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Fitch Assigns PTT Exploration First-Time IDR of ‘BBB+’/Stable

           Fitch Ratings has assigned Thailand's PTT Exploration and Production Public Company Limited (PTTEP) a first-time Issuer Default Rating (IDR) of 'BBB+'. The Outlook is Stable. The agency has also assigned the company a senior unsecured rating of 'BBB+'. 
          PTTEP's ratings are equalised with that of its parent, PTT Public Company Limited (PTT; BBB+/Stable), reflecting our assessment of the strong operating and strategic linkages between the two companies. We assess PTTEP's standalone credit profile (SCP) at 'bbb', reflecting its reasonable production size, relatively low but improving reserves and strong financial profile.

          KEY RATING DRIVERS
          Strong Linkages With Parent: The assessment of the strong linkage between PTTEP and its parent is in line with Fitch's Parent and Subsidiary Rating Linkage criteria and is driven by the integrated operations of the two companies as PTTEP provides the group's crucial upstream integration. PTTEP sold more than 80% of its production to PTT, derived nearly 90% of its revenue from its parent and contributed about 36% of PTT's consolidated EBITDA in 2018. 
          The company also plays an important role by supporting its parent's strategic role in Thailand's oil and gas sector and improving the energy security of the country. PTT has representation on PTTEP's board and is involved in the appointment of some key management personnel. It also plays an active role in supporting PTTEP in many strategic decisions including large acquisitions.
          Improving Operating Profile: We expect PTTEP's recent USD2.2 billion acquisition of Murphy Oil's Malaysian upstream assets and contract wins at the Erawan and Bongkot natural gas fields in Thailand to boost production and reserves. PTTEP acquired an additional stake in the Bongkot fields in 2018, which largely arrested the fall in proved reserves over the past few years until 2017. The domestic contract wins eliminated the risk to production loss from the Bongkot project, which accounted for about 27% of upstream sales volume in 2018, and will increase PTTEP's dominance in Thailand's natural gas production. The Erawan and Bongkot fields accounted for about 60% of Thailand's gas production in 2018.
          PTTEP had proved reserves of 677 million barrels of oil equivalent (mmboe) at end-2018, resulting in a weak proved reserve life of around five years. We think its investments, including a Mozambique LNG project, and contract wins will augment PTTEP's reserve profile and production volumes over the medium-to-long term. Significant progress has been made in the Mozambique project in the last 12 months with the company expecting the final investment decision in June 2019. We expect PTTEP's proved reserve life to improve gradually over the medium term to about seven years, which remains weaker than that of other exploration and production companies rated in the 'BBB' category. 
          Large Investments: We estimate PTTEP will invest around THB480 billion (USD15 billion) over the next five years amid its bid to boost production and reserves including spending on its acquired assets from Murphy Oil, outlay for development projects in Algeria, Vietnam and Mozambique, investments in other recently acquired assets and continuing exploration efforts. Fitch has not factored in any major acquisitions in its assessment and will treat any as an event risk.
          Strong Financial Profile: We expect PTTEP's financial profile to remain strong despite the large investment plans. The rising production volumes, in our view, will strengthen PTTEP's operating cash flows, resulting in mostly positive free cash flows from 2020 in the absence of any large acquisitions given Fitch's oil and gas price assumptions. We consequently expect the company to maintain net leverage at around zero over the medium term after reporting net cash at end-2018. The strong financial profile provides adequate headroom for the company to make large investments, in our view. 
          'bbb' Standalone Credit Profile: PTTEP's 'bbb' SCP reflects its position as Thailand's largest oil and gas producer, its gradually improving albeit relatively weak reserve life, rising production volumes, competitive cost position and strong financial profile. PTTEP's cash costs improved to USD13.8/boe during 1Q19 (4Q18: USD16.3/boe; 2018: USD15.1/boe) and the company expects to continue with cost-optimisation measures to maintain its competitive cost position. 

          DERIVATION SUMMARY
          Fitch equalises PTTEP's ratings with that of its parent, PTT, based on their strong linkages in line with Fitch's Parent and Subsidiary Rating Linkage criteria. We assess PTTEP's linkages to be strong, driven by its strong strategic and operational linkages with its parent. PTTEP is the flagship upstream company of PTT and is also the largest domestic oil and gas producer. It plays a critical role in meeting the energy security of the country, supporting the parent's strategic function. It is also the largest contributor to PTT's EBITDA and sells most of its products to its parent, reflecting the high level of operational integration. 
          The equalisation of PTTEP's rating with its parent is similar to that of PetroChina Company Limited (A+/Stable), the key operating entity under China National Petroleum Corporation (CNPC; A+/Stable). PetroChina also has strong linkages with CNPC, resulting in the equalisation of its ratings with that of its parent. We believe the strategic and operational linkages between PTTEP and PTT are stronger than those between PT Perusahaan Gas Negara Tbk (PGN; BBB-/Stable) and its parent PT Pertamina (Persero) (BBB/Stable), resulting in PGN's rating being one notch below that of its parent.

          KEY ASSUMPTIONS
          Fitch's Key Assumptions Within Our Rating Case for the Issuer
          - Production volume to increase by about 10% a year in 2019 and 2020
          - Crude oil prices as per Fitch's Brent price deck; USD65/barrel (bbl) in 2019, USD62.5/bbl in 2020, USD60/bbl in 2021 and USD57.5/bbl thereafter
          - Gas selling prices to move broadly in line with crude prices 
          - Capex between USD2 billion and USD4 billion over the next five years
          - Dividend payout of 50%

          RATING SENSITIVITIES
          Developments That May, Individually or Collectively, Lead to Positive Rating Action
          - Any upgrade in the parent's IDR, provided their linkages remain intact.

           Developments That May, Individually or Collectively, Lead to Negative Rating Action
          - A downgrade of PTT's IDR.
          - Any significant weakening of linkages with the parent though considered unlikely over the medium term.

          For PTT's rating, the following sensitivities were outlined by Fitch in its rating action commentary of 3 May 2019.
          Developments That May, Individually or Collectively, Lead to Positive Rating Action
          - An upgrade of Thailand's Issuer Default Rating, provided likelihood of support remains intact.          
          - We do not expect an upgrade of PTT's SCP over the next 18-24 months due to its weak upstream operations relative to peers.
          Developments That May, Individually or Collectively, Lead to Negative Rating Action
          - A downgrade of Thailand's ratings. 

          Factors that may lead to negative action on PTT's SCP include:
          - Large debt-funded investment or weaker operating cash flow, resulting in a sustained deterioration in FFO adjusted net leverage to over 2.8x (2018: 0.7x)
          - A weakening financial profile of its upstream operations (PTTEP), with FFO adjusted net leverage at above 2.5x and failure to address declining reserve life in the medium-term
          - Adverse changes to regulations, gas sales contracts or pipeline tariffs.

          LIQUIDITY
          Strong Liquidity: PTTEP's large cash balance of THB129.8 billion (about USD4 billion) as of end-2018 supports its strong liquidity. We expect PTTEP to remain mostly free cash flow positive without any acquisition over the medium term given Fitch's assumption of oil prices. This, in our view, will continue to support PTTEP's healthy liquidity. In addition, PTTEP's strong access to both domestic and international debt markets further supports its liquidity.