Fitch Rates Pertamina's Proposed USD Bonds 'BBB(EXP)'

(Fitch Ratings - Singapore - 22 July 2019)--Fitch Ratings has assigned Indonesia-based PT Pertamina (Persero)'s (BBB/Stable) proposed unsecured notes that will be issued out of its USD10 billion medium-term note programme an expected rating of 'BBB(EXP)'.

The proposed US dollar notes are rated at the same level as Pertamina's senior unsecured debt as they will constitute the direct, unconditional, unsubordinated and unsecured obligations of Pertamina. The final rating is contingent upon the receipt of final documents conforming to the information already received.

Pertamina's ratings are equalised with those of its parent, 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. The support record is 'Very Strong' and we believe there is a high likelihood of state support for Pertamina, which is Indonesia's holding company for the oil and gas sector. Pertamina has historically received subsidies under a regulatory framework for meeting the state's public-service obligations by selling certain petroleum products below market prices.

It was also compensated in 2018 for the disparity between the regulated compensation, including subsidies, and market prices due on some of its fuels. In addition, it benefits from its right to claim a stake in upstream oil and gas blocks at the expiry of their production sharing contracts (PSC). Pertamina has been awarded a few oil and gas blocks at the expiry of their PSC over the last 24 months

State's Incentive to Support: Fitch sees the socio-political implications of a default by Pertamina as 'Very Strong'. A default would derail the massive investments required in the oil and gas sector, Pertamina's domestic production and the company's ability to import crude oil and refined products, which would affect Indonesia's energy security. Indonesia, mostly through Pertamina, imports over half of its final refined products and about 20% of its crude requirements for refining. We believe a financial default would have a 'Very Strong' effect on the state as Pertamina is one of Indonesia's key borrowers and is an active international and domestic debt issuer.

Downstream Operations Weakening: Pertamina's downstream operations have been weakened significantly by stagnant prices of its regulated fuels, the RON88 blend of gasoline and Solar blend diesel, since 2016, despite the rise in global crude oil prices. Pertamina has been required since April 2018 to get government approval to periodically raise premium fuel prices, which are not fixed. A substantial disparity between the prices of regulated and premium fuels could also result in demand for premium fuels falling considerably, which might further add to the downstream losses.

Inadequate Reimbursements: We estimate that Pertamina's compensation for the sale of regulated products, including subsidies, is still only around 60%-70% of market prices. Under-recoveries on regulated gasoline and diesel were significant in 2018, resulting in weak downstream earnings. Its downstream segment recorded an EBITDA of around USD430 million - compared with around USD2 billion in 2017 - despite the increase in diesel subsidies. The government increased the explicit diesel subsidy that it pays to Pertamina to IDR2,000 per litre in August 2018 from IDR500 per litre, and the change was applied retrospectively from the start of 2018. In addition, Pertamina also received around USD2.9 billion from the state for the disparity between the regulated compensation, including subsidies, and market prices due on some of its fuels.

Fuel price regulations that took effect in 2015 removed explicit subsidies for gasoline and fixed the subsidy for diesel. The government continued to set the prices for regulated fuels, but indicated that prices would track the movement of international oil prices and the exchange rate. Instead, prices for the most popular types of regulated gasoline and diesel have remained unchanged since early 2016, and have fallen well below market prices as global oil prices have increased and the rupiah has weakened.

Upstream Volumes Improving: Fitch expects Pertamina's upstream volumes to increase marginally in 2019 from its investments in new fields and efforts to improve or maintain production at existing fields and fields it is taking over after PSCs expire. Higher upstream volumes should boost Pertamina's upstream profits and somewhat offset the weakness in its downstream business. Pertamina's oil and gas production volume rose by around 33% in 2018, driven by production from its Mahakam field, which Pertamina took over in January 2018 on the expiry of its previous PSC. Pertamina's upstream volumes increased to 921mboepd in 2018 (2017: 693mboepd).

Large Capex and Investments: We expect Pertamina to invest over USD20.0 billion over the next three years on expanding refining capacity and increasing oil and gas production. Fitch's estimate is lower than the USD27.5 billion Pertamina expects to invest in this period, taking into consideration the company's record of falling short of its capex estimates. The company plans to invest about USD4.2 billion in 2019. Investments in upstream fields where PSCs are expiring - mainly for Rokan which Pertamina takes over in 2021 - together with downstream investments are likely to result in investments remaining high beyond 2020. Increasing upstream production and augmenting refinery capacity are important to improve its profitability and contain the state's subsidy expenses. The investments are likely to increase Pertamina's net debt over the medium term.

Moderate Financial Profile: We expect modest deterioration of Pertamina's credit metrics on account of its weak downstream operations and large investment plans. Fitch expects Pertamina's funds from operations (FFO) annualised adjusted net leverage of around 2.0x in the next two to three years (1.9x in 2018). Pertamina's overall EBITDA improved to over USD9 billion from around USD7 billion in 2017, due to both the consolidation of PT Perusahaan Gas Negara Tbk (PGN, BBB-/Stable) and improved upstream volumes.

SCP Category of 'bbb-': Pertamina's SCP reflects its vertically integrated operations and dominant position in Indonesia's retail fuel market, which is offset by regulatory fuel pricing risks, short but improving upstream production position and our expectations of a moderate financial profile. The poor implementation of Indonesia's fuel and subsidy reforms during a time of high crude oil prices has slightly weakened Pertamina's business profile.

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 over 25% of crude output, and is the country's sole refiner and dominant retailer 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. PLN accounts for about 80% of Indonesia's power generation and is a monopoly in Indonesia's electricity transmission and distribution sector. Both Pertamina and PLN perform government-directed public-service obligations by selling certain products at below-market-prices as set by the state.

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 state linkages and likelihood of support are somewhat weaker than Pertamina's with Indonesia. 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 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 regards its status, ownership and control, support record and the financial implication of a default as 'Strong' compared with 'Very Strong' for Pertamina. (ends)