Tashkent, Uzbekistan (UzDaily.com) -- Fitch Ratings has assigned a ‘BB-(EXP)’ expected senior unsecured rating to US dollar-denominated notes to be issued by JSC Uzbekneftegaz (UNG; BB-/Stable). The Recovery Rating is ‘RR4’.

The prospective notes will be issued directly by UNG, which generates most of the consolidated group’s EBITDA. Proceeds will be used for debt repayment and general purposes. The final bond rating is contingent upon the receipt of final documentation materially conforming to information already received.

UNG’s 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. The agency views its Standalone Credit Profile (SCP) at ‘b+’, reflecting 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.

Notes’ Rating in Line with IDR: We rate the proposed senior unsecured notes using a generic approach for ‘BB’ category issuers, which reflects the relative instrument ranking in the capital structure, in accordance with our Corporates Recovery Ratings and Instrument Ratings Criteria. While UNG has a sizeable amount of prior ranking debt (mostly debt at two OpCos and secured debt at UNG level), the company is moderately leveraged and plans to focus on raising unsecured debt in the future. The Recovery Rating is ‘RR4’. This results in the expected senior unsecured rating being in line with the IDR.

Very Strong Support: UNG’s rating is equalised with Uzbekistan’s due to strong ties based on our Government-Related Entities (GRE) 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. We view the support record as ‘Very Strong’ because around 80% of its consolidated debt was guaranteed by the state at end-2020. We expect that the placement of new senior unsecured bonds will result in a moderate reduction of the share of state-guaranteed debt. 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 a proxy issuer for the government, but 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, offset by currently high leverage and a weak domestic operating environment. We estimate that successful completion of its large projects, such as a GTL plant and an expansion of its Shurtan gas chemical complex (GCC), will boost its EBITDA by more than half and reduce funds from operations (FFO) net leverage to 3.5x at end-2022 from 4.4x at end-2020.

Legacy Guarantees: UNG had UZS11 trillion (USD1.1 billion) of guarantees at end-2020, mainly issued to its former subsidiary JSC Uztransgaz for its gas purchases. We view these liabilities as part of the legacy from the previous group’s structure. UNG transferred its stake in Uztransgaz to the state in 2019. According to the company, any upcoming liabilities from Uztransgaz 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 then 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 plans to liberalise prices for natural gas, UNG’s main product, and liquefied petroleum gas (LPG) in 2022, which may boost 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 reform timing is uncertain.

Medium Upstream Scale: Most of UNG’s EBITDA is generated by the upstream division (82% in 2020). 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 33kboe/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 EBITDA of USD1 billion 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 (Fitch estimates). Additionally, Shurtan GCC’s expansion may generate USD0.2 billion annually by using naphtha and LPG to produce polyethylene and polypropylene.

Foreign Exchange Mismatch: Most of UNG’s revenue comes from gas sales that are based on regulated prices indexed by a rate close to inflation, while UNG’s debt is denominated in US dollars, the euro and the Chinese 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.