Fitch: Struggle with Oil Production Drives Lukoil M&A

Lukoil's acquisition of a small Russian oil producer is out of step with recent merger and acquisitions (M&A) activity, and indicates that it may be struggling to sustain domestic oil output, according to Fitch Ratings. The ratings agency said that Lukoil's ability to reverse declining output and stabilize crude production in Russia is a critical rating factor.

Lukoil spent nearly $7.3 billion on M&A between 2009 and 2012, and it acquired large stakes in a number of upstream and downstream assets abroad, but only $452 million of that was spent on Russian upstream acquisitions, Fitch pointed out.

"This week's deal clearly bucks the recent trend. Lukoil will pay $2.05 billion to acquire Samara-Nafta, an oil-producer based in the Volga-Urals region with 2.5 million tons of annual oil production," Fitch said.

Unlike Rosneft and TNK-BP, Lukoil has posted declines in Russian oil production every year since 2010. By 2012, its total oil production from Russian fields had fallen by 7.7 million tons, or 8 percent, from 2009.

"We therefore consider this latest acquisition as a sign that Lukoil is willing to engage in costly acquisitions to halt the fall in oil production," Fitch said.

The company has sufficient rating headroom to finance this all-cash transaction with borrowed funds only, if needed, Fitch highlighted, adding that an aggressive acquisition program or other spending could lead to negative rating action.

"On the other hand, stabilization of crude production in Russia, and the completion of key upstream projects while maintaining solid credit metrics, would be positive for the rating," Fitch said.

At the end of 2012, Lukoil had $2.9 billion in cash and cash equivalents; its gross total debt was $6.6 billion.

"Lukoil's falling production in Russia results mainly from the depletion of the company's brownfields in Western Siberia and lower than-expected production potential of the Yuzhno Khylchuyu field in Timan-Pechora. The company managed to slow the decline in crude production in Russia to one percent in 2012 from five percent in 2011 through enhanced recovery techniques in Western Siberia (mainly horizontal drilling and hydraulic fracturing) and the development of new upstream assets in the Ural and Volga regions," Fitch said.

Lukoil's exploration and production capex in Russia increased from $3.9 billion in 2010 to $7 billion in 2012, and Fitch estimates it may average $8 billion per annum over the next three years.

Fitch also highlighted that Lukoil is considering large-scale investments in unconventional oil production from the Bezhenov Shale, Russia's colossal shale deposit in Western Siberia, which is estimated to contain up to two trillion barrels of oil. Production costs for the shale deposit are estimated at several times that of conventional oil, so oil producers would need new tax breaks from the Russian government to make production economic.

"We estimate that the contribution from Samara-Nafta to Lukoil's total output will be fairly small – equivalent to around  three percent of the 83.8 million tons it produced in Russia in 2012, excluding its share in production of equity affiliates," Fitch said.

LUKOIL's total hydrocarbon output in 2012 reached 2.17 million barrels of oil equivalent per day (MMboepd), second only to Rosneft's 2.43 MMboepd.

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Fitch: Struggle with Oil Production Drives Lukoil M&A

Lukoil's acquisition of a small Russian oil producer is out of step with recent merger and acquisitions (M&A) activity, and indicates that it may be struggling to sustain domestic oil output, according to Fitch Ratings. The ratings agency said that Lukoil's ability to reverse declining output and stabilize crude production in Russia is a critical rating factor.

Lukoil spent nearly $7.3 billion on M&A between 2009 and 2012, and it acquired large stakes in a number of upstream and downstream assets abroad, but only $452 million of that was spent on Russian upstream acquisitions, Fitch pointed out.

"This week's deal clearly bucks the recent trend. Lukoil will pay $2.05 billion to acquire Samara-Nafta, an oil-producer based in the Volga-Urals region with 2.5 million tons of annual oil production," Fitch said.

Unlike Rosneft and TNK-BP, Lukoil has posted declines in Russian oil production every year since 2010. By 2012, its total oil production from Russian fields had fallen by 7.7 million tons, or 8 percent, from 2009.

"We therefore consider this latest acquisition as a sign that Lukoil is willing to engage in costly acquisitions to halt the fall in oil production," Fitch said.

The company has sufficient rating headroom to finance this all-cash transaction with borrowed funds only, if needed, Fitch highlighted, adding that an aggressive acquisition program or other spending could lead to negative rating action.

"On the other hand, stabilization of crude production in Russia, and the completion of key upstream projects while maintaining solid credit metrics, would be positive for the rating," Fitch said.

At the end of 2012, Lukoil had $2.9 billion in cash and cash equivalents; its gross total debt was $6.6 billion.

"Lukoil's falling production in Russia results mainly from the depletion of the company's brownfields in Western Siberia and lower than-expected production potential of the Yuzhno Khylchuyu field in Timan-Pechora. The company managed to slow the decline in crude production in Russia to one percent in 2012 from five percent in 2011 through enhanced recovery techniques in Western Siberia (mainly horizontal drilling and hydraulic fracturing) and the development of new upstream assets in the Ural and Volga regions," Fitch said.

Lukoil's exploration and production capex in Russia increased from $3.9 billion in 2010 to $7 billion in 2012, and Fitch estimates it may average $8 billion per annum over the next three years.

Fitch also highlighted that Lukoil is considering large-scale investments in unconventional oil production from the Bezhenov Shale, Russia's colossal shale deposit in Western Siberia, which is estimated to contain up to two trillion barrels of oil. Production costs for the shale deposit are estimated at several times that of conventional oil, so oil producers would need new tax breaks from the Russian government to make production economic.

"We estimate that the contribution from Samara-Nafta to Lukoil's total output will be fairly small – equivalent to around  three percent of the 83.8 million tons it produced in Russia in 2012, excluding its share in production of equity affiliates," Fitch said.

LUKOIL's total hydrocarbon output in 2012 reached 2.17 million barrels of oil equivalent per day (MMboepd), second only to Rosneft's 2.43 MMboepd.

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Fitch Unlikely to Alter Petrobras Credit Rating

RIO DE JANEIRO - Brazilian state-run energy giant Petrobras is borrowing heavily to develop massive new oil fields, but the investments should result in a cash surge that offsets any concerns about the recent rise in the company's debt levels, said Ana Paula Ares, senior director of corporate finance at Fitch Ratings.

Petrobras's finances have come under increasing scrutiny after a series of billion-dollar losses in the company's refining unit, which has been hurt by subsidized imports of gasoline and diesel fuel. The company sells the expensive imported fuels at a loss in the domestic market because of government reluctance to raise fuel prices for fear of stoking inflation.

The losses have undermined Petrobras's earnings and called into question the company's ability to carry out ambitious plans to spend $237 billion through 2016 developing some of the largest oil discoveries made in the past 20 years. With Petrobras spending more than it makes, net debt jumped more than 30% in 2012 from 2011 while the company's cash on hand--once flush with proceeds from a $70 billion share offer in 2010--fell more than 20% to $13.5 billion.

Still, "the deterioration was pretty much in line with what we were expecting," Ms. Ares said in an interview. "At this point, it doesn't impact the rating." Petrobras is in the midst of a significant exploration and investment program, so the increased leverage isn't necessarily a red flag, she added.

Fitch rates Petrobras triple-B with a stable outlook, two notches into investment grade and the same as Brazil's sovereign credit rating. While Ms. Ares doesn't anticipate any changes to the rating over the next 12 to 18 months, a change in the outlook for Brazil's sovereign rating to negative or an unexpected event could lead Fitch to re-evaluate Petrobras, she said.

Part of the credit-rating agency's confidence in Petrobras is based on its potential to quickly boost crude-oil production and reserves in coming years, Ms. Ares said. Petrobras's long history of exploration success, especially the discovery of multibillion-barrel oil fields buried under a thick layer of salt off Brazil's coast, make the company unique among its state-run and private-sector peers, she said.

Petrobras is "able on a yearly basis to replace in reserves the volume it has produced," Ms. Ares noted. Petrobras said that it ended 2012 with reserves of 12.3 billion barrels of oil-equivalent under Securities and Exchange Commission criteria, enough to keep Petrobras pumping oil for 15 years if it never discovered another drop. But the reserve figures currently include only a fraction of the newfound fields and should grow dramatically in coming years.

Petrobras is counting on the new fields to more than double current output to 4.2 million barrels per day by 2020. Fitch, meanwhile, expects crude oil production to start picking up in 2015, which should lead to a recovery in the company's finances as the new output generates cash, according to Ms. Ares.

The political tussle over domestic fuel prices, however, has Fitch watching closely, Ms. Ares said. Fuel-price increases granted in January and last year aren't enough to reverse Petrobras's losses on imports, but the hikes do suggest that the government is paying attention to Petrobras's losses, she said.

"There is a strong incentive for the government to have Petrobras performing and repaying its debt because of the significant financing resources Petrobras will need in coming years to fund its investments," Ms. Ares said.

Petrobras has faced similar situations where it lost money on imports in the past, only to later reap the rewards of selling local fuels at higher prices when international crude oil and fuel prices fell, she noted. The government's focus on fighting inflation, however, means future price hikes are uncertain.

"How politics play out this year will decide whether those price increases will come or not," Ms. Ares said.

Copyright (c) 2012 Dow Jones & Company, Inc.

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Fitch Unlikely to Alter Petrobras Credit Rating

RIO DE JANEIRO - Brazilian state-run energy giant Petrobras is borrowing heavily to develop massive new oil fields, but the investments should result in a cash surge that offsets any concerns about the recent rise in the company's debt levels, said Ana Paula Ares, senior director of corporate finance at Fitch Ratings.

Petrobras's finances have come under increasing scrutiny after a series of billion-dollar losses in the company's refining unit, which has been hurt by subsidized imports of gasoline and diesel fuel. The company sells the expensive imported fuels at a loss in the domestic market because of government reluctance to raise fuel prices for fear of stoking inflation.

The losses have undermined Petrobras's earnings and called into question the company's ability to carry out ambitious plans to spend $237 billion through 2016 developing some of the largest oil discoveries made in the past 20 years. With Petrobras spending more than it makes, net debt jumped more than 30% in 2012 from 2011 while the company's cash on hand--once flush with proceeds from a $70 billion share offer in 2010--fell more than 20% to $13.5 billion.

Still, "the deterioration was pretty much in line with what we were expecting," Ms. Ares said in an interview. "At this point, it doesn't impact the rating." Petrobras is in the midst of a significant exploration and investment program, so the increased leverage isn't necessarily a red flag, she added.

Fitch rates Petrobras triple-B with a stable outlook, two notches into investment grade and the same as Brazil's sovereign credit rating. While Ms. Ares doesn't anticipate any changes to the rating over the next 12 to 18 months, a change in the outlook for Brazil's sovereign rating to negative or an unexpected event could lead Fitch to re-evaluate Petrobras, she said.

Part of the credit-rating agency's confidence in Petrobras is based on its potential to quickly boost crude-oil production and reserves in coming years, Ms. Ares said. Petrobras's long history of exploration success, especially the discovery of multibillion-barrel oil fields buried under a thick layer of salt off Brazil's coast, make the company unique among its state-run and private-sector peers, she said.

Petrobras is "able on a yearly basis to replace in reserves the volume it has produced," Ms. Ares noted. Petrobras said that it ended 2012 with reserves of 12.3 billion barrels of oil-equivalent under Securities and Exchange Commission criteria, enough to keep Petrobras pumping oil for 15 years if it never discovered another drop. But the reserve figures currently include only a fraction of the newfound fields and should grow dramatically in coming years.

Petrobras is counting on the new fields to more than double current output to 4.2 million barrels per day by 2020. Fitch, meanwhile, expects crude oil production to start picking up in 2015, which should lead to a recovery in the company's finances as the new output generates cash, according to Ms. Ares.

The political tussle over domestic fuel prices, however, has Fitch watching closely, Ms. Ares said. Fuel-price increases granted in January and last year aren't enough to reverse Petrobras's losses on imports, but the hikes do suggest that the government is paying attention to Petrobras's losses, she said.

"There is a strong incentive for the government to have Petrobras performing and repaying its debt because of the significant financing resources Petrobras will need in coming years to fund its investments," Ms. Ares said.

Petrobras has faced similar situations where it lost money on imports in the past, only to later reap the rewards of selling local fuels at higher prices when international crude oil and fuel prices fell, she noted. The government's focus on fighting inflation, however, means future price hikes are uncertain.

"How politics play out this year will decide whether those price increases will come or not," Ms. Ares said.

Copyright (c) 2012 Dow Jones & Company, Inc.

Generated by readers, the comments included herein do not reflect the views and opinions of Rigzone. All comments are subject to editorial review. Off-topic, inappropriate or insulting comments will be removed.

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