This Special Report of Fitch Ratings assesses credit risks and opportunities surrounding the Caspian oil and gas sector as companies further develop their potential.
Fitch Ratings believes that oil and gas companies in Kazakhstan and Azerbaijan are comfortably positioned within their rating levels – given the current (April 2010) operational and financial performance. An upgrade of Caspian oil and gas companies’ ratings as a general trend is viewed by Fitch as unlikely in the short term. Most of the oil and gas companies in the region are rated on a standalone basis; the ratings of KazMunayGas National Company (NC KMG, ‘BBB‐’/Stable) and State Oil Company of the Azerbaijan Republic (SOCAR, ‘BB+’/Stable) are aligned with those of the sovereign (please see Summary Table).
Fitch expects the financial profiles of the rated Caspian players to stabilize somewhat in 2010–2011, following a period of deterioration, but to continue to present an unfavourable comparison with those of their Russian peers. The agency forecasts median funds from operations (FFO)‐adjusted leverage for the Kazakh companies to rise to 2.3x in 2009 (1.6x in 2008) and to stay at 2.1x in 2011, and for Azeri oil and gas companies to remain at around the 2008 level (2.1x).
Although most of the Kazakh and Azeri oil and gas companies rated by Fitch tend to operate on a smaller scale than their Russian peers, the agency expects their medium‐term production to grow, albeit without volumes matching the Russian companies. At the same time, the production costs of the Caspian producers are higher than those of the Russians – and closer to those of their international oil and gas peers. Fitch also notes that the oil and gas projects under development in these countries are more likely to experience significant cost overruns and/or delays, due to their complex geology.
As the reliance of OECD countries on imports of hydrocarbons has increased over time, they are seeking ways to diversify supplies. In this context, Kazakhstan, Azerbaijan and Turkmenistan (with a combined share of world proven oil and gas reserves of 3.7% and 5.9% in 2008, respectively) are gaining greater leverage on the global scale. Their ambitious expansion plans will further boost their export potential and visibility. Fitch forecasts Kazakh oil output to expand to about 2.2 million barrels of oil per day (bopd) by 2015, and Azeri oil production to some 1.2 million bopd. According to the Oil and Gas Industry Development Programme, Turkmenistan plans to boost its gas output to 250 billion cubic metres (bcm) by 2030.
In its assessment of the credit drivers and future oil and gas potential of Kazakhstan, Azerbaijan and Turkmenistan, Fitch analysed the risk areas described in Diagram 1.
Although the three countries have undertaken steps to diversify their export routes over the last few years, Fitch still considers the export infrastructure risk as relatively high. The agency plans to analyse this key credit factor along with market risk in a separate special report. Despite the fact that the governments of these countries are tightening environmental regulations, Fitch views environmental risk as relatively low, and will therefore omit its discussion in this report. The other credit‐relevant risks, and their impact on the companies’ ratings, are discussed below.
Kazakhstan, as the second‐largest oil producer in the Commonwealth of Independent States (CIS) after Russia, benefits from a relatively large reserve base, with proven oil reserves of 39.8 billion barrels (bbl) – 3.2% of the world’s proven oil reserves in 2008, and half of Russia’s reserves – and a long reserve life (70 years in 2008).
The successful completion of the expansion project by Tengizchevroil (TCO) in 2008 – eg the Sour Gas Injection/Second Generation Project – after significant delays and good progress in ramping‐up its oil production (485,000bopd in 2009 versus 375,000bopd in 2008), underpinned the country’s oil output growth of 5% in 2009 to some 1.6 million bopd (Table 1).
Fitch forecasts further expansion of Kazakh oil production at a compound annual growth rate (CAGR) of 4.7% over 2009‐2015 to about 2.2 million bopd in 2015 – driven by a boost in production at TCO, production growth at Karachaganak (Phase 3), and commencement of the Kashagan field (Chart 2). At the same time, Fitch notes there is downside risk to this growth pattern, as the final decision has been postponed on Phase 3 of the Karachaganak development.
Furthermore, Fitch expects Kazakh oil potential to be dependent in the long run on the development of offshore fields, which may prove to be challenging due to their complex geology. This could result in delays and cost overruns, as was already evident in the example of the Kashagan field – commencement of which was postponed from the initially planned 2005 to 2013–2014, and with an upward revision of capex to $136bn from $57bn.
Whilst achievements in Kazakh oil production growth during the last ten years are significant, its production scale remains limited in the global context, but could become more commensurate with that of Venezuela, Kuwait and Nigeria if its expansion continues largely as planned.
In turn, oil consumption in Kazakhstan substantially lagged production, and increased at a 4% CAGR during 2000–2009. Fitch expects Kazakh oil consumption to grow at a 4.4% CAGR over 2009–2015 to around 300,000bopd by 2015 (Chart 2). This mismatch between oil production and domestic consumption – in favour of the former – will continue to underpin Kazakhstan’s strong oil export potential.
Kazakhstan also possesses substantial gas reserves – the third‐largest in the CIS (after Russia and Turkmenistan) and comparable with those of Kuwait and Libya – with a long reserve life of 60.3 years in 2008.
Kazakh gas production is primarily related to associated gas, which is mainly either flared or re‐injected into the reservoir to maintain high pressure – in order to increase the recovery of liquids from the reservoir. This approach hindered gas production growth during 1998–2003, with output just sufficient to cover domestic consumption. However, in 2004 the Kazakh government introduced measures aimed at reducing the flaring of associated gas. As a result, gas production almost doubled in 2004 versus 2003, and has continued growing since then to about 35.6bcm in 2009, according to the Ministry of Energy and Mineral Resources (at present – the Ministry of Oil and Gas – editorial).
The main sources of gas production are Karachaganak (accounting for over 40% of the country’s gas output), TCO and CNPC‐Aktobemunaygas. The MEMR expects Kazakh gas output to increase at a CAGR of 8.7% over 2009‐2014 to about 54bcm by 2014, primarily on the back of the implementation of expansion projects by Karachaganak (Phase 3) and TCO (Chart 3).
At the same time, domestic gas consumption more than doubled during 2000‐2009, and Fitch expects it to grow steadily at a CAGR of 11.8% over 2009–2014 to about 37bcm by 2014. Nevertheless, the country’s gas export potential will largely depend on its treatment of associated gas in the future – the reduction of gas‐flaring could free up more gas for export. MEMR (MOG) forecasts the export of Kazakh gas to rise from 7bcm (excluding Karachaganak gas imported back into the country) in 2009 to somewhat over 9bcm by 2014.
Azerbaijan’s proven oil reserves of 7 billion bbl in 2008 (with a relatively long reserve life of 20.9 years) are the third‐largest in the CIS after Russia and Kazakhstan, and comparable with those of Norway, Sudan and Oman (Chart 1).
The country’s oil production expanded rapidly (15.5% CAGR) during 2000‐2009, and reached some 1 million bopd in 2009. The major contributor to this growth was the Azeri‐Chirag‐Deepwater Gunashli (ACG) megastructure operated by the international consortium Azerbaijan International Operating Company (AIOC), which accounted for over 70% of the country’s production (Table 2).
Fitch expects AIOC to remain the main driver of the country’s oil production growth over the next three to five years. The agency forecasts Azerbaijani oil output to expand at a 3.1% CAGR over 2009–2015, to about 1.2 million bopd by 2015 (Chart 4).
Although the agency expects steady growth of domestic oil consumption at a 3% CAGR over 2009–2015 to about 84,000bopd by 2015, consumption will still remain at a very low level versus production, which should enable Azerbaijan to enlarge its export potential.
At the same time, the estimates of the country’s proven gas reserves vary significantly from 1.2 trillion cubic metres (tcm) as at end‐2008 with a reserve life of 81.3 years, according to BP’s Statistical Review of World Energy 2009, to 3.5tcm, as per SOCAR figures. The country’s gas reserve base is the third‐largest among the three Caspian states, behind that of Turkmenistan and Kazakhstan, and on a par with that of Canada and Libya.
Fitch expects Azeri gas output growth over the next five years to be primarily driven by production expansion at the Shah-Deniz gas offshore deposit and the ACG oil and gas offshore fields. As part of Phase 1 of the Shah-Deniz field development, its gas production is forecast to peak at 8.6bcm. Preparations for Phase 2 are expected to start in the second half of 2010, with planned capex of about $20bn and an anticipated plateau of gas output of approximately 16bcm. However, the development of Phase 2 is subject to the re‐negotiation of gas supply terms with Turkey. The estimated timing for gas production from Phase 2 was reportedly pushed forward to 2015–2016 from the initially planned 2012–2013.
Given that, Fitch forecasts Azeri gas output to rise at a CAGR of 6% over 2009–2015 to about 33.6bcm by 2015 (Chart 5). SOCAR, in turn, estimates the country’s gas output growth potential at 48bcm by 2015, which may be achievable subject to the timing of gas production commencement and ramp‐up from Shah-Deniz Phase 2.
Although domestic gas consumption remained relatively stable, fluctuating at around 11bcm over 2005–2009, Fitch expects it to increase to about 15.3bcm by 2015, which implies a wider gap between domestic production and consumption and thus would contribute to the country’s export capabilities. SOCAR estimates Azerbaijan’s export potential at about 8.5bcm in 2010, which in Fitch’s view could grow to about 10.5bcm by 2015 – and is poised for quick expansion depending on Shah-Deniz Phase 2 production.
Unlike Kazakhstan and Azerbaijan, Turkmenistan is not rich in oil (proven reserves of 0.6 billion bbl in 2008 and production of 205,000bopd), but possesses large gas reserves (7.94tcm in 2008) – which rank number four in the world after Russia, Iran, and Qatar. The country’s proven gas reserves were revised upward by BP to 7.94tcm in 2008 from 2.43tcm in 2007 following an international reserve audit of one of the largest fields in Turkmenistan. In October 2008, Gaffney, Cline and Associates (GCA) confirmed that the Yolotan/Osman gas field contained 4–14tcm of gas, and the Yashlar field 0.3–1.5tcm.
Turkmenistan posted dynamic gas production growth at a CAGR of 5.7% during 2000–2008, to 66.1bcm in 2008, while Fitch expects this to decline in 2009 due to the interruption of gas exports to Russia. The gas export to Russia was resumed at the beginning of 2010 but is expected to be significantly lower than in 2008, which could be somewhat offset by Turkmen gas supplies to China and Iran through the newly built pipelines. Overall, the country’s gas production volumes in 2010 are likely to be affected by its ability to secure steady flows of gas exports to Russia.
According to the Oil and Gas Industry Development Programme, Turkmenistan plans to boost its gas production to 250bcm by 2030 and oil production to 110 million tonnes, with gas exports reaching 140bcm by 2020 and 200bcm by 2030. Fitch views these targets as ambitious, and believes that their achievement is reliant on the country’s ability to attract large investment and expertise to develop its fields. If Turkmen gas output growth over 2008–2030 continues at the same rate as during 2000–2008, the country could produce up to 100bcm of gas by 2015 and approach around 220bcm by 2030, which is still somewhat short of its long-term target.
Gas consumption in Turkmenistan experienced the same growth rate as gas production during 2000–2008, but is expected to moderate somewhat in 2009 due to the economic slowdown. If this growth pace is retained over 2008–2030, domestic gas consumption would reach about 28bcm by 2015 and considerably above 60bcm by 2030. This would result in a gap between gas production and domestic consumption of up to 70bcm by 2015 and up to 160bcm by 2030, which could be used as potential export supplies.
In view of the heavy reliance of the economies of Kazakhstan, Turkmenistan and Azerbaijan on the export of hydrocarbons, state involvement in the oil and gas sector is strong – and also influenced by geopolitics and the relationships between national and international oil and gas companies.
These countries are trying to capitalise on their geographical location in proximity to Russia (all three countries) and China (in the case of Kazakhstan and Turkmenistan), and at the same time diversify their export routes to the European markets. Kazakhstan and Turkmenistan are increasing their cooperation with China, as evident from the construction of the Kazakhstan – Turkmenistan – China gas pipeline and loans provided by China to Kazakhstan and Turkmenistan for the development of oil and gas deposits. Azerbaijan in turn benefits from two pipelines – the Baku – Tbilisi – Ceyhan pipeline and the South Caucasus gas pipeline – connecting it to Turkey.
The balance between national and international companies in the oil and gas sector in these countries is determined by the governments’ interests to control reserves, on the one hand, and their reliance on international expertise and funding to develop these reserves, on the other hand. In all three countries, the state-owned companies were created to represent the state’s interests in the industry, eg NC KMG in Kazakhstan, SOCAR in Azerbaijan, and Turkmengaz and Turkmenneft in Turkmenistan. These companies benefit from a favourable operating environment, which supports their creditworthiness.
For example, NC KMG has a pre-emptive right for the acquisition of any oil and gas assets offered for sale in the domestic market, and also the right to acquire at least 50% in new offshore projects. SOCAR was established to coordinate the development of the hydrocarbons industry in Azerbaijan, promote exploration activities, and attract foreign investment in the sector via production-sharing agreements (PSAs) and/or JVs. The Turkmen state‐run companies hold an exclusive right to extract oil and gas onshore in Turkmenistan.
At the same time, a large portion of the oil and gas production in Azerbaijan and Kazakhstan is derived from the fields developed by international consortia. This also reflects a friendlier operating environment in these countries (especially Azerbaijan) for international oil and gas players than in some other resource-rich countries. The Turkmen oil and gas sector is expected to become more open for international participation, which, however, is likely to be limited to the development of deposits in the Turkmen shelf of the Caspian and provision of services for onshore oil and gas projects.
Nevertheless, there are also signs of a tightening grip by the region’s states over oil and gas resources. In this context, Fitch analyses the stability and reliability of the operating environment and the impact of measures taken on the financial profile of affected companies – and on a country’s ability to develop its reserves in the context of ambitious expansion plans.
Kazakh and Azeri upstream companies tend to operate on a smaller scale than their Russian counterparts, and are closer in size to such international players as Colombia’s ECOPETROL S.A. (‘BB+’/Stable) and Pioneer Natural Resources Co. (‘BB+’/Stable) of the US (Table 3). According to Fitch’s “Rating Oil and Gas Exploration and Production Companies” methodology, most are likely to be categorised as small-scale producers with oil and gas output below 500,000boepd, except for a handful of companies, for example TCO in Kazakhstan and ACG in Azerbaijan. Fitch also notes some limitations to the comparability of their operating data, as the companies use different reserve classification systems. For example, NC KMG uses the Kazakh A+B+C1 classification, whereas other companies apply international standards.
Nevertheless, Fitch expects the Caspian oil and gas producers to become more significant players on the international markets in the medium- to long-term, as they roll out their expansion plans. The agency anticipates NC KMG’s total oil output growth to be driven by its equity stakes in TCO and Kashagan, as its majority-owned assets are at a mature stage of development. Similarly, SOCAR’s output growth is dependent on production expansion at ACG and Shah-Deniz, in which it owns equity stakes.
Both SOCAR and NC KMG benefited from high reserve replacement rates (above 100%) in 2008. At the same time, the Kazakh and Azeri upstream companies are unfavourably positioned versus their Russian counterparts based on reserve life, which is closer to that of their international peers (Table 3).
On the cost side, the Caspian producers rated by Fitch tend to be positioned at the higher end of the spectrum, which puts them at a disadvantage to their Russian peers and closer to the international counterparts. This is partly related to their smaller scale and the fact that, for example, both KMG EP and SOCAR are developing mature fields – which require additional investment to maintain plateau production. Furthermore, Fitch believes that the projects under development in this region are likely to be susceptible to significant cost overruns and/or delays due to their complex geology.
As illustrated in Chart 6, Kazakh and Azeri companies were well-placed in 2008, based on their profitability and leverage level. However, in 2009 the financial profiles of Kazakh and Azeri oil and gas companies were more negatively affected by a drop in oil prices and economic recession than their Russian and international counterparts, due to their relatively high levels of debt. This effect was further exacerbated by their smaller scale of operations. The relatively high indebtedness of Caspian oil and gas companies is reflected in their gross debt-to-reserves ratios, which tend to be weaker than those of their Russian peers.
The financial profile of integrated companies was also adversely affected by the poor performance of the refining industry, for which Fitch has a Negative Outlook in the short- to medium-term, amid lower refining margins and utilisation rates and with new refining capacity expected to come on stream in 2009–2010.
Fitch forecasts the credit metrics of the Caspian players to somewhat stabilise over 2010–2011, but to underperform their Russian peers. As shown in Chart 7, the agency expects median FFO-adjusted leverage for the Kazakh companies to rise to 2.3x in 2009 from 1.6x in 2008, and to stay at 2.1x in 2011. For Azeri oil and gas corporates, this ratio is expected by Fitch to fluctuate around the 2008 figure (2.1x), whereas the median ratio for the Russian oil and gas companies is projected to slightly increase to 1.2x in 2009 (1.1x in 2008) and further to 1.3x in 2011. The forecasts for profitability margin over 2009–2011 are largely comparable across the peer group (Chart 8).
The agency’s forecasts are based on its oil price deck – which was revised upward to $70/bbl in 2010, $65/bbl in 2011, and $60/bbl over the long run, given the anticipated slow global economic recovery.
The slow deleveraging assumed in Fitch’s forecasts for the Kazakh and Azeri oil and gas companies is driven by their ambitious expansion plans. As the oil and gas companies had to balance their aggressive growth plans with the necessity to maintain solid credit metrics in the less favourable market environment in 2009, most Caspian oil and gas players implemented costcutting initiatives and reduced their capex programmes. However, their investment programmes still remain substantial, eg NC KMG intends to implement a $20.4bn capex programme over 2009–2013. SOCAR plans to invest about $6.4bn over 2009–2013 in the development of its fields, and some $4.4bn for the construction of the refinery in Turkey, whereas Shah-Deniz’s capex for Phase 2 is estimated at $20bn.
State-owned companies are especially poised for ambitious capex programmes as they are involved in strategically and socially important energy projects that support the security of energy supply. Given the size of their capex programmes, the internally generated cash flows of these companies are unlikely to be sufficient to cover investments, therefore requiring external funding. However, the ability of these companies to obtain funding may be constrained amid current market conditions, and also in view of their balance sheets which are already highly leveraged. This, in Fitch’s view, increases the need for state-owned companies to cooperate with large international oil and gas players and/or to seek state funding.
Fitch believes that small Caspian oil and gas players with high indebtedness are more exposed to liquidity risk than their larger counterparts. The latter can be divided into two categories – international consortia developing fields in the Caspian region, which can capitalise on the strong financial standing of their participating parties (usually large international oil and gas companies); or state-owned companies, which can rely on state support.
Kazakh entities are worth mentioning in this context, as they continue to be exposed to the vulnerability of the domestic banking system. Therefore, when analysing the credit metrics of Kazakh energy companies, Fitch places greater emphasis on gross figures for leverage-related ratios, rather than net figures. Nevertheless, the agency gains comfort from the companies’ ability to manage their liquidity needs satisfactorily in 2009 and from some early signs of stabilisation in the Kazakh banking sector.
Fitch rates most of the oil and gas companies in Kazakhstan and Azerbaijan on a standalone basis, despite the ultimate state ownership of many rated corporates in the region. The ratings of NC KMG and SOCAR are aligned with those of their respective sovereigns, according to Fitch’s “Parent and Subsidiary Rating Linkage” methodology.
During 2009 and up until April 2010, negative rating actions on oil and gas companies in the region were primarily driven by sovereign rating actions (as some of the ratings were constrained by the sovereign’s), apart from the downgrade of Kazakhstan-based Tristan which was due to company-specific factors. The Sovereign Outlook on Kazakhstan was revised to Stable from Negative at the end of 2009, and sovereign-constrained ratings were also revised as a consequence.
Given the current financial and operational profiles of the Kazakh and Azeri oil and gas companies, Fitch believes that they are comfortably positioned within their respective ratings. As Fitch expects these companies to stabilise their credit metrics in 2010, and to continue seeking for a balance between their ambitious expansion plans and the necessity to maintain solid financial profiles, the agency does not view an upgrade of their ratings on a broader scale as a likely scenario in the short-term.
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