, Rosneft needs to repay or refinance around USD38bn, including syndicated loans raised for TNK-BP's acquisition. We expect that Rosneft will repay and refinance the amounts falling due mainly from the prepayments for oil received under long-term contracts.

LIST OF RATING ACTIONS

OJSC OC Rosneft

Long-term foreign currency IDR: downgraded to 'BBB-' from 'BBB'; removed from RWN; Stable Outlook

Long-term local currency IDR: downgraded to 'BBB-' from 'BBB'; removed from RWN; Stable Outlook

Senior unsecured rating: downgraded to 'BBB-' from 'BBB'; removed from RWN

Rosneft International Finance Limited

Senior unsecured rating: downgraded to 'BBB-' from 'BBB'; removed from RWN

Rosneft International Holdings Limited (formerly TNK-BP International Ltd.)

Long-term foreign currency IDR: downgraded to 'BBB-' from 'BBB'; removed from RWN; Stable Outlook

Long-term local currency IDR: downgraded to 'BBB-' from 'BBB'; removed from RWN; Stable Outlook

Short-term foreign currency IDR: affirmed at 'F3'; removed from RWN

Rosneft Finance S.A. (formerly TNK-BP Finance S.A.)

Senior unsecured rating: downgraded to 'BBB-' from 'BBB'; removed from RWN

Short-term rating: affirmed at 'F3'; removed from RWN

Rates

View Comments (0)