Fitch Assigns 'BBB' Rating to Pertamina's Proposed Notes

(Fitch Ratings - Singapore - 13 January 2020)--Fitch Ratings has assigned a rating of 'BBB' to PT Pertamina (Persero)'s (Pertamina; BBB/Stable) proposed USD dollar notes to be issued under its USD10 billion global medium-term note programme.

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-'.

The US dollar notes are rated at the same level as Pertamina's senior unsecured debt as they constitute direct, unconditional, unsubordinated and unsecured obligations of Pertamina. The bond proceeds will be used for capex and general corporate purposes.

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 around 30% of 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 currently sets prices within a state approved price band for unsubsidised premium fuels. 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 will help Pertamina's downstream earnings in the near to medium term. Pertamina reported a downstream EBIT loss of USD0.3 billion in 2018 compared to a profit of USD1.3billion in 2017.

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 2020 to 2022 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 in 2018 fell due to reduced profitability of its downstream operations, driven by higher crude prices. The lower EBITDA was offset by improved upstream volumes and Pertamina's consolidation of PT Perusahaan Gas Negara Tbk (PGN, BBB-/Stable), resulting in EBITDA remaining at around USD8 billion.

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. Improvement in 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. (ends)