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Standard & Poor’s Ratings Services has affirmed its ‘B’ corporate credit and senior unsecured debt ratings on Russia-based OJSC Oil Company Rosneft, following the decision of its bondholders to change the eurobond covenants. The outlook is negative.

“Rosneft’s bank debt includes tight financial covenants, as well as those just renegotiated with bondholders. Therefore, the company’s ability to avoid technical default continues to depend on the success of covenants renegotiation with its banks,” says Standard & Poor’s credit analyst Elena Anankina. “Moreover, the ratings and outlook on Rosneft already incorporated Standard & Poor’s expectation that Rosneft would be able to avoid technical default on its eurobonds. Beyond the covenant renegotiation, the ratings and outlook continue largely to reflect the company’s aggressive investment and financial policy.”

Rosneft is already significantly leveraged, has large capital requirements to invest in continuing production growth and modernising refineries, and has an ambitious policy to grow through external acquisitions. Because of an acquisition in early 2003, Rosneft’s total debt significantly increased, and the company was close to technical breach of its covenants on eurobonds and on bank debt, hence the current renegotiation.

In addition, Rosneft faces the sovereign risks of the

  • Russian Federation, where essentially all its assets are based. The company is exposed to nontransparent regulation of the oil industry in Russia, transportation bottlenecks, and a domestic fuel price that is significantly lower than the international one. Rosneft’s profitability and cash flows are significantly exposed to crude oil price volatility, and the cost base is no better than the industry average.

 

The ratings on the company continue to be supported by:

 

    • Large reserves (at December 31, 2001, the company had proven reserves of 2.6bn barrels, as audited by De Golyer and MacNaughton), supporting strong production growth, which increased by 8% in 2002.

 

    • Access to foreign currency revenues from exports of crude oil and refined products (43% and 40% of 2001 production, respectively)

 

    • Vertical integration into refining

 

  • Growing control over key operating subsidiaries.

Rosneft’s liquidity is tight, because of the risk of technical violation of the covenants on its bank debt. In addition, a very large portion of Rosneft’s crude exports is pledged against bank facilities. Nevertheless, Rosneft benefits from successful renegotiation of its eurobond covenants, as Standard & Poor’s expected. The company also benefits from improving access to domestic and international finance, reflecting the progress of the Russian economy.

Rosneft has an aggressive financial policy and its ability to avoid technical default will depend on the successful renegotiation of financial covenants on its bank debt. Standard & Poor’s expects the company to successfully renegotiate the covenants with the banks. If such a process were to fail or be subject to litigation, the ratings on Rosneft may be lowered, if necessary by more than one notch. Standard & Poor’s is, however, unaware of any litigation with the creditors that may result in a downgrade of the company. “Even if the company obtains the banks’ approval, as Standard & Poor’s expects, the concern about the company’s financial policy remains,” adds Anankina.

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