Weekly Credit Risk Monitor /

Weekly Credit Risk Monitor

  • We round up the week's key developments in the world of sovereign and corporate credit

  • In focus: What lower oil prices mean for Kurdistan oil & gas

  • Also in the news: Angola and Bolivia downgrade, Lebanon default, Nostrum Oil & Gas

Stuart Culverhouse
Stuart Culverhouse

Chief Economist & Head of Fixed Income Research

Tellimer Research
12 March 2020
Published byTellimer Research

In Focus: What lower oil prices mean for Kurdistan oil & gas

An unfortunate combination of the oil price war and the COVID-19 pandemic has sent Brent below US$35/bbl, causing a sell-off in the high yield debt of exploration and production (E&P) companies. Prices of Iraq sovereign bonds (Sell) and Kurdistan E&P sector are down 10-15ppts since 6 March 2020 when the OPEC+ failed to reach a deal on further production cuts. There are more questions than answers now, but what seems to be quite clear is that the market will have to endure more pain before a recovery trend emerges. In such an environment of high uncertainty, resilience in the face of a prolonged period of low prices will separate the losers from the winners. But first, all bond prices will have to fall. We reiterate Hold on DNONO 20s, 23s and 24s, GULFKY 23s and HKNENG 24s – all of which saw prices fall substantially over the past few days. Of the two bonds that have so far avoided correction, we downgrade GENLLN 22s to Hold as substantial cash reserves and low operating costs make it the strongest credit among peers, and SNMCN 23s to Sell due to its tight liquidity and high costs. 

Low oil prices increase Iraq risks. Iraq’s dependence on oil prices is very high. According to the IMF, north of 90% of the country’s budget revenues were directly attributable to oil. A sharp decline in oil prices from cUS$60/bbl in Jan-Feb 2020 to US$36/bbl today could reduce federal budget revenues by more than 30%. Already, the country is faced with several crises: Popular protests which started in October 2019 continue; the government is in limbo after the resignation of Prime Minister Adel Abdul and PM-designate Mohammed Allawi’s failed attempt to win support from the parliament. If oil prices stay low for longer, Iraq will have to cut on expenditures. This could keep political tensions in the country elevated and affect the recipients of government funding, including Kurdistan. 

Like Iraq, Kurdistan budget revenues also depend on oil prices and transfers from the federal budget with respect to certain expenditures, like the Peshmerga salaries. According to Reuters, the KRG agreed to deliver 250,000boepd, or 50-60% of the region’s daily production, to the state oil marketing company SOMO, something the Federal government has long insisted on. This is likely to be in exchange for commitments to make certain budget transfers to the region, which according to media reports, could be around 12.7% in 2020. However, the Iraqi 2020 budget has not been approved yet and (according to Reuters) Kurdistan will only start delivering oil to SOMO after the new government is formed, and Baghdad starts meeting its obligations. If oil prices don’t recover, both Iraq and Kurdistan will have to moderate their spending. Potential consequences for the oil companies operating in Kurdistan are delayed payments for oil, which will likely trigger a capex revision. The latter is not desirable for the region as investments from the private sector is what keeps oil revenues coming. 

Picking your exposure to Kurdistan E&P sector. No company is immune to a sharp decline in oil prices, but some are in a better position than others. The companies with high production, low operating costs, low discount to Brent and high liquidity would be in a better position. Genel (GENLLN) stands out on all criteria and has the strongest standalone credit profile. DNO (DNONO) ticks most of the boxes, but exposure to the North Sea region compromises its low-cost position. Gulf Keystone (GULFKY) has the highest discount to Brent in the sector, which could overshadow an otherwise very low cost and high cash balance. HKN Energy’s (HKNENG) weakness comes from low production and significant capex requirements. ShaMaran Petroleum (SNMCN) ranks weakest on all key metrics.

Read the full report here

Recap of the week’s key credit developments

Angola (ANGOL): On Friday, Angola’s long term foreign currency rating was downgraded by Fitch to B- from B, and the outlook was changed to stable from negative. The move brings Fitch’s rating into line with the comparable B3 and B- from Moody’s and S&P, respectively; S&P has a negative outlook on its rating. Fitch cited various reasons for the downgrade: lower oil production and prices, the larger-than-expected depreciation of the kwanza, rising public debt and external debt service costs, and declining foreign reserves. Oil prices fell to close at US$34.36 on Monday (generic 1st future contract), from a close of US$45.27 on Friday, after a failed agreement to lower production by OPEC+ on Friday. The agency noted that oil production stabilisation could contribute to economic growth recovery. General government debt rose to over 100% of GDP at end-2019 from 81% the year before, on Fitch figures, and 2020 interest payments will be almost 36% of general government revenue. The state-owned oil company, Sonangol, and other SOEs add another 8% of GDP to public debt. Meanwhile, gross international reserves have been on a declining trend since H2 13, to end January 2020 at US$16.85bn, and the kwanza dropped 36% in value versus the USD in 2019. Fitch now expects the kwanza depreciation to slow during 2020. See our recent report here.

Lebanon (LEBAN): On Monday, Lebanon defaulted on its US$1.2bn bond, as expected. S&P and Fitch both downgraded the sovereign’s long term foreign currency rating this week. As of Monday, Fitch rates the sovereign C, down from CC previously. On Wednesday, S&P lowered its rating to SD from CC. Like S&P, Moody’s downgraded Lebanon on 21 February, now rating it Ca (stable outlook). Following a cabinet meeting on Saturday, Prime Minister Hassan Diab said that Lebanon would prioritise funding basic imports over foreign debt payments, as foreign reserves continue a decline started in October 2017. Diab announced that the US$1.2bn bond due on Monday would not be repaid, and that the government would instead seek to restructure its debt. It is not clear if this will include domestic debt or just foreign debt. Diab reported that public debt was US$90bn (170% of GDP); eurobonds are about a third of this. Fitch will review Lebanon’s ratings after the 7-day grace period, or if a payment is made before that. If the payment is not made during the grace period, Fitch will downgrade the country rating to RD and the specific bond rating to D. Our view: A big haircut seems likely (we assume a 50% principal haircut). That the government said it wanted to restructure its debt through negotiations with bondholders may be seen as positive. A cooperative solution may lead to a better outcome all round. However, the nature of the bonded debt, given the extent of local holdings, high foreign ownership of front end bonds, and presence of collective action clauses (without aggregation) mean restructuring may not be straightforward. See our recent report here.

Bolivia (BOLIVI): On Tuesday, Moody’s lowered its long term foreign currency rating on Bolivia by one notch to B1. The move brings the rating in line with the comparable B+ rating assigned by Fitch, and one below the BB- assigned by S&P. All three major rating agencies now have a negative outlook on their respective ratings. Moody’s had placed the rating on negative watch on 5 December 2019. Moody’s cited heightened political risk and policy uncertainty, negatively impacting growth, and challenges to the hydrocarbon sector, all while fiscal and foreign reserve buffers have weakened over recent years. There has been a large drop in the fiscal savings buffer since 2013, from 27% of GDP to 13.2% in 2018. Over that period, the government debt burden rose to 55% of GDP (nonfinancial public sector). Higher imports for infrastructure projects and lower oil exports and prices contribute to the expanding current account deficit. On IMF figures, the current account deficit in 2019 was c5% of GDP and the fiscal deficit was 7.8% of GDP, both following similar figures since 2015, and contributing to declining foreign reserves. Gross foreign reserves ended January at US$6.4bn, almost a 58% decline from the end-2014 level. Moody’s negative outlook reflects the continued risks likely to be faced by the government following the presidential election on 3 May, which could impede fiscal policy adjustments and structural reforms.

Nostrum Oil & Gas (NOGLN): The company has announced that gas deliveries from UOG will be delayed, but are still expected to start before April 2023. In January, Nostrum released bearish 2020 production guidance of 20,000 boepd and focused on cash preservation and securing third-party gas supplies for its recently commissioned gas treatment unit, GTU-3. The only such contract is with UOG, which has yet to start gas deliveries. With little progress reported on the gas processing contracts, investors were left guessing about potential partners. Kashagan, the biggest offshore oil and gas company filed in Kazakhstan, was seen as one of such opportunity. However, according to recent news, the Kazakh government has decided to build its own 1bcm gas processing plant, rather than use Nostrum’s spare capacity. In Q3 19, Nostrum had US$91mn cash. Even in a US$60 per barrel oil price environment, we expected that, without higher production and/or substantial third-party gas processing volumes, the company would gradually burn cash. If the oil price stays at US$35-40/bbl, we expect Nostrum to start using cash reserves to pay interest on the bonds. We reiterate our sell recommendation on the NOGLN 22s and 25s. See our recent report here.