Fitch Ratings has affirmed China Petroleum & Chemical Corporation (Sinopec)’s Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDR) at ‘A+’. The Outlook is Stable.
The integrated oil, gas and petrochemical company’s ratings are based on Fitch’s assessment of the credit profile of Sinopec’s 68.77% parent, China Petrochemical Corporation (Sinopec Group), under its Parent and Subsidiary Linkage Rating Criteria, due to strong legal, strategic and operational linkages. Fitch’s assessment of Sinopec Group’s credit profile is based on that of the China sovereign (A+/Stable), reflecting a ‘Very Strong’ likelihood of state support under our Government-Related Entities (GRE) Rating Criteria.
Sinopec Group is wholly owned by the China State-owned Assets Supervision and Administration Commission. It is China’s largest supplier of oil and petrochemical products as well as one of the largest oil and gas producers and plays a key policy role in implementing China’s retail fuel-price mechanism.
Parent’s Strong State Linkage: Fitch assesses Sinopec Group’s status, ownership and control by the Chinese state as ‘Very Strong’. Sinopec Group is wholly owned by the state and has strategic importance as one of China’s three national oil companies. We assess the government’s influence over the company’s operation and key management appointments as ‘Very Strong’. We assess the record and expectations of government support to Sinopec Group as ‘Very Strong’, as the company has received large capital injections and subsidies over the years, which have helped it to maintain a healthy financial position.
‘Very Strong’ Incentive to Provide Support: Fitch assesses the socio-political implications for the government, should Sinopec Group default, as ‘Very Strong’, due to the company’s importance as China’s leading downstream refining and marketing company and its strategic policy role in implementing the country’s retail fuel-price mechanism and refining and petrochemical policies. A default would jeopardise Sinopec Group’s ability to process crude oil into refined products and disrupt production distribution, affecting around 60% of China’s fuel supply.
We also assess the financial implications of a default as ‘Very Strong’, due to the high reputational risk for the government, since Sinopec Group is a proxy government borrower. We believe a default by the company would severely damage access to financing for the sovereign and other major central GREs.
Strong Parent-Subsidiary Linkage: Fitch regards Sinopec’s credit profile as closely linked with that of its parent in light of strong legal ties as well as strategic and operational linkages. There is a cross acceleration clause embedded in substantial offshore bonds, which are guaranteed by Sinopec Group. Sinopec Group has also made substantial loans to Sinopec, which owns the majority of group assets and is closely integrated with other units within the group. Sinopec is also the group’s major publicly listed platform.
Integration Mitigates Business Volatility: Sinopec’s integrated oil and gas operation mitigates the impact of a volatile oil price and product spread. Fitch expects Sinopec to benefit from low oil procurement costs to buffer weakening upstream earnings and vice versa should oil prices rise. Sinopec’s established marketing network, with 30,000 service stations in China, also facilitates the sale of refined oil products and stabilizes cash flow generation.
Low Oil Price Dampens Upstream Earnings: We estimate that Sinopec’s total production will contract by 0.4% in 2020, along with a large fall in EBITDA. EBITDA should recover following an oil-price recovery in 2021, although it is unlikely to return to pre-pandemic levels, according to Fitch’s oil price deck assumptions.
The coronavirus pandemic and lack of supply side discipline muted oil demand in early 2020, leading to lower oil prices. This saw a 35% yoy drop in Sinopec’s realised oil price and a 14% yoy fall in its gas price in 9M20. The company’s upstream segment performed worse than that of peers due to comparatively higher costs, despite an 8% drop in lifting costs.
Lower refining and marketing Margin: Sinopec’s refining and marketing margin fell to USD0.4/barrel (bbl) in 9M20, from USD4.7/bbl, due to lower demand and utilisation as well as inventory losses, before recovering in 3Q20, supported by a pick-up in demand. In the longer term, we expect the refining margin to remain pressured by overcapacity in the domestic refining and chemicals industry. However, cash flow pressure from a lower margin should be moderated by Sinopec’s upstream exposure, more complex refinery result in its product-mix optimisation and established distribution networks.
Midstream Asset Disposal Neutral to Rating: Sinopec Group’s announced the transfer its midstream assets to the newly formed China Oil & Gas Piping Network Corporation (PipeChina) in July 2020. Sinopec will see it dispose of CNY122.7 billion in midstream assets in exchange for a 14% stake in PipeChina and CNY52.6 billion in cash. Fitch does not expect this to affect Sinopec’s cash flow, as the assets make an insignificant EBITDA contribution, while its financial metrics will marginally benefit from the cash settlement, capex savings and net debt deconsolidation.
‘a-‘ Standalone Credit Profile: Sinopec’s Standalone Credit Profile (SCP) is underpinned by its integrated operation, prominent leadership in China’s refining and marketing segment and strong financial metrics among Fitch-rated refining peers. Fitch expects capex to rise from 2021, following a 12% drop in 2020, to support ongoing downstream expansion and accelerate upstream activities under the country’s national security mandate. This will offset savings from the mid-stream asset disposal, but should still leave Sinopec in a net cash position after cash collection and debt deconsolidation.
Higher Leverage at Sinopec Group: We assess Sinopec Group’s SCP at ‘bbb+’, which is weaker than that of Sinopec, due to higher leverage. Sinopec Group has substantial debt that it on-lends to subsidiaries other than Sinopec that have lower profitability, including the petroleum and petrochemical engineering business and some overseas oil and gas investments and operations. Fitch expects Sinopec Group’s consolidated FFO net leverage to hover at around 2.5x between 2021 and 2024, down from 3.4x in 2020.
Fitch rates Sinopec on a top-down basis based on strong links with Sinopec Group, as assessed under our Parent and Subsidiary Linkage Rating Criteria. Strong legal ties are reflected in the cross acceleration clause embedded in the substantial offshore bonds, which are guaranteed by Sinopec Group. Sinopec has also received substantial borrowing from Sinopec Group through inter-company loans and is closely integrated with other units within the group. It owns the majority of the group’s assets and is strategically important in executing the parent’s core responsibilities.
The linkage between Sinopec and Sinopec Group is similar to that between CNOOC Limited (A+/Stable) and its parent, China National Offshore Oil Corporation. Both subsidiaries hold the group’s core assets and represent a majority of the group’s revenue and cash generation.
Fitch’s Key Assumptions Within Our Rating Case for the Issuer
– Fitch oil price base-case assumptions for Brent: USD41/bbl for 2020, USD45/bbl for 2021, USD50/bbl for 2022 and USD53/bbl thereafter
– Oil production to decline by 0.9% in 2020 and gas production to rise by 0.5%. We assume oil production will increase by 0.5% -1.5% between 2021-2023, while gas production will rise by 5%-7%
– We incorporated weak refining and chemical volume in 9M20 and expected full-year volume to decline. Volumes should rise slightly over 2021-2023 on new projects and better utilisation. We believe refining and marketing EBIT will edge down due to pressure from ongoing market competition.
– We adopted the company’s guidance on 2020 capex, which will fall by around 12% yoy. However, we expect capex to stay high due to investment in exploration and production, ongoing downstream project construction and new business development, offsetting the lower pipeline investment.
Factors that could, individually or collectively, lead to positive rating action/upgrade:
– Positive rating action on the sovereign, provided Fitch’s assessment of Sinopec Group under the GRE criteria and linkage with Sinopec Group remain intact
Factors that could, individually or collectively, lead to negative rating action/downgrade:
– A weaker likelihood of state support for Sinopec Group
– Significant weakening of linkage with Sinopec Group
For the sovereign rating of China, the following sensitivities were outlined by Fitch in its rating action commentary on 27 July 2020:
Factors that could, individually or collectively, lead to positive rating action/upgrade are:
– Structural: A material reduction in financial sector risks, for example, through credit growth decelerating to levels below nominal GDP growth over a multi-year period, which would cause the removal of the -1 QO notch on Structural Features.
– External finances: Widespread adoption of the Chinese yuan as a reserve currency, as reflected in a substantial increase in the share of yuan-denominated claims in the IMF’s currency composition of official foreign exchange reserves (COFER) database.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
– Structural: A sharp rise in financial vulnerabilities, for example through failure to taper credit growth to a level close to nominal GDP growth over the next few years.
– Public finances: Failure to reduce the budget deficit after the initial shock from the pandemic that leads to a sustained upward trend in government debt/GDP, or evidence of a substantial rise in contingent liabilities associated with off-budget quasi-fiscal spending.
– External finances: Sustained capital outflows sufficient to erode China’s external balance-sheet strengths relative to ‘A’ category peers, which would cause the removal of the +1 QO notch on External Finances.
International scale credit ratings of Non-Financial Corporate issuers have a best-case rating upgrade scenario (defined as the 99th percentile of rating transitions, measured in a positive direction) of three notches over a three-year rating horizon; and a worst-case rating downgrade scenario (defined as the 99th percentile of rating transitions, measured in a negative direction) of four notches over three years. The complete span of best- and worst-case scenario credit ratings for all rating categories ranges from ‘AAA’ to ‘D’. Best- and worst-case scenario credit ratings are based on historical performance.
Strong Liquidity: Sinopec’s short-term loans of CNY84 billion (1H20: CNY121 billion), equal to 58% of its outstanding debt, could be fully covered by cash on hand of CNY129 billion (1H20: CNY188 billion) as at end-2019. We expect higher capex of CNY129 billion in 2020, as indicated by management, to be mostly covered by strong operating cash flow and bank loans.
Strong Funding Access: Sinopec’s close state linkage and strong financial position provides solid access to onshore and offshore funding. It reported total standby credit facilities from several Chinese financial institutions of CNY380 billion at end-2019 (1H20: CNY288 billion) on an unsecured basis. These facilities had a weighted-average interest rate of 3.57% (1H20: 3.14%). The utilised amount of these facilities was only CNY3 million at end 2019 (1H20: CNY6.5 million).
REFERENCES FOR SUBSTANTIALLY MATERIAL SOURCE CITED AS KEY DRIVER OF RATING
The principal sources of information used in the analysis are described in the Applicable Criteria.
PUBLIC RATINGS WITH CREDIT LINKAGE TO OTHER RATINGS
Sinopec’s ratings are directly linked to the credit quality of Sinopec Group. A change in Fitch’s assessment of the credit quality of Sinopec Group would automatically result in a change in the ratings on Sinopec.
Unless otherwise disclosed in this section, the highest level of ESG credit relevance is a score of ‘3’. This means ESG issues are credit-neutral or have only a minimal credit impact on the entity, either due to their nature or the way in which they are being managed by the entity.