CNOOC Ltd. (CEO) Long-Term Rating Affirmed by S&P; Crude Prices Seen Offset on Discretionary Expansion, Vertical Integration

Standard & Poor's Ratings Services said that it had affirmed its 'AA-' long-term corporate credit rating on China National Offshore Oil Corp. (CNOOC)(NYSE: CEO). The outlook is stable. We also affirmed our 'cnAAA' long-term Greater China regional scale rating on CNOOC, the third-largest oil exploration and production (E&P) company in China. We also affirmed our 'AA-' long-term issue rating and 'cnAAA' long-term Greater China regional scale rating on the senior unsecured notes that CNOOC guarantees.

"We affirmed the ratings because we expect the discretionary nature of CNOOC's debt-funded expansion and improving vertical integration to moderate the financial pressure on the company stemming from low crude oil prices," said Standard & Poor's credit analyst Jian Cheng. "We believe CNOOC has the flexibility to defer the capital spending on its expansion projects to manage its debt-to-EBITDA ratio at 2.0x-2.2x in the next 12-24 months."

We continue to see an "extremely high" likelihood that CNOOC would receive timely and sufficient extraordinary government support if it is under financial stress. Our assessment is based on CNOOC's "very strong" link with, and "critical" role to, the government of China.

We believe that CNOOC's dominant position in offshore China is unlikely to be challenged. The upstream business has an increasing and diversified reserve base and satisfactory reserve life. In addition, it has good production growth associated with the company's gradually improving vertical integration, which includes oil field services, offshore engineering, petrochemicals, refining and marketing, and liquefied natural gas operations. These factors support our "strong" business risk profile assessment on the company.

We have lowered our assessment of the company's financial risk profile to "intermediate" from "modest" because, under our current oil price assumptions, lower oil prices will substantially reduce the company's EBITDA generation and push up the cash flow leverage ratio. We expect the company's debt-to-EBITDA ratio to deteriorate to about 2.2x in the next 12-24 months from about 1.2x in 2014.

Significant capital spending could weaken CNOOC's leverage position, in our view. The company has gradually increased its non-E&P investment, aiming to further improve its vertical integration. The company has become one of the largest liquefied natural gas players in China. It aims to triple its storage capacity in the next four to five years from 8.5 million tons in 2014. CNOOC also plans to double its refinery capacity through Huizhou Phase II in the next two to three years. We believe that such spending is discretionary and has room to be deferred. The company has also cut spending in the upstream business amid low oil prices, targeting capital expenditure of about Chinese renminbi (RMB) 70 billion-RMB80 billion in 2015, significantly lower than RMB107 billion in 2014.

We expect CNOOC to maintain its financial risk profile at the higher end of the "intermediate" category over the next two years. We therefore reflect such strength in our "positive" comparative rating analysis. Our "positive" comparable rating assessment has led to a one-notch uplift from the anchor, resulting in a stand-alone credit profile of 'a'.

We have revised our liquidity assessment for CNOOC to "adequate" from "strong" given the deterioration in the company's funds from operations (FFO) generation due to low oil prices. Nevertheless, the company has good relationships with its banks and has a good standing in the credit markets.

"The stable outlook reflects our expectation that CNOOC will remain disciplined in its capital expenditure to maintain its financial position," said Mr. Cheng. It also reflects the outlook on the sovereign credit rating on China (AA-/Stable/A-1+; cnAAA/cnA-1+).

We could lower the rating on CNOOC if we downgrade China or if the government reduces its support to the company because of a change in the government's strategies or priorities, a scenario we view as unlikely.

We could also lower the rating if the company's stand-alone credit profile deteriorates. This could happen if CNOOC or its subsidiaries become more aggressive in acquisitions, or the company were to maintain large capital spending in its non-E&P businesses, such that its debt-to-EBITDA ratio is sustained at substantially more than 2x.

We may upgrade CNOOC if we raise the sovereign credit rating.

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