Fitch Affirms Indonesia's Pertamina at 'BBB'; Outlook Stable

(Fitch Ratings-Singapore-25 September 2019)-- Fitch Ratings has affirmed Indonesia's PT Pertamina (Persero)'s Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'BBB' with a Stable Outlook. Fitch has also affirmed Pertamina's senior unsecured rating, USD10 billion global medium-term note programme and existing senior unsecured notes at 'BBB'.

Pertamina's ratings are equalised with that of its parent, the Republic of Indonesia (BBB/Stable), in line with Fitch's Government-Related Entities Rating Criteria. This is based on our assessment of very strong linkages between Pertamina and the state as well as the state's incentive to provide support. Fitch continues to assess Pertamina's Standalone Credit Profile (SCP) at 'bbb-'.

KEY RATING DRIVERS

Very Strong State Linkages: Fitch sees Pertamina's status, ownership and control by the Indonesian sovereign as 'Very Strong'. The state fully owns Pertamina, appoints its board and senior management and directs and approves its investments. Pertamina is also the state holding company for the oil and gas sector. The government has a high level of influence in setting the prices of fuel, which are retailed by Pertamina. Some prices are set well below market rates, and Pertamina receives reimbursements for these shortfalls. Pertamina distributes nearly all the subsidised fuels in Indonesia under the state's public-service obligation (PSO) mandate.

We see the support record as 'Very Strong' and believe there is a high likelihood of state support for Pertamina if needed. The state has compensated Pertamina for the losses incurred from selling fuels below market prices and the amount of compensation has been sufficient to keep Pertamina's financial profile at a healthy level. Support can also be seen in the state continuing to award some of the larger oil and gas blocks upon the expiry of their production sharing contracts (PSC) to Pertamina, which should help improve its business and financial profile.

'Very Strong' Incentive to Support: Fitch sees the socio-political implications of a default by Pertamina as 'Very Strong'. A default would materially impact Indonesia's energy security, including derailing the massive investments required in the oil and gas sector, domestic fuel production and the state's ability to import crude oil and refined products. Indonesia, through Pertamina, imports around half of its refined product and crude requirements. We believe a financial default would have a very strong effect on the state as Pertamina is one of Indonesia's key borrowers, is an active international and domestic debt issuer, and is viewed by investors as a proxy government borrower.

State Compensation: Selling prices for Pertamina's subsidised fuels are set by the state and Pertamina has been required since April 2018 to obtain government approval to periodically raise unsubsidised premium fuel prices. Pertamina received USD2.9 billion in 2018 as compensation for selling some of its price-controlled fuels below market prices since 2017. This is in addition to the USD 5.6 billion of subsidies it received in 2018. The compensation follows 2018 regulations allowing Pertamina to be reimbursed for the gap between revenue from selling some of its popular fuels at regulated rates and revenue it would have received under market rates. Fitch believes this helps Pertamina's downstream earnings. After adjusting for the additional compensation, Pertamina's downstream EBITDA was about USD2.3 billion in 2018, and its 2017 EBITDA improved to USD3 billion compared with USD2 billion before the adjustment.

Strong Upstream Operations: Fitch expects Pertamina's upstream volume to increase gradually over the next five years due to its investments in new fields, efforts to improve or maintain production at existing fields and the fields it is taking over after PSCs expire. Pertamina's upstream operations also benefit from its strong cash cost position of below USD10 per barrel of oil equivalent (boe). Pertamina's oil and gas production volume rose by 33% in 2018 to 921 million barrels of oil equivalent per day (mboepd) in 2018 (2017: 693 mboepd), driven by output from its Mahakam field, which Pertamina took over in January 2018 on the expiry of its previous PSC.

Moderate Financial Profile: We expect modest deterioration of Pertamina's credit metrics due to its large investment plans. We expect Pertamina to invest about USD21.0 billion over the next three years to expand refining capacity and increase oil and gas production. Fitch expects Pertamina's funds from operations (FFO) annualised adjusted net leverage to be around 2.0x in the next three to four years (1.7x in 2018). Pertamina's overall adjusted EBITDA was around USD8 billion each in 2018 and 2017, despite the consolidation of PT Perusahaan Gas Negara Tbk (PGN, BBB-/Stable) and improved upstream volume. This was because higher crude prices reduced profitability of its downstream operations.

SCP Category of 'bbb-': Pertamina's SCP reflects its vertically integrated operations and dominant position in Indonesia's retail fuel market, which are offset by regulatory fuel pricing risks, lower upstream volumes relatively to its downstream sales, and our expectations of a moderate financial profile. The improvement of Pertamina's SCP would depend on the consistent application of the subsidy mechanism and regulations governing reimbursements for the differences between market and selling prices, during periods of high oil prices.

DERIVATION SUMMARY

Pertamina is one of Indonesia's largest crude oil producers, accounting for almost 50% of its oil and gas output, and has a near monopoly in refining and retailing of petroleum products. This is similar to state-owned PT Perusahaan Listrik Negara (Persero) (PLN, BBB/Stable), whose ratings are also equalised with those of the sovereign. Pertamina and PLN have the same assessment under each of the four GRE factors. PLN accounts for over 70% of Indonesia's power generation capacity and has a monopoly over Indonesia's electricity transmission and distribution. Both Pertamina and PLN perform government-directed public-service obligations by selling certain products at below-market-prices.

Indian Oil Corporation Ltd's (IOC, BBB-/Stable) ratings are also equalised with those of its parent, the Indian sovereign (BBB-/Stable), which owns 52% of IOC. IOC's 'Status, Ownership, and Control' factor is assessed as 'Strong', due to a lower degree of government involvement in its operation. Fuel prices are mostly market-driven in India. IOC's 'Support Track Record and Expectations' factor is assessed as 'Strong' due to less tangible financial support received than Pertamina, although we still expect state support to be forthcoming if needed. IOC is India's largest oil refining and marketing company and, along with two other state-owned oil refining and marketing companies, imports a large share of India's crude requirements. The socio-political impact of a default by IOC would be 'Very Strong', as it would significantly affect the country's ability to import crude, similar to that of Pertamina to Indonesia. However, Fitch assesses the 'Financial Implications of a Default' factor for IOC as 'Strong' compared with 'Very Strong' for Pertamina, because while IOC is an active Indian GRE borrower, it is not viewed as close to being a proxy government borrower as Pertamina is.

KEY ASSUMPTIONS

Fitch's Key Assumptions Within Our Rating Case for the Issuer

- Brent oil prices to average USD65 per barrel in 2019, USD62.5 in 2020, USD60.0 in 2021 and USD57.5 thereafter.

- Marginal increases to oil and gas production from 2018 levels over the next three years.

- Downstream volume increasing by around 1% over the medium term.

- No change in the selling prices of subsidised products compared to end 2018.

- Prices of most unsubsidised products to also remain stagnant (except for industrial fuels)

- Present subsidy formulas for diesel, kerosene and liquefied petroleum gas to continue. The reimbursements for the gap between revenue from selling some of its popular fuels at regulated rates and revenue it would have received under market rates to continue.

- PGN gas distribution volume to fall to 925mmscfd in 2019 (967mmscfd in 2018), and remain at about 900mmscfd from 2020.

- PGN's distribution spread at around USD2.1 per million btu in 2019 (USD2.25 per million btu in 2018) and USD2.0 per million btu from 2020.

- Capex of USD4 billion in 2019 and USD21.0 billion over the next three years.

- Dividend payout of 30% of net income over the medium term.

RATING SENSITIVITIES

Developments That May, Individually or Collectively, Lead to Positive Rating Action

- Positive rating action on the sovereign provided there is no significant weakening of the likelihood of the government extending support to Pertamina's

Developments That May, Individually or Collectively, Lead to Negative Rating Action

- Negative rating action on the sovereign

- Weakening of the likelihood of state support

For the sovereign rating of Indonesia, the following sensitivities were outlined by Fitch in its rating action commentary of 14 March 2019:

The main factors that, individually or collectively, could trigger positive rating action are:

- Strengthening of external finances, for instance, by an increase in foreign-exchange reserves, diversification away from commodities, and lower dependence on volatile portfolio flows.

- Continued improvement of structural indicators, such as governance standards.

- An improvement in the government revenue ratio, for example, from better tax compliance and a broader tax base.

The main factors that, individually or collectively, could trigger negative rating action are:

- A sharp and sustained external shock to investor confidence, leading to a decline in foreign-exchange reserves.

- A material increase in the overall public debt burden, for example resulting from relaxation of the budget deficit ceiling.

- A weakening of the policy framework that could undermine macroeconomic stability.

LIQUIDITY

Strong Liquidity: Pertamina's liquidity remains strong, with a cash balance of USD9.1 billion as of end-2018 (end-2017: USD6.4 billion) and strong access to funding. Fitch believes Pertamina will maintain its strong access to bank and bond markets, taking into account its state linkages, and that it will be able to meet its debt obligations and obtain funding for expansion. Pertamina's debt maturities are spread out, with no significant maturities up until 2021. (ends)