Fitch improves SOCAR's rating

Baku/29.10.22/Turan: On October 28, the authoritative agency Fitch Ratings changed the outlook on the long-term issuer default rating (IDR) of the State Oil Company of the Republic of Azerbaijan (SOCAR) from "Stable" to "Positive" and confirmed the IDR and senior unsecured rating at 'BB+' and a recovery rating of 'RR4', according to Fitch.

The rating action follows the revision of the outlook on Azerbaijan's sovereign rating (BB+/Positive) and the strengthening of SOCAR's creditworthiness, which could lead to an upward revision of its standalone credit profile (SCP).

SOCAR is wholly owned by the state and its rating is currently equal to that of Azerbaijan in accordance with Fitch's rating criteria for state-related companies (GRE). The company's positions are reinforced by state support provided in the form of financial guarantees, cash contributions and capital investments, as well as SOCAR's social functions and its importance as a state mechanism for the development of oil and gas projects.

As an explanation for the improvement in SOCAR's credit rating, Fitch experts point to the fact that the company's gas production is growing.

According to the rating agency's forecasts, SOCAR's production will grow by 4% in 2022 and by 5% in 2023, mainly due to an increase in the production of "blue fuel", and will remain stable in the future.

The agency recalls that most oil and gas projects in Azerbaijan are carried out under production sharing agreements in which SOCAR has a minority share and where it also represents the state and participates in the sale of its share of crude oil and gas (profit oil). In addition, SOCAR has stakes in some other major energy projects promoted by the state, such as the Southern Gas Corridor (SGC).

The state exercises significant control over SOCAR's profitability and balance sheet through regulation of domestic fuel prices, cash injections and other measures. SOCAR's high debt burden, although improving, is largely a consequence of the company's close ties with the state.

"We believe the government has incentives to maintain adequate funding for SOCAR," Fitch said in the filing. Under 'favorable business profile', Fitch indicates that cash from operations (FFO) net leverage will decline from 2022, driven by gains from higher oil and gas prices.

“Keeping FFO net leverage below 4.0x, coupled with satisfactory liquidity and improved financial transparency, could result in a positive revaluation of SOCAR's 'self-reliant credit profile'.

Fitch recalled that SOCAR had transaction commitments regarding the alienation of certain assets to SGC (Supply Gas Co) and Goldman Sachs International (GSI) for a total of AZN 7 billion as debt obligations, .

This mainly referred to the sale of a 10% stake in Shah Deniz and the South Caucasus Pipeline Company to SGC, as well as the sale of a 13% stake in SOCAR Turkey Enerji AS to GSI.

“According to the terms of the agreement between SGC and SOCAR, SGC paid advances to SOCAR, and control over assets is expected in 2023, subject to the conditions preceding the sale. At the same time, if something interferes with the deal, and SOCAR is obliged to return advance payments, this will not have a significant impact on SOCAR's ability to reduce the share of borrowed funds,” Fitch believes.

The balance of cash on SOCAR's accounts at the end of 2021 was 9 billion manats compared to 5.9 billion manats of short-term debt.

“We expect the company's earnings to increase in 2022 and 2023 on the back of rising oil and gas prices, and this supports SOCAR's liquidity,” Fitch notes.

The rating agency predicts that in 2022 the benchmark Brent (the price for exported Azerbaijani oil is also pegged to it) will average $100 per barrel, and in 2023 - $85 per barrel, in 2024 - $65 per barrel and then may drop to $53 per barrel. At the same time, the USD/AZN exchange rate is stable at 1.7.

Fitch notes that the company's total capex over 2022-25 is expected to be AZN 16 billion, with annual dividend payments (starting in 2022) averaging AZN 0.6 billion (through 2025).

“Fitch does not expect a short-term negative rating action on SOCAR. SOCAR's credit rating can be revised only if the FFO net leverage increases by more than 6 times over a long period, provided that the sovereign rating does not change,” the experts of the rating agency point out.

The rating may be affected by the fall in energy prices, but only if this affects the reduction of the country's external reserves.

However, Fitch is confident that Azerbaijan has a robust medium-term fiscal strategy, which is positive, coupled with continued high energy prices (which would also strengthen the balance of payments).

SOCAR has an ESG Relevance Rating of 4, which is due to the limited independence of the board of directors of this state-owned company, and weak disclosure of information.

But in general, ESG issues are neutral to the company's creditworthiness or have only a minimal impact on the company's creditworthiness.