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Report | December 2017

Indian Sector Outlook Stable: Fitch Ratings

<span style="font-weight: bold;">Forecast<br /> State-owned Companies' Credit Metrics to Weaken</span><br /> Fitch expects Indian state-owned oil and gas companies to undergo large debt-funded consolidation in 2018. This, combined with large committed downstream capex, is likely to result in modest weakening of the credit metrics for Indian Oil Corporation Ltd (BBB-/Stable), BPCL, HPCL and HPCL-Mittal, although their standalone credit profiles will still have some headroom. <p></p> <p>We expect the credit metrics of Reliance Industries Ltd (RIL, BBB-/Stable) to improve in the near to medium term due to its recently completed capex, which enlarges its petrochemical capacity and enhances its refining efficiency. However, any further large investment for its digital business may limit the upside in its standalone credit profile.</p> <p> <span style="font-weight: bold;">Sector Fundamentals<br /> State-owned Enterprises Consolidation</span><br /> Fitch expects the state to continue to try to create vertically integrated oil and gas companies in 2018. This is likely to drive largely debt-funded acquisitions of the state's majority ownership in the state-owned oil and gas entities. The proceeds will help to bridge the state's budget deficit.</p> <p> <span style="font-weight: bold;">Upstream Investment to Increase</span><br /> The Indian government's new hydrocarbon exploration policy, including an introduction of gas price ceilings for difficult oilfields, will help to address the previous hurdles to upstream investment and should drive investment over the medium term, on top of the planned USD6 billion investment by RIL and partners.</p> <p> <span style="font-weight: bold;">Robust Downstream Demand and Profitability</span><br /> We expect India's overall demand growth for petroleum products to remain at around 5% over the medium term, driven by strong GDP growth of around 7.4%-7.5% over the next two fiscal years and continued growth in auto sales. We expect downstream entities' refining margins to remain solid overall, despite some compression from the FY17 levels due to slightly higher crude prices and tapering product spreads. We expect higher gross refining margins for RIL and BPCL as a result of their recently completed capex programmes.</p> <p> <span style="font-weight: bold;">South-East Asia sector outlook stable<br /> Forecast<br /> Credit Metrics to Remain Stable</span><br /> Fitch expects the credit metrics of PETRONAS and PTT to remain stable. Pertamina's leverage is likely to deteriorate moderately, but remain commensurate with its standalone credit profile at 'BBB'. We expect capex to remain high for all three companies over the next three years, although PETRONAS' capex may marginally decline from historical levels. We expect neutral FCF for PETRONAS compared with negative FCF for Pertamina and positive FCF before acquisitions for PTT.</p> <p> <span style="font-weight: bold;">Sector Fundamentals<br /> Large Capex to Continue</span><br /> We anticipate PTT's upstream capex to increase. It has plans to invest in midstream operations and LNG import terminals, and will seek to shore up reserves, which had weak five-year average reserve replacement ratio of around 0.6x, while it had limited exploration success and reduced capex in 2016-2017. We expect PTT's upstream production to fall in the next two to three years in the absence of any acquisitions.</p> <p>We expect Pertamina's production to increase by 10%-15% over the next three years mainly driven by takeover of some producing fields whose production contracts are expiring. Pertamina's plans to increase its upstream production and augment and upgrade its refining capacity, which will drive its investment of USD25 billion-30 billion over the next three years, resulting in a sharp increase in capex/CFO.</p> <p>We expect PETRONAS's capex to remain elevated, although it has decided not to proceed with some upstream capex, such as the Canadian liquefaction project. Its capex burden is also likely to be alleviated through Saudi Arabian Oil Company's (Saudi Aramco) planned purchase of a 50% stake in selected ventures and domestic downstream assets.</p> <p> <span style="font-weight: bold;">Reform Continues; Steady Downstream</span><br /> We expect all three entities' downstream operations to be steady. However, if oil prices were to be sustained above USD55/bbl, Pertamina's downstream margins may weaken further from the ad-hoc implementation of Indonesia's retail price policy, which may result in inadequate cost pass-through and partly offset its upstream margins. We expect PETRONAS and PTT to see low subsidies under the continuing domestic energy-price reforms.</p> <p> <span style="font-weight: bold;">What to Watch?</span><br /> </p> <ul> <li>Large debt-funded upstream capex in India and south-east Asia</li> <li>Gradual recovery in upstream capex in China, but still at restrained levels</li> <li>Consolidation of Indian state-owned oil and gas companies</li> <li>Rising natural gas consumption</li> <li>Downstream market-based reforms to continue</li></ul> <p><span style="font-weight: bold;">Author: Ying Wang, Senior Director, Fitch Ratings</span></p>
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