Province of Neuquen 'B' Ratings Affirmed, Outlook Remains Stable


  • The dynamic oil and gas sector should bolster Neuquen's operating revenues and more than compensate for its high spending, which we expect to grow above inflation, resulting in solid operating surpluses.
  • However, the Argentine province will continue to face challenges in implementing formal medium- and long-term financial policies.
  • We're affirming our 'B' long-term global scale foreign and local currency issuer credit ratings on the province of Neuquén. We're also affirming the 'B' issue-level ratings on its rated secured and unsecured notes.
  • The outlook is stable, reflecting our view that Neuquen will continue attracting investments in the hydrocarbon sector, and the local economy should grow faster than national GDP, resulting in operating surpluses and a lower debt.
RATING ACTION
BUENOS AIRES (S&P Global Ratings) March 12, 2019--S&P Global Ratings affirmed 
its 'B' global scale foreign and local currency ratings on Neuquen. We also 
affirmed our 'B' issue-level ratings on the province's rated secured and 
unsecured notes.


OUTLOOK
The stable outlook reflects our expectation that in the next 12 months Neuquen 
will continue attracting investments to its hydrocarbon sector, supporting 
growth in the local economy that's faster than the national average. We expect 
own source revenues to benefit from this dynamism in the provincial economy 
and keep operating surpluses at 6% on average, similar to those in 2018, 
despite higher spending. However, difficult financial market conditions that 
limit prospects for debt issuance and weakness in the province's capital and 
financial planning should delay infrastructure spending.


Downside scenario
We could lower the ratings in the next 12 months if we were to lower the 
ratings on the sovereign. We could also lower the ratings if the province 
doesn't manage its spending such that its fiscal profile erodes unexpectedly, 
posting consistent operating deficits. Under this scenario, we would also 
expect a weakening in the province's liquidity position. 

Upside scenario
Given we don't believe that Argentine local and regional governments (LRGs) 
meet the conditions to be rated above the sovereign, we could only upgrade 
Neuquen if we take a similar action on Argentina in the next 12 months while 
the province's individual credit profile continues to improve. The individual 
credit profile could strengthen from a longer track record of sustainable 
revenue and expenditure management and longer-term planning.


RATIONALE
Our 'B' ratings on Neuquen are at the same level as its 'b' stand-alone credit 
profile (SACP). The ratings reflect Neuquén's individual profile and the very 
volatile and underfunded institutional framework in which the Argentine 
provinces operate. Despite the recent improvement in Neuquén's finances, we 
expect its budgetary performance to remain volatile because of the province's 
exposure to cyclical revenues, namely hydrocarbon royalties, and weak revenue 
and expenditure management. Neuquen's economy, although  dynamic is highly 
concentrated in the hydrocarbon industry, which exposes the province to swings 
in commodity cycles. On the other hand, the province's low debt burden and 
contingent liabilities, with a track record of managing its exposure to 
foreign currency risk, support its creditworthiness.

We estimate that the province's GDP per capita averaged $16,479 in 2016-2018, 
above the national average of $13,565 for the same period. Despite some 
efforts to diversify the economy, Neuquén still depends on the hydrocarbon 
sector, which represents 34% of the provincial economy. This concentration 
makes the province vulnerable to potential risks from variables such as oil 
and gas prices. However, the robust oil and gas investments in the past three 
years provide some cushion to Neuquén against Argentina's economic downturn. 
More than half of the gas in Argentina is produced in Neuquen thanks to the 
growth of the non-conventional gas production. The Vaca Muerta field is the 
second-largest shale reserve in the world, and we believe it will continue to 
attract robust investment and foster above-average economic growth in the 
province.

The province's management of its cyclical revenue base has been a weakness, 
which led to a volatile fiscal performance and low quality in budgetary 
planning, with budgets often having to be revised mid-way through the fiscal 
year. Nonetheless, Neuquen has maintained adequate debt management, in 
particular its foreign currency exposure. On March 10, 2019, the governor Omar 
Gutierrez was reelected to serve for a four-year period, until 2023. We assume 
continuity in the province's main budgetary and financial policies following 
the election. We believe the administration's main challenge will be devising 
and implementing intermediate- and long-term financial policies that ensure a 
sustainable fiscal performance.    

We continue to view the institutional framework for Argentine LRGs as very 
volatile and underfunded, despite recent improvements. In our opinion, there's 
a positive trend in the predictability of the outcome of potential reforms and 
the pace of their implementation, amid an increasing dialogue between LRGs and 
the national government to address various fiscal and economic challenges that 
we expect will remain in the short-to-medium term.

Thanks to the Argentine peso's sharp depreciation in 2018, coupled with higher 
oil prices and sound performance of the oil and gas industry, the province's 
royalties jumped about 121% year over year. At the same time, Neuquen raised 
its gross receipt tax rate to the upper limit established in the 2017 fiscal 
pact between the federal government and provinces. We expect the healthy 
hydrocarbon sector to keep the province's own-source revenue at 79% of total 
operating revenue in the next three years, up from 73% in 2017. However, 
Neuquén's ability to raise its own-source revenue further will be limited, in 
our view, given that the province has already reached the cap on tax rates 
established in the fiscal pact, while increases in royalties would go against 
the policy of fostering the development of the industry.

We assume that sound operating revenue will more than compensate for high 
spending pressures, particularly for provincial payroll, given high inflation. 
This should keep operating surpluses at 6.3% of operating revenues on average 
in 2019-2021, compared with a surplus of 7.7% in 2018 and a swing from a 7.5% 
deficit in 2017. In the next three years, we expect the province's operating 
expenses to continue rising above inflation, given the constant demands for 
public-employee salary increases and the need to expand the coverage of basic 
social services in the area of Vaca Muerta. Neuquén's capacity to cut spending 
is limited, given the important role that the public sector plays in the 
province. We believe such budgetary constraints, the limited access to 
borrowings given the national and global market conditions, and the reduction 
in capital transfers will leave limited room for public works. We expect 
Neuquen's capex to represent slightly less than 8% of the total expenses in 
2019-2021.

Tight credit market conditions will continue discourage Neuquen from borrowing 
heavily. During the next two years, we assume its borrowings will be limited 
to the refinancing of its maturing debt. As of the end of 2021, we estimate 
Neuquén's debt stock to reach 36% of the province's projected operating 
revenue, down from 52% in 2018.  

On April 26, 2011, Neuquén issued $260 million in the global capital markets 
through the issuance of structured notes (TICAP). The province used the 
proceeds to pay down existing debt and to finance several new infrastructure 
projects. We rate these notes as any other direct, general, unconditional, and 
unsubordinated obligation of the province, given that we believe their 
creditworthiness is directly linked to that of Neuquen's. The notes are 
secured by oil royalties the province receives from oil producers (the 
dedicated concessionaires) from predetermined areas. In May 2016, Neuquén 
announced the exchange of $110.4 million of TICAP notes for TICADE notes due 
2028, benefiting from better market conditions to refinance its debt and 
extending the maturity of 69.62% of TICAP notes. 

The province's liquidity position has improved in 2018 following a recovery in 
its fiscal performance. In our view, Neuquén's net free cash and liquid assets 
can cover 78% of its projected debt service of ARP8.9 billion for 2019. 
However, we assess Neuquen's access to external liquidity as limited, largely 
due to our view of Argentina's volatile capital markets and weak banking 
system. For the latter, our Banking Industry Country Risk Assessment (BICRA) 
is at group '8' in Argentina. We group our BICRAs, which evaluate and compare 
global banking systems, on a scale from '1' to '10', ranging from what we view 
as the lowest-risk banking systems (group '1') to the highest-risk (group 
'10').

Neuquén owns 10 government-related entities (GREs) including a bank (Banco de 
la Provincia de Neuquén [BPN]) and a gas and oil company (Gas y Petróleo de 
Neuquén [GPN]). We estimate that the potential losses among GREs under a 
stress scenario would total slightly below 10% of Neuquén's operating revenue. 
The province doesn't guarantee the liabilities of its bank, which we consider 
as self-supporting. The last time Neuquén provided financial support to BPN 
was in 2001. We believe that given GPN's strategic role for the province, 
Neuquén would likely provide support to it if needed.
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