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Fitch Rates Energy Development Oman SAOC

Fitch Ratings – Warsaw – 22 Aug 2022: Fitch Ratings has assigned Energy Development Oman SAOC (EDO) a Long-Term Issuer Default Rating (IDR) of ‘BB’ with a Stable Outlook.

EDO’s IDR is constrained by the rating of its sole shareholder, the government of Oman (BB/Stable), given their close links. We assess EDO’s Standalone Credit Profile (SCP) at ‘bbb’, supported by large-scale oil and gas operations and low leverage. The SCP is constrained by a fairly complex operating structure and short 1P reserves life, albeit with a strong record of successful reserves replacement.

KEY RATING DRIVERS

Sovereign Constrains Rating: EDO’s rating is constrained by that of Oman, in accordance with Fitch’s Government-Related Entities (GRE) Rating Criteria and Parent and Subsidiary Linkage Rating Criteria. This reflects the influence the state exerts on the company through strategic direction, taxation and dividends. EDO’s SCP is contingent on the company’s ability to maintain funds from operations (FFO) net leverage at below 3x through the cycle.

GRE Considerations: Under our GRE Rating Criteria we assess support track record and socio-political implications of default as ‘ Strong’ while status, ownership and control as well as financial implications of default as ‘Very Strong’. This assessment results in a support score of 45 out of a maximum of 60. The strong linkages between EDO and Oman underline the former’s importance to its owner.

Ownership and Support Factors: The ‘Very Strong’ status, ownership and control reflects EDO’s full ownership by the state with no near-term privatisation plans. The board of directors comprises representatives of the Ministry of Energy and Ministry of Finance as well as an independent member. Given EDO’s robust financial and operational profile the company has not required government support thus far but we expect support to be forthcoming given the pivotal role EDO plays within Oman’s infrastructure and economy. This leads to ‘Strong’ support track record.

Strategic Importance of Sector: The oil and gas sector represents a significant part of the Omani economy, with EBO’s Block 6 concessions accounting for a very large portion of the nation’s total oil and gas reserves. Furthermore, EDO in one of the largest corporate employers in Oman. We therefore view socio-political implications of default as ‘Strong’.

Financial Implications Factor: While EDO has limited capital market presence thus far, a default at the company would significantly impair the financial standing of the sovereign and the ability of either the government or other GREs within the country to raise financing in the future, which underlines our ‘Very Strong’ assessment of financial implications of default.

Strong Financial Profile: EDO plans to maintain FFO net leverage below 2.2x on a through-the-cycle basis. The metric has been set by the Board. EDO plans to optimise its capital structure by raising additional debt, but based on our forecasts FFO net leverage will remain below 2.2x at least until 2026.

Supportive Scale of Operations: EDO owns a 60% interest in the Block 6 oil concession and a 100% interest in the Block 6 gas concession. Petroleum Development Oman (PDO) operates the onshore Block 6 oil and gas concessions, which have more than 50 years of production history. We therefore expect an output of around 865 thousand barrels of oil equivalent per day (kboe/d) until 2026. Contracts for sales of oil at market prices are signed by the government, but EDO receives payments directly from customers. Non-associated gas (NAG) is sold to the government, which pays EDO a fixed transfer price, subject to annual indexation.

Mature Oil Reserves Base: Most of PDO’s oil fields have been producing for many decades at annual depletion rates of 5%-15% relative to estimated ultimate recovery. PDO plans to increase usage of enhanced oil recovery technology in its production. A fairly short reserves life is mitigated by PDO’s successful reserves replenishment record.

New System Increases Tax Pay-outs: EDO is subject to a new taxation system since 1H21. These new fiscal terms include royalties paid to the government on a weekly basis, based on EDO’s monthly revenue from the sale of oil and condensate and taxes paid on income derived from its oil and gas operations. The new system also affects the accounting for NAG revenue, depreciation charge and abandonment estimates, due to changes in reserves, finance income and transportation costs. While the taxation changes are overall negative for EDO as they significantly increase pay-outs to the government, we view the taxation system as generally in line with global standards, where oil and gas companies are subject to generous taxation payments.

Favourable Unit Economics: In 2021, EDO’s total production costs before royalties amounted to around USD3/boe of direct production costs and around USD10/boe of capex, which puts EDO at the lower end of the global cost curve. However, adding Fitch-estimated generous royalties of around USD10/boe sharply increases total production costs. The increase in cost is somewhat mitigated by EDO’s still strong financial profile, by EDO’s and the government’s interests being largely aligned and by the progressive nature of taxation with respect to oil prices.

Improving ESG Footprint: EDO continues to reduce greenhouse gas emissions from operations and flaring as well as improving energy efficiency. PDO also plans to expand its green generation portfolio to 30% of energy capacity by 2025, with the commissioning of Amin and Miraah solar projects in recent years. We view EDO’s and PDO’s environmental targets as broadly in line with Middle Eastern peers’, but lagging that of their large European peers such as TotalEnergies SE (AA-/Stable), BP plc (A/Stable) or Eni SpA (A-/Stable).

DERIVATION SUMMARY

EDO’s SCP of ‘bbb’ is lower than Qatar Petroleum’s (QP; AA-/Stable) and Saudi Arabian Oil Company’s (Saudi Aramco; A/Positive) SCPs of ‘aa+’ due to its smaller scale of operations and lower reserve life. EDO’s rating is constrained by that of Oman due to our assessment of strong linkage between the company and the sovereign. Similar to EDO, the ratings of QP and Saudi Aramco are also constrained by their respective sovereigns’.

EDO has a stronger SCP than OQ S.A.O.C.’s (BB-/Stable) ‘b+’, due to the latter’s complex group structure and higher leverage metrics that are, however, likely to decline over the medium term. OQ’s GRE support score is five points lower than EDO’s due to plans to privatise some subsidiaries, which results in a ‘Strong’ assessment for status, ownership and control. Nevertheless, strong linkages between OQ and its ultimate parent, the government of Oman, result in rating equalisation.

KEY ASSUMPTIONS

Fitch’s Key Assumptions Within Our Rating Case for the Issuer

– Brent and gas prices for 2022-2026 in line with Fitch’s base case price deck

– Oman export blend realised at a USD1.5/bbl discount to Brent to 2026

– Gas production sold at current fixed prices to 2026

– Net production volumes averaging around 865kboe/d through 2026

– Capex averaging USD3.7 billion per year between 2022 and 2026

– Dividends in line with the company’s financial policy

RATING SENSITIVITIES

EDO:

Factors that could, individually or collectively, lead to positive rating action/upgrade:

– A positive rating action on Oman would be mirrored in EDO’s rating

– An upward revision of the SCP is unlikely given the inherent volatility of the oil and gas industry, EDO’s concentrated production assets and operations in a single country

Factors that could, individually or collectively, lead to negative rating action/downgrade:

– A negative rating action on Oman would be mirrored in EDO’s rating

– Weakening linkages between Oman and EDO (which we believe is unlikely), coupled with significant deterioration of the latter’s SCP

– FFO net leverage rising above 2.5x on a sustained basis due to, for example, sustained negative free cash flow (FCF) driven by high capex or large acquisitions, which may be negative for the SCP but not necessarily for the IDR

Oman:

Factors that could, individually or collectively, lead to negative rating action/downgrade:

-Public Finances: A higher trajectory of government debt/GDP than the baseline scenario, for example, stemming from weak implementation of the medium-term fiscal plan, a materialisation of large contingent liabilities or lower-than-expected oil prices

-External Finances: Substantial deterioration of Oman’s external balance sheet and liquidity conditions, for example, in the form of a large decline in central bank reserves and Oman Investment Authority assets

Factors that could, individually or collectively, lead to positive rating action/upgrade:

– Public Finances: Greater confidence in medium-term stabilisation of government debt/GDP and sovereign net foreign assets/GDP through staying broadly on track with the government’s fiscal reform programme

-External Finances: A sustained decline in net external debt/GDP, reflecting lower SOE external debt, lowering risks to Oman’s external finances

– Public and External Finances: A sustained period of high oil prices that enables a material strengthening of the sovereign and external balance sheets

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, visit https://www.fitchratings.com/site/re/10111579.

LIQUIDITY AND DEBT STRUCTURE

Strong Liquidity: EDO had cash and cash equivalents of USD341 million at end-2021 against no short-term debt.

We expect EDO to maintain a robust liquidity profile as negative post-dividend FCF will be offset by no debt service outflows until 2024, and a flexible dividend policy allowing for liquidity preservation during periods of restricted capital-market access and/or lower prices.

ISSUER PROFILE

EDO is Oman’s national energy company and owns participating interests in two concessions, accounting for approximately 65% of Oman’s oil and gas production. EDO’s liquids production totalled 381kbbl/d in 2021 while gas production totalled 60mcm/d.

SUMMARY OF FINANCIAL ADJUSTMENTS

We re-classify expenses related to capitalised leases as operating expenses and remove lease liabilities from debt

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

The rating of EDO is constrained by the sovereign rating of Oman.

ESG CONSIDERATIONS

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. For more information on Fitch’s ESG Relevance Scores, visit www.fitchratings.com/esg

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