Tashkent, Uzbekistan (UzDaily.com) -- Fitch Ratings has assigned JSC Uzbekneftegaz (UNG) a first time ‘BB-’ Long-Term Issuer Default Rating (IDR) with Stable Outlook.

The rating is equalised with that of its parent Uzbekistan (BB-/Stable). UNG is a fully state-owned integrated natural gas and liquid hydrocarbons producer with strong links with the government. We view its Standalone Credit Profile (SCP) at ‘b+’, which reflects its medium scale and low-cost position as well as fairly high, albeit declining leverage, regulated domestic gas prices and limitations of the general operating environment in Uzbekistan.

Very Strong Support: UNG’s rating is equalised with Uzbekistan’s due to strong ties based on our Government-Related Entities Rating Criteria. We view the status, ownership and control factor as ‘Strong’ as the state is UNG’s sole shareholder but may sell around a quarter of the company. Support record is ‘Very Strong’ because 80% of its consolidated debt was guaranteed by the state at end-2020, though we believe the share of state-guaranteed debt may significantly reduce as debt is gradually refinanced. Other forms of support are the conversion of UNG’s USD1.7 billion of debt to the sovereign wealth fund of Uzbekistan and dividends payable into equity in 2020, lowered taxes, and liberalised oil product prices charged by UNG.

Very Strong Socio-Political Impact: We view the socio-political impact of UNG’s default as ‘Very Strong’ because the company is focused on providing gas and liquid hydrocarbons to domestic utilities, industry and the private sector and does not export gas. Uzbekistan is reliant on gas for power generation, heating and as automobile fuel. UNG is one of the largest companies and employers in the country. We assess financial implications of its default as ‘Strong’ as UNG is a large borrower hence deemed as a proxy issuer for the government, but the size of UNG’s debt is substantially smaller than that of the government.

EBITDA Growth to Lower Leverage: UNG’s ‘b+’ SCP reflects the company’s medium scale, regulated gas prices, very low upstream costs and integration into chemicals and refining, which are offset by currently high leverage and a weak domestic operating environment. We estimate that successful completion of its large projects, such as a gas-to-liquids (GTL) plant and an expansion of its Shurtan gas chemical complex (GCC), will boost its EBITDA by more than a half and lead to a decline in funds from operations (FFO) net leverage to 3.5x at end-2022 from 4.2x at end-2019.

Legacy Guarantees: At end-2020 UNG had UZS11 trillion (USD1.1 billion) financial guarantees mainly issued to its former subsidiary JSC Uztransgaz. We view these liabilities as part of the legacy under the previous group’s structure. UNG transferred its stake in Uztransgaz in 2019 to the state. According to the company, any Uztransgaz’s upcoming liabilities will be covered with the assistance of the state without recourse to UNG. We do not add these guarantees to UNG’s total debt, but if the guarantees were added the additional impact on FFO net leverage would have been around 1.3x in 2020.

Liberalisation Supports Revenue: UNG has benefited from the 2020 abolition of regulated prices for condensate, oil and oil products through higher revenues. The Uzbek government currently plans to liberalise prices for natural gas, UNG’s main product, and liquefied petroleum gas (LPG) in 2022, which may considerably increase UNG’s profitability if the collectability of receivables does not deteriorate.

We do not incorporate higher gas and LPG prices into our rating case because the timing of this reform is still uncertain.

Medium Upstream Scale: Most of UNG’s EBITDA is generated by the upstream division (82% in 2020; all 2020 figures are management accounts). Its consolidated hydrocarbon output was 552 thousand barrels of oil equivalent per day (kboe/d) in 2020, comparable to that of Wintershall Dea AG (BBB/Stable) or PJSC Tatneft (BBB-/Stable). Raw natural gas accounted for 99% of UNG’s production, of which around 33 kboe/d of condensate and LPG was extracted. Its PRMS 1P reserve life was 12 years at end-2020, which is moderate.

Low Upstream EBITDA: UNG’s upstream EBITDA/boe was USD3/boe in 2020, one of the lowest among peers’, because domestic regulated gas prices are kept low to subsidise the national economy.

Nevertheless, the company generated USD1 billion EBITDA in 2020, due to very low lifting costs and sizeable production.

Value-Added Projects: UNG plans to launch its large GTL plant in the short term and complete an expansion of its Shurtan GCC in the coming years. Around 60% of UNG’s consolidated end-2020 debt was raised at the level of the GTL plant. The GTL plant should convert cheap gas into expensive diesel, naphtha and jet fuel, adding around USD0.4 billion to UNG’s annual EBITDA as per our estimates.

Additionally, Shurtan GCC’s expansion may generate USD0.2 billion annually by using naphtha and LPG to produce polyethylene and polypropylene. Foreign-Exchange (FX) Mismatch: Most of UNG’s revenue is gas sales that are based on regulated prices indexed by a rate close to inflation, while UNG’s debt is denominated in US dollars, euro and renminbi. UNG’s petroleum products and petrochemicals prices take recent international prices and exchange rates into account. We view the possible gas price liberalisation and the start of GTL plant as positive for reducing FX debt exposure.

UNG’s rating is equalized with the sovereign’s. The strength of UNG’s ties with the government under Fitch’s GRE Rating Criteria is comparable to Qatar Petroleum’s (AA-/Stable) or Abu Dhabi National Oil Company’s (AA/Stable), and is slightly greater than National Joint Stock Company Naftogaz of Ukraine’s (B/Positive), OQ S.A.O.C.’s (BB-/Negative) and JSC National Company KazMunayGas’s (KMG; BBB-/Stable). UNG’s ‘b+’ SCP is on a par with State Oil Company of the Azerbaijan Republic’s (SOCAR; BB+/Stable; SCP: b+).

We expect UNG’s leverage (3.5x in 2022) will be below SOCAR’s (4.3x in 2022), and UNG has further material deleveraging prospects due to GCC expansion set for 2023. However, SOCAR has larger FFO and a stronger operating environment. KMG’s ‘bb-’ SCP reflects an even larger scale and a stronger operating environment, better diversification into non-upstream segments and a leverage profile that is broadly comparable to UNG’s. UNG’s SCP reflects the limitations of the operating environment in Uzbekistan.