Fitch Revises Outlook on Saka Energi to Negative; Affirms 'BB+'

(Fitch Ratings-Singapore-11 April 2019)-- Fitch Ratings has revised the Outlook on Indonesia-based oil and gas producer, PT Saka Energi Indonesia's Long-Term Issuer Default Rating (IDR) to Negative from Stable and has affirmed the IDR at 'BB+'. The agency has also affirmed the rating on the company's USD625 million 4.45% senior unsecured notes due 2024 at 'BB+'.

The Outlook revision follows our assessment of weakening linkages between Saka and its parent, PT Perusahaan Gas Negara Tbk (PGN, BBB-/Stable), as PGN is contemplating reducing its stake in Saka. This creates uncertainty over Saka's position within the updated ownership structure for state-owned oil and gas companies. Fitch believes PGN no longer views Saka as a highly integrated and strategic subsidiary, although the sale of its stake could be a drawn-out process. In addition, we believe the current linkage, albeit weakening, is still sufficient to rate Saka using a top-down approach from PGN's standalone credit profile of 'BBB-', as per our Parent and Subsidiary Rating Linkage criteria. Fitch will re-assess the linkage upon clarity on Saka's repositioning plan.

Fitch has downgraded Saka's standalone credit profile to 'B', from 'B+', due to its weakening business profile from an expected decline in reserves and production.

KEY RATING DRIVERS

Weakened Linkages with PGN: Fitch believes Saka's position is misaligned within the ownership structure of Indonesia's state-owned oil and gas companies post state-driven restructuring, where the state's 57% ownership of PGN was transferred to PT Pertamina (Persero) (BBB/Stable) and PGN acquired 51% of PT Pertamina Gas. Under the restructure, most state-owned Indonesian upstream oil and gas operations are held under Pertamina and all state-owned gas distribution and transmission companies are held under PGN.

Saka played a key role in PGN's vertical integration strategy until early 2018, benefitting from large equity infusions and intercompany loans since its inception in 2011; these helped its organic and inorganic growth while maintaining a healthy capital structure. Saka accounted for over 30% of PGN's consolidated EBITDA in 2018. However, we believe the level of operational integration and strategic importance of Saka to PGN has weakened since mid-2018 due to PGN's positioning under Pertamina and its focus on mid- and down-stream gas operations. This has resulted in PGN contemplating the sale of its stake in Saka, in part or in whole, although there is no clarity on the timing or the route to be taken for the sale.

Moderate Legal linkages with PGN: PGN's USD1.35 billion senior unsecured notes due 2024 include a cross default provision that applies to any debt at its subsidiaries of over USD50 million; this provision applies to all of Saka's debt. The linkages could break if PGN's notes are prepaid. However, we believe the likelihood of such an event is remote. PGN notes mature after Saka's USD625 million notes become due. Fitch also considers the reputational risk - which is enhanced by the cross default provision - for PGN of a potential default by Saka as significant.

In addition, Saka's syndicated term loan will have to be repaid if shareholder loans from PGN fall below USD400 million; PGN and Saka have indicated that the shareholder loans will be maintained above this level. Furthermore, PGN eased certain terms and conditions of the shareholder loans to Saka in 1Q19, reflecting continuing support.

Standalone Profile Downgraded: The downgrade of Saka's standalone credit profile to 'B' reflects the company's declining production and reserves. We expect production to decline from 2019 to about 40 million-45 million barrels of oil equivalent per day (mboepd), from 50 mboepd in 2018, due to the expiry two concessions that accounted for over 10% of 2018 production and estimate Saka's proved reserve life to be less than five years, even with lower 2019 production.

A meaningful improvement in reserve life is contingent on reserve acquisitions, as we assess that Saka's organic reserve replacement is likely to remain well below 1x, the company has weak contingent reserves against proved reserves and limited assets in development, inhibiting organic reserve additions. However, we do not expect Saka to make large investments until its ownership structure is finalised.

Diversified Operations; Fixed Gas Prices: Saka's operational diversification across eight producing fields in Indonesia and one in the US, earning mix, healthy low-cost position of USD9 per barrel (BBL) in 2018, strong liquidity and adequate financial profile support its ratings. Saka's gas output in Indonesia, which comprise nearly half of its oil and gas production, is subject to fixed-price take-or-pay contracts for the life of its production concessions, which include escalation terms over the life of the contracts. This is a key strength as reduces commodity-price risk compared with most global oil and gas peers.

Adequate Financial Profile: Fitch expects Saka's financial profile to remain adequate for its standalone credit profile, with FFO net leverage of 2.5x-3.5x until 2021 and debt/EBITDA at around 3.0x. However, we forecast Saka's EBITDA to decline to less than USD350 million over the next three years, from USD408m in 2018, owing to lower production volume and weaker oil prices.

DERIVATION SUMMARY

Saka's ratings are notched down once from the standalone credit assessment of its parent, PGN, of 'BBB-'. The Negative Outlook reflects our opinion of weakening operational and strategic linkages between Saka and PGN, due to the misalignment of Saka's position within the revised ownership structure of state-owned oil and gas companies and PGN's potential sale of its stake in Saka. Saka's ratings remain linked to PGN, as we expect continued support due to moderate legal linkages and significant reputational risk of default to PGN.

The downgrade of Saka's standalone credit profile reflects its weakening operational profile, with falling production and proved reserve life falling to less than five years; we believe a significant improvement in reserve life is contingent on new acquisitions. Saka's long-term fixed-price contracts on more than half of its sales volume, competitive cost position, operational scale and adequate financial profile compare favourably against other oil and gas companies in the 'B' category.

Saka's ratings reflect its weaker expected reserve life compared with Kosmos Energy Ltd. (B+/Stable) at nine years; GeoPark Limited (B+/Stable) at seven years; Gran Tierra Energy International Holdings Ltd. (B/Positive) at five years; and PT Medco Energi Internasional Tbk (B/Positive) at seven years. These companies' ratings are constrained at the 'B' category due to limited operational scale and geographical diversification. The Positive Outlook on Medco reflects its improving financial profile and on Gran Tierra its expanding production scale and geographic diversification. Saka's credit profile benefits from long-term fixed-price contracts, similar to Medco, and healthy liquidity profile due to linkages with PGN. Saka's leverage is better than Medco's, comparable with Kosmos's, but is weaker than that of most other 'B' category companies.  (ends)