Fitch Ratings: Propensity of Indonesia's PGN to Support Saka is High; Weakened Ability Factored In

(Fitch Ratings-Singapore-10 June 2020)-- Fitch Ratings believes rating linkages between PT Perusahaan Gas Negara Tbk (PGN, BBB-/Stable) and its wholly owned subsidiary, PT Saka Energi Indonesia (BB/Negative), remain strong due to the cross-default provisions in PGN's bonds and high reputation risk for PGN should Saka default. We continue to rate Saka one notch below PGN's Standalone Credit Profile of 'bb+' in accordance with our Parent and Subsidiary Rating Linkage criteria.

Fitch believes that a recent press release by PGN that indicates risk to its financial profile on account of gas selling price caps and to Saka's financial profile from lower oil prices reflects the general challenges facing their businesses and is unlikely to result in any material change PGN's willingness to support its subsidiary. PGN has confirmed this with Fitch.

Fitch has a Negative Outlook on Saka's rating, as PGN no longer views Saka as a highly strategic subsidiary that will bring vertical integration benefits following the restructure of Indonesia's state-owned oil and gas companies. However, PGN does not have immediate plans to reposition Saka, as possible options are not easily executable in the near term. These include selling Saka to PGN's parent, PT Pertamina (Persero) (BBB/Stable), or a third party or a Saka IPO.

We believe PGN remains committed to providing extraordinary support to Saka in case of financial distress while it explores available options. This is based on the cross-default provision in PGN's bonds due 2024 in relation to Saka being a major subsidiary as well as significant reputational risk, potential to limit its funding access and increase funding costs. The presence of cross-default provisions between PGN and its state-owned parent could also incentivise PGN to avoid default, even though Fitch does not factor in state support to flow to Saka.

Saka will require support from PGN to meet its external debt obligations, as its cash generation is likely to be much lower than its debt obligations in the period to 2024. Fitch thinks PGN will extend its shareholder loans due 2021 and 2022 in light of Saka's financial difficulties amid the low oil prices. Saka's ability to refinance debt on a standalone basis is compromised due to its diminishing operating profile. Fitch expects PGN to have a refinancing plan to help Saka repay its USD625 million notes at least 12 to 18 months before the bonds' 2024 maturity date. Fitch may reassess linkages in the absence of this or if there are other indications of a weakening commitment from PGN to support Saka.

Our assessment of linkages between PGN and Saka and the ability of PGN to support Saka is based on PGN's Standalone Credit Profile of 'bb+', which was lowered from 'bbb-' in April 2020 due to higher pricing pressure and Saka's weakening operation. That month Indonesia also announced regulations to cap gas price at USD6/million British thermal units (mmbtu) for select industries. The regulations also require PGN's upstream gas sourcing costs to be reduced to between USD4.0-4.5/mmbtu. Fitch has already factored in the lower margins in its assessment and expects PGN's average distribution margin to fall to around USD2.0/mmbtu in 2020, from USD2.2/mmbtu in 2019.

PGN says it is yet to sell gas at the capped rate and implement the mechanisms for lower sourcing costs, but Fitch believes the state may require PGN to sell gas at the capped rate to support struggling industries due to the coronavirus pandemic, even if regulations to reduce sourcing costs are not fully implemented. However, we expect the state to make good the difference in sourcing costs should this occur, albeit with a delay that will lead to a spike in working capital outflow in 2020. This should not affect PGN's Standalone Credit Profile.

PGN says sourcing costs for about 15% of the affected supply of 600 million standard cubic feet of gas per day from Pertamina has been repriced as per regulations. The remainder is yet to be finalised. (ends)