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

(Fitch Ratings - Singapore - 24 Sep 2020)--Fitch Ratings has affirmed Indonesia-based 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 strong incentive to provide support. Fitch continues to assess Pertamina's Standalone Credit Profile (SCP) at 'bbb-' due to its resilient financial profile through the oil price cycle, low-cost upstream production and integrated operations, which offset oil-price volatility to an extent. The SCP, however, remains constrained due to regulatory fuel pricing risks.

Fitch expects Pertamina to maintain an adequate financial profile relative to its SCP over the next four-to-five years, even after factoring in weaker petroleum sales volume amid the coronavirus pandemic. We expect its EBITDA to decline by about 40% to USD5 billion in 2020 from USD8.1 billion in 2019 due to lower upstream production and retail fuel volume. Fitch expects a gradual improvement in Pertamina's EBITDA from 2021, as its upstream volume increases following the addition of new upstream assets, retail volume improves to pre-pandemic levels by 2022 and retail prices stay relatively stable.

Pertamina imports and retails a considerably higher volume of petroleum products than its upstream production can support. As a result, Fitch expects Pertamina's credit metrics to be less affected by lower oil prices, especially as we expect the company's retail selling prices to remain more stable over the rating horizon until 2024.

KEY RATING DRIVERS

Very Strong State Linkages: Fitch believes Pertamina's status, ownership and control by the Indonesian sovereign is 'Very Strong'. The state fully owns Pertamina, appoints its board and senior management and directs and approves its investments. Pertamina was also appointed the state's holding company for the oil and gas sector. It functions as an important state vehicle in managing retail fuel prices and, hence, inflationary pressure, as it controls the majority of Indonesia's fuel distribution.

State Support: We assess the support record as 'Very Strong' as we believe there is a high likelihood of state support for Pertamina. The government effectively controls the prices of the majority of fuels distributed by Pertamina, some of which are sold below market rates. The state in turn supports Pertamina through various mechanisms, including subsidy reimbursements for fuels sold under the public-service obligation mandate and additional compensation for the under-recovery of some fuels.

The state has awarded some of the larger oil and gas blocks upon the expiry of their production-sharing contracts (PSC) to Pertamina and Fitch expects this practice to continue, per government policy, which should improve Pertamina's 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 affect Indonesia's energy security, including derailing the sizeable investments needed 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 a large share of its retailed final petroleum products and externally sources more than half of its crude requirements for refining. We believe a default would have a very strong effect on the state as Pertamina is one of Indonesia's key borrowers and an active international and domestic debt issuer.

Downstream Offsets Weaker Oil Prices: Pertamina has not cut its rupiah-based retail prices for most fuels since the start of 2020, despite the falling cost of purchasing refined products and crude. We assume the government is reluctant to lower retail fuel prices despite the economic downturn as raising retail prices is politically sensitive. Fitch thinks the increase in Pertamina's downstream earnings will partly offset the decline in its upstream profit due to lower oil prices over the rating horizon. Fitch, however, expects 2020 earnings to be dampened by lower volume and a weakening rupiah.

Lower Subsidies and Compensation: Fitch expects lower oil prices and stable selling prices to reduce the need for subsidy reimbursements and other forms of state compensation over the next three-to-four years. Fitch expects subsidy reimbursement to drop to around USD2 billion-3 billion per annum until 2023, from USD4.8 billion in 2019. Pertamina also received additional compensation of USD5.4 billion since 2017 for selling some of its price-controlled fuels below market prices, which we expect to decline to an average of around USD300 million a year until 2023.

Upstream Volume to Increase: Fitch expects Pertamina's upstream volume to rise by 10% per year in 2021 and 2022 after it takes over the Rokan oil field in late 2021. Its production fell by around 2% to 901mboepd in 2019 from 921mboepd in 2018 on the natural ageing of its fields. Fitch expects production to fall marginally in 2020 with lower demand and capex cuts. We, however, assume its upstream production will remain stable after 2022 due to its investments in new fields and efforts to improve or maintain production at existing fields. Pertamina's upstream operations also benefit from its strong cash cost position of below USD11 per barrel of oil equivalent in 2019.

Moderate Financial Profile: Fitch expects Pertamina to keep its FFO net leverage unchanged at 1.9x in 2020 from 2019 by materially curtailing its operating expense and capex to mitigate the impact of lower earnings and report FFO net leverage of 1.9x-2.4x until 2024. We expect its capex and investment intensity to rise after it takes over some of the large mature PSCs, which will require heavy investment to maintain production, and upgrades its refineries. Pertamina is also interested in acquiring sizeable foreign oil and gas assets, investments or earnings, which we have not factored in our forecasts.

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

DERIVATION SUMMARY

Pertamina's ratings are equalised with those of its parent, the Indonesian sovereign. Pertamina is one of the country's largest crude oil producers, accounting for the majority of its oil and gas output, and has a near-monopoly in refining and retailing petroleum products. Our assessment of the likelihood of support for Pertamina under each of the four factors of the Government-Related Entities Rating Criteria is the same as our assessment for PT Perusahaan Listrik Negara (Persero) (PLN, BBB/Stable), whose ratings are also equalised with those of the sovereign. PLN accounts for over 70% of Indonesia's power generation capacity and is a monopoly in Indonesia's electricity transmission and distribution sector.

The ratings of Indian Oil Corporation Ltd (IOC, BBB-/Negative) are also equalised with those of its parent, the Indian sovereign (BBB-/Negative). Fitch, however, considers IOC's state linkages weaker than those of Pertamina. The socio-political impact of an IOC default is 'Very Strong', as it would significantly affect India's ability to import crude, similar to that of Pertamina. However, Fitch regards its status, ownership and control as 'Strong' versus 'Very Strong' for Pertamina due to the lower 52% state ownership of IOC. IOC's support record is assessed 'Strong' rather than 'Very Strong' because of the established support mechanisms benefitting Pertamina relative to the more extraordinary support received by IOC. IOC's financial implications of a default are also 'Strong' compared with 'Very Strong' for Pertamina due to Pertamina's position as a proxy borrower for the Indonesian government.

KEY ASSUMPTIONS

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

- Oil prices based on Fitch's Brent price deck of USD41/barrel (bbl) in 2020, USD45/bbl in 2021, USD50/bbl in 2022 and USD53/bbl thereafter (see Fitch Ratings Cuts Long-Term Oil Price Assumptions, published 8 September 2020, at https://www.fitchratings.com/site/pr/10135260)

- Upstream volume to drop by 5% in 2020. Volume to increase by around 10% per annum in 2021 and 2022 after Pertamina takes over Rokan. Production to remain constant after 2022.

- Petroleum sales volume to fall by around 12% in 2020, and recover by around 8% per annum in 2021 and 2022

- Retail prices of the majority of retail fuels to remain unchanged in rupiah terms in 2020. Retail prices of subsidised products to remain unchanged and retail prices of other main petroleum products to drop by about 20% in 2021 and remain constant through 2024.

- Subsidy reimbursements to fall from USD4.8 billion in 2019 to around USD2 billion-3 billion per year from 2020 to 2023.

- Considerably less additional compensation for the sale of certain selected fuels as low oil prices will alleviate the need.

- Capex of USD6 billion in 2020, and around USD8 billion per annum from 2021

RATING SENSITIVITIES

Factors that could, individually or collectively, lead to positive rating action/upgrade:

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

Factors that could, individually or collectively, lead to negative rating action/downgrade:

- 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 a rating action commentary on 10 August 2020:

Factors that could, individually or collectively, lead to positive rating action/upgrade are:

- External Finances: Reduction in external vulnerabilities, for instance, through a sustained increase in foreign-exchange reserves, reduced dependence on portfolio flows or lower exposure to commodity price volatility.

- Fiscal Finances: An improvement in the government revenue ratio in the next few years, for example, from better tax compliance or a broader tax base, which would strengthen public finance flexibility.

- Structural: Continued improvement of structural indicators, such as governance standards, to closer in line with those of 'BBB' category peers.

Factors that could, individually or collectively, lead to negative rating action/downgrade:

- External Finances: A sustained decline in foreign-exchange reserve buffers, resulting, for example, from a deterioration in investor confidence.

- Fiscal Finances: A continued increase in the overall public debt burden over the next few years to levels beyond our forecasts, for example, resulting from failure to reduce the fiscal deficit back to pre-crisis levels or accumulation in the debt of publicly owned entities.

- Macroeconomic: A weakening of the policy framework that could undermine macroeconomic stability, for instance, resulting from continued monetary financing of the deficit in the next few years.

BEST/WORST CASE RATING SCENARIO

International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from 'AAA' to 'D'. Best- and worst-case scenario credit ratings are based on historical performance. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, visit https://www.fitchratings.com/site/re/10111579.

LIQUIDITY AND DEBT STRUCTURE

Strong Liquidity: Pertamina had a cash balance of USD8.9 billion as of June-2020 and strong access to funding, against around USD3 billion in short-term debt maturities. Fitch believes Pertamina will maintain its strong access to banks and the bond market, taking into account its state linkages, and it will be able to meet its debt obligations and obtain funding for expansion.

REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING

The principal sources of information used in the analysis are described in the Applicable Criteria.

PUBLIC RATINGS WITH CREDIT LINKAGE TO OTHER RATINGS

Pertamina's ratings are equalised with that of its parent, the Indonesian sovereign.

ESG CONSIDERATIONS

Pertamina has an ESG Relevance Score of 4 for Human Rights, Community Relations, Access & Affordability due to the politically sensitive nature of fuel prices in Indonesia. Fuel price hikes have affected affordability and resulted in social unrest in the past. Pertamina sells refined oil products at government-regulated prices and bears the burden of under-recoveries to maintain the affordability of fuel prices.

Except for the matters discussed above, the highest level of ESG credit relevance, if present, is a score of 3 - ESG issues are credit neutral or have only a minimal credit impact on the entity(ies), either due to their nature or the way in which they are being managed by the entity(ies). For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg.