Fitch Affirms OIL at BBB- Outlook Negative

Fitch Ratings - Singapore/Mumbai: Fitch Ratings has affirmed Oil India Limited's (OIL) Long-Term Foreign-Currency Issuer Default Rating (IDR), senior unsecured rating, and the rating on its outstanding senior unsecured bond at 'BBB-'. Fitch has also affirmed the Long-Term Foreign-Currency IDR of OIL's subsidiary, Oil India International Pte. Ltd. (OIIPL), and the rating on its US-dollar senior unsecured notes at 'BBB-'. The Outlook is Negative, reflecting that on the Indian sovereign (BBB-/Negative).

We have maintained OIL's Standalone Credit Profile (SCP) at 'bb+', which reflects competitive lifting costs and low finding and development costs, balanced by its geographically concentrated operation and smaller scale than similarly rated peers. The improved diversification from OIL's increased stake of 70% in Numaligarh Refinery Limited (NRL), which has strong downstream operations, is offset by our expectation of a weakening of OIL's financial profile due to CAPEX for the refinery's expansion and associated execution risks.

OIL's IDR benefits from a one-notch uplift from the SCP due to its 'Strong' state linkages and the government's incentive to provide support under our Government-Related Entities (GRE) Rating Criteria.

KEY RATING DRIVERS

Capex to Drive Up Leverage: We expect higher leverage, measured by net debt/EBITDA, as OIL's capex intensity substantially increases through to the financial year ending March 2025 (FY25). NRL estimates capex of about INR280 billion to triple its refinery capacity to 9 million metric tonnes (MMT) a year. This will further add to OIL's already high capex for exploration and development of oil blocks that it won in auctions and need to be completed within mandated timelines.

We forecast leverage will reach around 3.0x in FY24 (FY22e: less than 2x; FY21: 2.6x) and breach our negative rating sensitivity of 3.0x in FY25. Nevertheless, the increase should be temporary, with leverage falling below 3.0x in FY26 and continuing to decline, supported by cash flow from the expanded refining capacity. OIL expects excise duty benefits to be extended to NRL's expanded capacity, further boosting its strong operating cash flows, which are key to our deleveraging expectations.

Medium-Term Integration Benefits: We believe OIL's business profile will benefit in the medium-term from the downstream integration of NRL, once project execution risk has eased. The elevated execution risk for the refinery expansion limits near-term benefits from downstream integration. We assess the execution risks as higher than for other brownfield refinery expansions due to the remote location of the refinery and larger supporting infrastructure investment.

'Strong' State Linkages: We assess OIL's status, ownership and control by the sovereign as 'Strong'. The state directly owns 56.66% of the company and appoints its chairman, managing director, board representatives and independent directors. This enables the government to exert control over OIL and implement its socio-economic objectives related to the oil and gas industry. OIL has not received tangible financial support from the government due to its adequate financial profile, although it has received indirect support in sourcing acquisitions.

'Strong' Incentive for State Support: We assess the financial implications of a default as 'Strong', as we regard OIL as a key GRE and believe its default would significantly affect the availability and cost of domestic and foreign financing options for the state and other GREs. However, we assess the socio-political implications as 'Moderate' in light of OIL's small size; it contributes less than 10% to India's crude oil production.

Russian Sanctions; Evolving Crisis: We believe recent global geopolitical developments, particularly Russia's invasion of Ukraine and the subsequent sanctions applied to Russia, may disrupt the receipt of dividends from OIL's Russian investments in the short term. We do not expect this to significantly impact OIL's SCP, but will continue to monitor the crisis as it evolves.

Robust Operating Profile Supports SCP: OIL's SCP reflects the low-cost position of its upstream operation and efficient downstream presence via NRL, and is balanced by its smaller scale relative to similarly rated peers.

OIL's upstream operating profile benefits from lifting costs of around USD13-14/barrel (bbl) and finding and development cost of around USD6.0-6.5/bbl, about 40%-50% lower than that of global peers. NRL also maintains stable operations, with a 90% utilisation rate in FY21 despite the Covid-19 pandemic, and a gross refining margin of around USD37/bbl, including excise duty benefits.

OIIPL's Rating Equalised With OIL: We equalise OIIPL's rating with that of its parent, OIL, due to our assessment of OIL's 'High' legal incentive and 'Medium' strategic and operational incentives to provide support to its subsidiary under our Parent and Subsidiary Linkage Rating Criteria. OIL guarantees all of OIIPL's debt, oversees its operation and appoints its management.

DERIVATION SUMMARY

OIL's closest GRE peer in India is Oil and Natural Gas Corporation Limited (ONGC, BBB-/Negative). We assess ONGC's status, ownership and control factor and the state's support record and expectations as 'Strong'. However, we believe the socio-political implications of a default are 'Strong' for ONGC, compared with 'Moderate' for OIL, given ONGC's larger contribution to the country's oil and gas requirements and its greater geographical presence. We assess the financial implications of a default as 'Strong' for both companies.

We assess Thailand-based PTT Public Company Limited's (BBB+/Stable) status, ownership and control factor as 'Moderate', compared with 'Strong' for OIL. We believe the degree of government involvement in PTT's operation, investments and financing is less than that for other major state-owned oil and gas companies in Asia, including OIL. We assess the support record and expectations factor as 'Strong' for both PTT and OIL, as we expect their respective governments to provide support, if needed. However, we measure PTT's socio-political impact of a default as 'Strong', against 'Moderate' for OIL, reflecting PTT's higher importance to Thailand's natural gas supply as compared with OIL's limited contribution to India's domestic oil demand. We assess the financial implications of a default for both entities as 'Strong', as they are key bond issuers and borrowers and a default would make funding difficult for most other local GREs.

OIL's SCP is comparable with the rating of Murphy Oil Corporation (BB+/Stable), which has a slightly larger scale, with production of 182,000 bbl of oil per day and proved reserve size of 715 million bbl. We believe Murphy's geographically diversified asset base with a comparable financial profile is counterbalanced by OIL's stronger downstream integration.

KEY ASSUMPTIONS

OIL Standalone:

Oil sales volume to increase by 2.0% in FY22, 3.0% in FY23, FY24 and FY25, and then by 0.5% thereafter (FY21 sales: 2.9MMT; production: 3.0MMT).

Gas volume to increase by 15% in FY22 and FY23, 10% in FY24 and FY25, and 3%-5% thereafter (FY21: 2.3 billion cubic metres).

Oil price assumptions in line with Fitch's price deck, with Brent at USD70/bbl in 2022, USD60/bbl in 2023 and USD53/bbl thereafter. Gas prices incorporating Fitch's price deck adjusted for India's price mechanism.

Capex of INR42 billion-41 billion between FY22-FY26.

Dividend payout ratio of around 45%, in line with management guidance.

Dividends from overseas investments of about USD60 million-70 million per year.

Numaligarh Refinery Limited:

New capacity to increase throughput by 0.5MMT in FY25, 4.3MMT in FY26 and 5.7MMT in FY27. We factor in lower capacity utilisation for the new capacity in FY25 and FY26.

Gross refining margin of USD8-9/bbl, excluding excise duty benefits.

Dividend payout at 30%, in line with management guidance.

Expansionary capex for the refinery of INR67 billion in FY23, INR105 billion in FY24 and INR62 billion in FY25.

RATING SENSITIVITIES

Developments that May, Individually or Collectively, Lead to Positive Rating Action

- The Outlook is Negative and we therefore do not expect positive rating action. The Outlook will be revised to Stable if we revise our Outlook on the sovereign to Stable.

- An upward revision of the SCP may result if net leverage, measured by net adjusted debt/operating EBITDAR, decreases sustainably below 2x or if there is a significant improvement in OIL's business profile, including a larger production and reserve profile with greater geographical diversification.

Developments that May, Individually or Collectively, Lead to Negative Rating Action

- A downgrade of the sovereign rating.

- We may lower the SCP if net leverage exceeds 3x; if the SCP falls to 'bb' or below, OIL's IDR would be rated top down minus 1 from the sovereign rating, as long as the SCP is up to three notches away from the government, in line with our GRE criteria.

BEST/WORST CASE RATING SCENARIO

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. For more information about the methodology used to determine sector-specific best- and worst-case scenario credit ratings, check on fitch ratings website

LIQUIDITY AND DEBT STRUCTURE

Adequate Liquidity: OIL's liquidity position remains adequate, as we think the company has good access to international bond markets and strong relationships with domestic banks. We believe the majority of OIL's funding needs will be fulfilled by drawing down its INR189 billion loan, which was signed by NRL in 2021. OIL's debt maturity profile is back-ended, with about 70% of its debt maturing in or after FY27 as at end-2021.

OIL had about INR11.4 billion of debt maturing over the next 12 months as of September 2021, versus cash of about INR1.9 billion. However, the debt was repaid in March 2022.