S&P: Kilang Pertamina Internasional PT Assigned 'BBB' Rating; Outlook Stable

(SINGAPORE (S&P Global Ratings) March 27, 2024)--S&P Global Ratings today took the rating actions listed above.

We equalize our 'BBB' issuer credit rating on KPI with the overall credit quality of its parent, Pertamina (BBB/Stable/--), given we view KPI as a core subsidiary. We assess KPI's SACP at 'bb-'.

We expect KPI to remain well-entrenched as a core subsidiary of its parent's integrated operations. Pertamina will remain Indonesia's national oil company and be a key conduit for Indonesia's energy policy. As the strategic refining and petrochemical sub-holding, KPI owns and operates nearly all of Pertamina's crude oil refineries and petrochemical facilities.

KPI's total daily crude oil processing capacity of 1.05 million barrels of oil represents close to 100% of Indonesia's refining capacity. The company also plays an integral role in reducing Indonesia's reliance on fuel imports, thereby improving the country's current account. We estimate KPI meets about 65% of Indonesia's annual fuel consumption, which would increase to about 70% once the company completes its Balikpapan refinery upgrade in 2024. The upgrade will increase KPI's refining capacity by 100 thousand barrels of oil per day (kb/d) and allow one of KPI's oldest refineries to meet Euro V emissions standards.

KPI has strong operational integration within the Pertamina group. The company serves as a key intermediary between Pertamina Hulu Energi PT (PHE) and Pertamina Patra Niaga PT (PPN), two key entities in the group. The bulk of KPI's operations are intercompany transactions because it purchases almost all of PHE's domestic crude oil production and sells almost all of its refined products to PPN. KPI's proportion of sales outside of the Pertamina group represented less than 2% in 2022 (sales to PPN alone were 96%). These sourcing and offtake agreements are negotiated bilaterally between the parties and are renewed periodically.

PHE operates Pertamina's upstream oil and gas assets and contributes the largest proportion of the group's EBITDA. PPN, the commercial and trading sub-holding of Pertamina, makes up close to 100% of Indonesia's fuel retail market. It is the largest contributor of cash receipts from external parties within the Pertamina group.

PHE, PPN, and KPI collectively play an irreplaceable role of meeting Indonesia's PSO mandate, and consequently expose KPI to the risk of working capital build up. This occurred over 2022 when receipt of cash compensation from the government to PPN was delayed, delaying cash payments to KPI.

Pertamina's sizable capital contributions to KPI reflect the group's strong commitment to the refining and petrochemical segment, in our view. KPI has received close to US$2.0 billion of equity capital injection and ongoing access to a US$6 billion shareholder loan facility since its designation as the refining and petrochemical sub-holding of Pertamina in September 2021. The shareholder loans represent about 65% of KPI's total debt as of Dec. 31, 2023.

In our view, the availability of shareholder loans for working capital support is credit positive to KPI. This is given the propensity for huge working capital swings amid volatility in crude oil and fuel prices. The access to loans also underscores the extent of tangible group support provided by KPI's parent.

We believe Pertamina's intent to maintain its 100% ownership in KPI (directly and indirectly) reinforces the strategic importance of the subsidiary to the group. This enabled the parent to provide timely and extraordinary support when oil prices soared following the Russia-Ukraine war. In 2022, Pertamina temporarily upsized the shareholder loan facility to US$8 billion from US$1 billion to provide KPI with more flexibility to finance an anticipated heavy build-up of working capital on its balance sheet. This coincides with KPI's peak drawdown on the shareholder facility of US$4.3 billion in 2022.

We assess KPI's SACP at 'bb-'. Underpinning our view are the company's monopolistic position in Indonesia's downstream refining sector, its mature and less-complex refineries, and highly leveraged balance sheet due to a sizable investment pipeline.

KPI's sizable refining scale is constrained by its mature and less-complex refineries, in our view.The company's 1.05 million b/d refining capacity is spread over six refineries across Indonesia's archipelago. This contrasts with peers like Reliance Industries Ltd. and SK Innovation Co. Ltd., both of which have more than 800 kb/d refining capacity in a single site, supporting their operations' economies of scale.

Similarly, KPI's average Nelson Complexity Index is at 6.4, which contributes to the company's relatively higher operating and processing costs than regional peers. That said, we note that the ongoing upgrade in Balikpapan will lift KPI's average complexity to 8.3, bringing the measure closer to those of North Asian peers like GS Caltex Corp. and S-Oil Corp.

KPI maintains a strong competitive advantage in Indonesia, given its effective monopoly in Indonesia's refining sector. Indonesia's government policy aims to reduce fuel imports and improve the current account, thereby protecting KPI from offshore competition. Meanwhile, Pertamina's PSO mandate to distribute fuel at government-designated prices means that any incremental output from KPI will be absorbed by sister company PPN, which we estimate still imports about 30% of Indonesia's annual fuel requirement.

In our view, these linkages elevate the importance of Pertamina's integrated operating model and create high barriers of entry for private operators to challenge the group's domestic market position in downstream refining, and in marketing and distribution. We believe KPI will maintain its advantage in Indonesia because we do not currently envisage any material changes to the regulatory landscape for Indonesia's downstream energy sector. We also do not foresee Pertamina altering its current stance to maximize self-sufficiency under its integrated operating model.

KPI may not always be able to maximize its profits. This is given Pertamina's mandate to prioritize domestic needs under its PSO mandate. KPI is exposed to a fairly fixed domestic fuel demand profile, which limits its ability to alter its production slate to maximize profits. We view this as a key weakness compared with commercially-oriented refining peers in the region, because the PSO mandate could lead to lower gross refining margins than peers'. For example, KPI's refining margin was about US$8/bbl for 2022, whereas peers like Thai Oil and GS Caltex reported refining margins in the strong double digits.

Given KPI's operational integration within the group, the company's product slate prioritizes Pertamina's PSO mandate to distribute and market fuel via sister company PPN, which receives close to 100% of the government's PSO quota annually. This, in turn, reflects domestic consumption needs, which is tilted toward cheaper, subsidized lower-octane products instead of higher value-added products that are not subsidized.

In return for undertaking this obligation, Pertamina allows KPI to earn an agreed margin that is reflective of ongoing market prices for each unit of its production that is sold to PPN under an internal transfer pricing formula. This implies that KPI's susceptibility to volatility in margins is in line with regional refiners, because KPI also procures its feedstock at market prices.

KPI's highly leveraged financial profile reflects our expectation that the company will have to invest to fulfill national strategic projects. Such projects include upgrades of refineries at Cilacap, Balongan, and the ongoing Balikpapan upgrade to bring Indonesia's fuel emissions standards closer to global standards and to execute on Indonesia's bio-fuel mandate. We project KPI's annual EBITDA will grow from about US$900 million in 2024 to about US$1.1 billion over 2025-2026, assuming mid-cycle pricing conditions where KPI's gross refining margins would range between US$6/bbl-US$7/bbl. The growth in EBITDA largely stems from increased volumes and a higher proportion of value-added products after the Balikpapan refinery upgrade in 2024.

Over the same period, our base case projects KPI will generate cumulative negative free cash flow of US$1.5 billion-US$2 billion over 2024-2026, which would result in debt increasing to about US$6 billion in 2026. KPI will likely prioritize the completion of its Balikpapan refinery upgrade, which the company expects will fully ramp up in 2025. KPI's investment plans beyond 2024 largely center around upgrading its refineries to support the nation's bio-fuel mandate, decarbonizing initiatives, as well as downstream petrochemical projects.

Our base-case capital expenditure (capex) projections of US$4 billion-US$5 billion over 2024-2026 reflect our expectations that capital outlay will not accelerate in the near term, and will be in line with its annual capex of about US$1.5 billion over 2021-2023. This is underpinned by our view that the parent will remain closely involved in any new project undertakings, while considering KPI's ability to service its financial obligations. Large projects (organic and inorganic) exceeding a certain threshold would require approval from Pertamina.

KPI's access to ongoing financial support from Pertamina partly mitigates financial risks compared with similarly rated peers. This is mainly due to the US$3.6 billion in shareholder loans (as of Dec. 31, 2023) on KPI's balance sheet. We consider the loan as debt-like due to the loans' stated short maturity. Consequently, we include these shareholder loans, which make up 65% of the company's debt capital structure, in our credit measures. They have primarily been used to finance working capital and funding gaps borne by Pertamina due to delayed government compensation over 2022.

That said, we acknowledge the equity-like characteristics of this inter-group loan arrangement. For example, Pertamina maintains discretion and has provided KPI with flexibility around the computation of interest rates on the loans, as well as the timing around interest servicing.

This was demonstrated in 2022 amid huge price volatility, where KPI's cash interest paid was less than 10% of its interest expense for the year. Pertamina has also extended the maturities on these shareholder loans several times since 2021, which reduces any near-term refinancing risk. We believe this flexibility will help KPI maintain a stronger interest servicing capability than peers with similar leverage.

The stable rating outlook on KPI mirrors that on the parent, Pertamina. It also reflects our view that KPI will maintain its operational integration with the parent and the wider group, as well as its monopoly in the domestic refining industry.

We may lower the rating on KPI if:

• We lower our ratings on Pertamina; or

• KPI's importance to its parent diminishes. This may materialize in the form of a dilution of Pertamina's shareholding in the company, reduced supply and offtake within the group, and delays in financial and operational support from the parent.

Although a revision would not immediately affect the issuer credit ratings, we may revise downward KPI's SACP to 'b+' if the company's debt-to-EBITDA ratio were to remain above 6x and FFO cash interest coverage were to remain sustainably below 3.0x. This could happen if KPI's operating performance weakens, or if it takes on more debt than we expect to fund its investments, or any spike in working capital.

We could raise the rating on KPI if we raised the rating on Pertamina while continuing to assess KPI as a core subsidiary of the group. This would likely only materialize if we raised the sovereign credit rating on Indonesia.

We may revise upward our assessment of KPI's SACP if we believe the company's capex pipeline has peaked and that the company will utilize cash flows for debt reduction. In such a scenario, KPI's debt-to-EBITDA ratio should decline toward 4.0x on while the FFO cash interest coverage stays above 3.0x.

Environmental factors are a negative consideration in our analysis of KPI's credit profile given its operation in crude oil refining, while social factors are somewhat less so.

KPI is essential to its parent in the execution of Pertamina's social and energy security mandates, particularly in the provision of subsidized fuel to the domestic market. As the largest refiner in Indonesia, KPI has to bear the capital costs and potentially retain debt on its balance sheet to bring its refineries closer to international standards, and at the same time expand to meet Indonesia's growing fuel needs. For example, KPI's ongoing Balikpapan upgrade will increase the refinery unit's Nelson Complexity Index to 8.0 from 3.4, allowing it to process heavier crude and produce more low-sulfur products. On a broader portfolio level, KPI has a target to upgrade its refineries to be in accordance with the Euro V emission standards and to reduce its energy and carbon intensity.

In our view, KPI's governance practices reflects that of parent company Pertamina, given their deep operational integration. Like its parent Pertamina, KPI also faces substantial government scrutiny because it is the key conduit to meeting the country's fuel demand domestically. The parent appoints KPI's management and board of commissioners, and these appointments have to be approved by the government, which should support an adequate governance framework. (ends)