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Russian Oil Major Rosneft Upgraded To 'BBB-' On Reducing Leverage; Outlook Stable

  • Russian national oil company Rosneft continues to reduce its net financial obligations, particularly its short-term debt. On Dec. 31, 2018, its reported net debt including prepayments was $68 billion, down from $82 billion a year before.
  • Lower adjusted debt will help Rosneft build financial resilience to industry cycles and geopolitical risks, including existing and potential sanctions on Rosneft, Russia, and other Russian entities.
  • We are raising our long-term issuer credit rating on Rosneft to 'BBB-' from 'BB+'.
  • The stable outlook indicates that in our view, the strengthening underlying credit profile and government backing should be sufficient to underpin the ratings in most likely scenarios.
LONDON (S&P Global Ratings) Feb. 5, 2019--S&P Global Ratings today took the 
rating actions listed above. Oil Company Rosneft OJSC has reported solid 
full-year results. Its robust cash generation benefited from higher oil prices 
in 2018, especially prices denominated in rubles. In addition, liquids 
production grew by about 2% and management has focused on reducing short-term 
debt and leverage. Because capital investment has been moderate, Rosneft has 
been able to use reported free cash flow of $17.9 billion and cash from 
disposals to reduce net debt. 

We estimate funds from operations (FFO) to debt was close to 30% on Dec. 31, 
2018, up from 15.8% on Dec. 31, 2017. In our view, this improves Rosneft's 
financial resilience in the face of uncertain geopolitical developments and 
sanctions. Even with lower average oil price assumptions in 2019 and beyond, 
we project Rosneft will maintain its resilient operating performance. The 
Russian tax and duty regime is supportive; the correlation between the price 
of oil in U.S. dollars and the U.S. dollar/Russian ruble (RUB) exchange rate 
is beneficial (if less so than historically); and despite the agreed 
production cuts by the Organization of the Petroleum Exporting Countries 
(OPEC) and Russia, it could maintain a modest growth in production. 

Critically, Rosneft continued to reduce short-term debt and improve 
prospective liquidity into the fourth quarter of 2018, aided by lower year-end 
prices. Maintaining this trend signals that treasury policy, senior 
management, and government engagement with both Rosneft and the domestic 
banking system have aligned to enable the company to manage liquidity 
prudently. 

In 2017, Rosneft made a series of acquisitions in Russia, India, and Egypt, 
totaling about $7.5 billion. This caused its proportion of short-term debt to 
rise to a high 56% by Dec. 31, 2017. However, by redeeming some short-term 
debt and extending the maturity of other debt, this proportion has now fallen 
to 22%. We now assess liquidity as adequate.

Significantly, Rosneft achieved these balance sheet and operating improvements 
while it was subject to the U.S. and EU sanctions that have been in place 
since 2014. The sanctions include a ban on capital market access for 
maturities more than 60 days (U.S.) and 30 days (EU). We still see a risk of 
additional U.S. sanctions on Russian entities such as banks and on nondomestic 
secondary market activities. In our view, if limitations were placed on 
Russian banks' U.S. dollar transactions, it could have a serious effect not 
only on financial stability, but also on gas and oil supply to Europe. We 
believe U.S. policy makers would likely try to avoid such an outcome. 

Russia's and Rosneft's liquids production stands at about 11.4 million barrels 
a day (Mbpd) and 4.8Mbpd respectively--a material proportion of global oil and 
oil product supply (about 100Mbpd). Therefore, we consider an embargo on oil 
exports would be difficult to offset or manage. The impact on global supply 
and on higher oil prices would be cumulative, given the existing sanctions on 
Iran and Venezuela, from which exports have already declined. 

Rosneft's financial exposure to Venezuela as a result of prepayment agreements 
has reduced to $2.3 billion; the agreements originally implied an exposure of 
$7.0 billion. In our liquidity analysis, we do not assume that Rosneft's 
Venezuelan or Kurdistani loans will be repaid, nor do we net them off against 
debt.

The stable outlook reflects our view that the Russian government will continue 
to demonstrate support for Rosneft, directly or indirectly. This will help the 
company manage its liquidity and improve its capital structure.

We project that Rosneft's FFO to debt, after our adjustments, will remain 
close to 25%-30% on average in 2019-2020. Rosneft's credit metrics could 
improve beyond this range, for example, if Brent oil prices averaged $60 per 
barrel or more. However, because of the company's sizable capital expenditure 
(capex), we anticipate these metrics will see only modest improvement, largely 
due to production and operating cash flow growth. We also assume that Rosneft, 
the country's largest government-related entity (GRE), will receive ongoing 
support from the government, especially in rolling over short-term debt.

We would revise the outlook on Rosneft to negative if there were to be a 
similar action on the sovereign. Harsh additional sanctions might be one 
trigger for this. But we could also take this action if we saw a lower 
likelihood of government support for Rosneft, which could happen if the 
government did not help Rosneft address any actual or prospective liquidity 
challenges. Such a scenario would call into question the link between the 
company and the government. However, we continue to expect that Rosneft will 
remain an important GRE in Russia and will therefore enjoy relatively strong 
support from the government.

Downside could also result from a deterioration in Rosneft's stand-alone 
credit profile to 'b+' or lower. However, absent weaker liquidity, this 
scenario appears unlikely, since it would likely imply a very material debt 
increase, with FFO to debt falling below 12%; this is not part of our 
base-case scenario.

We would be highly unlikely to raise the rating without raising our sovereign 
credit rating on Russia, given the company's state ownership and other links, 
and Rosneft's important economic role for Russia.

Although it would not affect the rating directly, in time, we would see 
greater strategic visibility, especially regarding acquisitions, as positive. 
We would also consider revising upward our assessment of Rosneft's underlying 
credit profile if it sustained a stronger balance sheet with FFO to debt 
comfortably above 30% and at least neutral cash flow after capex and 
dividends. This would largely depend on the outperformance of oil prices and 
cash generation compared with our base-case forecasts.
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