Fitch Assigns Pertamina Hulu Energi First-Time 'BBB' Rating; Outlook Stable

(Fitch Ratings - Singapore - 21 Jun 2023)--Fitch Ratings has assigned Indonesia-based PT Pertamina Hulu Energi (PHE) a first-time Long-Term Foreign-Currency Issuer Default Rating (IDR) of 'BBB' with a Stable Outlook.

The IDR is based on our assessment of PHE's Standalone Credit Profile (SCP) at 'bbb', which is on a par with the IDR of its parent, PT Pertamina (Persero) (Pertamina, BBB/Stable).

The SCP is driven by PHE's resilient operating profile, underpinned by its low-cost position and a reasonable scale that we expect to grow consistently, supported by its capex programme, and a conservative financial profile for its rating level. These factors are partly balanced by our assessment of PHE's smaller proved reserve base and modest proved reserve life compared with that of most other 'BBB' rated peers, and limited geographical diversification outside Indonesia.

PHE's IDR would be equalised with Pertamina's 'BBB' even if its SCP weakens below 'bbb', reflecting our assessment of the parent's high legal, strategic and operational incentives to support the subsidiary in accordance with Fitch's Parent and Subsidiary Linkage (PSL) Criteria. If PHE's SCP improves above 'bbb', its IDR will be constrained by the consolidated credit profile of Pertamina at 'BBB', as we assess both legal ring-fencing and Pertamina's access and control of PHE as 'Open' under the PSL criteria's "stronger subsidiary" path.

Key Rating Drivers

Solid Production Growth: We expect PHE to sustain production growth of 7%-8% (2022: 8%) in the next four years on a planned increase at the Rokan block to 260,000 barrels of oil equivalent per day (boepd) by 2025-2026 from 160,000 boepd currently. PHE also plans to raise production by about 10% at its other key subsidiary, PT Pertamina EP (PEP), by 2025 from 2022 levels, partly offset by the natural decline in other mature fields, including Mahakam. PHE's production rose by 8% in 2022 on Rokan's first full-year inclusion after it was acquired in August 2021.

Competitive Costs: PHE's SCP benefits from the low-cost position of its key assets with an estimated production cost of USD12-14 per barrel of oil equivalent (boe) and an over-the-cycle breakeven cost of USD25-27/boe, which is competitive compared with similarly rated peers regionally and globally. We expect PHE's EBITDA/boe to remain robust at about USD18-25 in 2025-2026 even with Fitch's declining oil price assumptions. PHE sustained reasonable profitability in the last oil price downturn in 2020, with EBITDA of about USD4 billion, or USD18/boe.

Gas Contracts Reduce Earnings Volatility: PHE's earnings from gas are more stable than from crude oil as 30% of its gas volume is sold at fixed-price take-or-pay contracts while the remaining 70% is indexed to a mix of oil, gas and product benchmarks. About 46% of PHE's volume sold was gas in 2022. This proportion is not likely to change materially over the next four years.

Modest Reserve Base: PHE's proved (1P) reserves of 1.4 billion boe - Fitch's estimate of PHE's entitlement - as of 2022 are moderately lower than that of most rated peers in the 'BBB' category. At 2022 production, this translates into a 1P reserve life of about seven years, which is at the low end of the range for similarly rated peers.

We believe PHE's plan to spend about 8%-10% of its total capex on exploration should help it maintain the reserve replacement ratio above 100%, according to its target. We expect PHE's additions to its reserves to be driven by exploration of existing assets, instead of inorganic growth, as we foresee limited similar acquisition opportunities in the next two-three years.

High Capex: We expect PHE's capex to remain high in 2023-2026 with an annual outlay of about USD5 billion (2022: USD3 billion), in line with management guidance, primarily focused on the development of its existing domestic assets. PHE is currently implementing several production-boosting projects at its five largest blocks, including an extensive well-drilling programme, Rokan's heavy oil development, and improved or enhanced oil recovery methods.

Capex in 2023 and early 2024 will mainly be for the development of the Rokan, Mahakam and PEP blocks. PHE also plans to continue to explore inorganic opportunities, especially near its existing blocks.

Robust Financial Profile: We factor in a high dividend payout of 97% in 2023 on high oil prices, followed by a 60%-70% payout in 2024-2026. We expect this, together with the high capex and declining oil price assumptions, to raise EBITDA net leverage gradually to about 0.8x by 2026 from a neutral net debt position at end-2022. Nevertheless, we expect PHE's financial profile to remain conservative for its rating level, maintaining a comfortable rating headroom over the next four years.

Limited International Presence: PHE's earnings are primarily generated domestically as 83% of its total production and 87% of its reserves are in Indonesia. PHE has stakes in 25 blocks in 13 countries outside Indonesia, but their size is too small relative to its domestic blocks to provide any meaningful diversification. Therefore, we think PHE remains exposed to Indonesia's regulatory risks, which are similar to those of other developing nations and higher than those in developed economies with more established policy frameworks.

Derivation Summary

PHE's closest peers in the APAC oil and gas industry are Woodside Energy Group Ltd (BBB+/Stable) and PTT Exploration and Production Public Company Limited (PTTEP, BBB+/Stable, SCP: bbb+).

Australia-based Woodside has a better operational profile with marginally higher production scale of about 561,000 boepd in 1Q23, and a much larger proved reserve base of 2,385 million boe. Woodside's rating benefits from the lagged impact of oil prices on its liquefied natural gas, which accounts for 40%-45% of Woodside's volume and is sold under long-term contracts, and the diversification of its domestic gas portfolio, which is partly sold under fixed-price term contracts and makes up 15% of Woodside's volume.

PTTEP's operational profile is largely comparable with PHE's in terms of scale. However, PTTEP's better geographical diversification in its asset portfolio and higher share of earnings from long-term take-or-pay gas contracts (70% compared with PHE's 45%) linked to dated oil prices adds to the stability of PTTEP's earnings, differentiating their SCPs. We expect PTTEP to maintain a net cash position over the medium term despite factoring in high capex and declining oil prices based on Fitch's oil price deck. PHE also has a strong financial profile, but we expect its net leverage to increase to about 0.8x in 2026 from 0.0x currently.

Key Assumptions

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

- Brent in line with Fitch's oil and gas price deck of USD85/barrel (bbl) in 2023, USD75 in 2024, USD65 in 2025 and USD53 thereafter;

- Gas prices to decline in line with the oil price assumptions but adjusted for fixed-price contracts, in line with management guidance;

- Annual production growth of 7%-8% up to 2026;

- Capex of USD2.4 billion in 2023 and USD2.7 billion-3.4 billion through 2026;

- Reasonably stable production costs of USD11.9-12.9/bbl, moderately higher than historical costs due to the maturity of the fields;

- Dividend payout at 96% in 2023 due to high oil prices before dropping to 60% in 2024-2026.

RATING SENSITIVITIES

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

- Any upgrade in the parent's IDR, provided the parent's incentives to support PHE remain intact.

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

- A downgrade in Pertamina's IDR.

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: PHE has adequate liquidity with a cash balance of USD4.4 billion versus short-term debt of USD824 million as of December 2022. PHE has a well-spread-out debt maturity profile for its secured long-term loans, which constitute about 96% of its total debt. PHE has banking relationships with various domestic and international banks and we believe it will be able to maintain its strong access to bank funding, which is further buoyed by the state linkages of its 100% parent, Pertamina.

Issuer Profile

PHE is the largest upstream exploration and production oil and gas company in Indonesia with total production of 568 million boepd. Oil contributed 53.2% of its average daily oil and gas production with 46.8% from gas in 2022.

Date of Relevant Committee

06 June 2023

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

PHE's ratings are directly linked to its ultimate parent, Pertamina. Any change in Pertamina's ratings will result in a similar revision in PHE's ratings.

ESG CONSIDERATIONS

Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of '3'. This means ESG issues are credit neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity. For more information on Fitch's ESG Relevance Scores, visit www.fitchratings.com/esg. (ends)