Fitch: Upstream Slump Hits China's Oil Majors; Midstream Buffer May Shrink in 2H16

Kunlun Energy

01/09/2016 04:50

(The following statement was released by the rating agency)

HONG KONG/SHANGHAI, August 31 (Fitch) Fitch Ratings expects the segmental losses 
of China's national oil companies' exploration and production (E&P) operations 
to continue into 2H16, under the agency's average 2016 Brent price assumption of 
USD42 per barrel of oil equivalent (boe), as room for further cost cutting is 
limited. Midstream refining and chemical operations continue to buttress the 
earnings of integrated operators affected by E&P margin weaknesses, but margin 
pressure and intense competition may lower support from midstream segments in 
2H16. 

The E&P operations of national oil companies, PetroChina Company Limited 
(PetroChina; A+/Stable), China Petroleum & Chemical Corporation (Sinopec) 
(Sinopec; A+/Stable) and CNOOC Limited (A+/Stable), reported operating losses 
(after non-cash items, including depletion, depreciation and amortisation) in 
1H16, as realised oil prices fell 35% yoy to below USD35/boe during the period. 
Average E&P EBITDA/boe for the three companies fell by 46% to USD12.2/boe in 
1H16, from USD20.1/boe in 2015, despite an absence of the special oil-gain levy 
due to low prices and an average 13% decline in lifting costs. 

Fitch estimates full-cycle costs, which include cash production costs, reserve 
replacement and cost of capital, at above USD50/boe, although costs vary between 
the three companies due to different asset focus and geologies. These costs are 
clearly not supported by current market prices, especially in light of the 
average 10%-15% discount to benchmark prices for the three companies' realised 
price for oil produced. 

Companies need to restrain spending on less economical projects due to continued 
low crude prices. PetroChina revised its full-year 2016 production target down 
by 3%, from 1,454 million barrels (bbl), in its mid-year guidance, while Sinopec 
revised its target down by 8%, from 476 million bbl. 

Upstream investments will also remain restrained, although this needs to be 
balanced by the requirement to maintain an adequate reserve size, especially for 
CNOOC, which had a low proved developed reserve life of 3.5 years at end-2015. 
All three companies maintained their full-year capital expenditure budgets in 
their mid-year results briefings, which are 8%-10% lower than in 2015. The 
companies only spent on average 25% of their full-year budgets in 1H16, implying 
that investment outflows will increase in the second half. This could be 
especially so for Sinopec, which only spent 14% of its full-year budget.

Unlike CNOOC, which is upstream focused and incurred an operating loss during 
1H16, both PetroChina and Sinopec reported operating profits in 1H16, albeit 
substantially lower, due to their significant downstream operations. The 
midstream operations of PetroChina and Sinopec benefited from solid demand and a 
refined product price-floor enacted by the government in January 2016, boosting 
refining operation profitability. PetroChina's refining and chemical EBITDA 
margin was 14% in 1H16, while Sinopec's was 9%, compared with 5% for both 
companies in 2015. PetroChina saw 12% yoy revenue shrinkage from natural gas 
sales and its pipeline segment, mainly due to lower gas prices, but segmental 
EBITDA held up relatively well at CNY20.5bn (1H15: CNY21.9bn), supported by the 
stable transmission business.

We expect the refining operations to remain profitable in 2H16, despite intense 
competition from independent 'teapot' refineries, which are encouraged by the 
government through relaxed crude import rights. Sinopec's refinery utilisation 
dropped to 75.4% during 1H16, from 82% in 1H15, while PetroChina's declined to 
70.1%, from 78.9%. In contrast, the Shandong's teapot refineries saw their 
utilisation rate increase to 52.8% in 1H16, from 40.6% during the same period 
last year. Margins could shrink if oil-prices in 2H16 remain stronger than in 
1H16. 

The Chinese national companies' financial leverage metrics, measured by 
net-debt/EBITDA, inevitably deteriorated, as EBITDA declined by 18% yoy in 
aggregate during 1H16. This was within Fitch's expectations. Nevertheless, all 
three oil majors managed to lower their net borrowings by 6% in total between 
December 2015 and June 2016. The companies need lower debt to support inventory 
levels as crude prices fall and capex cuts have helped preserve cash.  

There could be more pressure on cash balances as 2H16 capex increases compared 
with 1H16.  All three companies have cut dividends, which is positive for their 
standalone credit profiles. However, to manage shareholder expectations the 
companies increased their payout ratios as a percentage of profits and 
PetroChina paid a special dividend. Overall, dividends are still below prior 
year outflows and we continue to believe the three companies have more 
flexibility than oil majors in Europe and the US due to their majority state 
ownership.    

Contact: 

Renee Lam

Director

+852 2263 9971

Fitch (Hong Kong) Ltd

19/F Man Yee Building

68 Des Voeux Road Central

Hong Kong

Penny Chen

Associate Director

+86 21 5097 3165

Media Relations: Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: 
wailun.wan@fitchratings.com.

Additional information is available on www.fitchratings.com

ALL FITCH CREDIT RATINGS ARE SUBJECT TO CERTAIN LIMITATIONS AND DISCLAIMERS. 
PLEASE READ THESE LIMITATIONS AND DISCLAIMERS BY FOLLOWING THIS LINK: 
HTTP://FITCHRATINGS.COM/UNDERSTANDINGCREDITRATINGS. IN ADDITION, RATING 
DEFINITIONS AND THE TERMS OF USE OF SUCH RATINGS ARE AVAILABLE ON THE AGENCY'S 
PUBLIC WEBSITE 'WWW.FITCHRATINGS.COM'. PUBLISHED RATINGS, CRITERIA AND 
METHODOLOGIES ARE AVAILABLE FROM THIS SITE AT ALL TIMES. FITCH'S CODE OF 
CONDUCT, CONFIDENTIALITY, CONFLICTS OF INTEREST, AFFILIATE FIREWALL, COMPLIANCE 
AND OTHER RELEVANT POLICIES AND PROCEDURES ARE ALSO AVAILABLE FROM THE 'CODE OF 
CONDUCT' SECTION OF THIS SITE. FITCH MAY HAVE PROVIDED ANOTHER PERMISSIBLE 
SERVICE TO THE RATED ENTITY OR ITS RELATED THIRD PARTIES. DETAILS OF THIS 
SERVICE FOR RATINGS FOR WHICH THE LEAD ANALYST IS BASED IN AN EU-REGISTERED 
ENTITY CAN BE FOUND ON THE ENTITY SUMMARY PAGE FOR THIS ISSUER ON THE FITCH 
WEBSITE