Fitch Ratings has affirmed Korea National Oil Corporation's (KNOC) Long-Term Foreign-Currency Issuer Default Rating (IDR) and foreign-currency senior unsecured rating at 'AA-'.

The Short-Term Foreign-Currency IDR has also been affirmed at 'F1+'. The Outlook on the Long-Term IDR is Stable.

KNOC's ratings are equalised with those of Korea (AA-/Stable) under Fitch's Government-Related Entities (GRE) Rating Criteria. This reflects a very strong likelihood of government support, underpinned by KNOC's strategic importance as a GRE focusing on oil and gas exploration and production. KNOC also manages Korea's strategic petroleum reserves.

Key Rating Drivers

'Very Strong' State Linkages: We assess KNOC's status, ownership and control as 'Very Strong'. The Korean government fully owns KNOC under the KNOC Act, which differentiates it from other domestic Fitch-rated GREs. It also directs and supervises KNOC's investments and financial plans and monitors its financial profile. We assess KNOC's support record as 'Moderate', as it has received periodic capital injections, but despite this, KNOC's financial profile remains weak.

'Very Strong' Default Implications: We assess the socio-political and financial implications of a KNOC default as 'Very Strong' for the government, as KNOC manages the country's strategic oil and gas reserves. Its default would jeopardise the energy security of Korea, which imports nearly all of its oil needs. KNOC is also a major borrower in international and domestic bond markets, a key funding source for GREs, and its default would damage other GRE's funding access and raise borrowing costs. This provides the government with a strong incentive to extend extraordinary support to KNOC, if needed.

Robust Profit, but on Downward Trend : We expect revenue and profit, which has shown robust growth in the past two years, to gradually decline over the next two to three years, along with falling oil and gas price assumptions. We estimate that KNOC's revenue and profit improved significantly in 2022, reflecting higher oil and gas prices. KNOC posted yoy revenue growth of 41% and EBITDA growth of more than 70% in 1H22. Production fell in 2021 due to a decline in KNOC's major mature fields, but remained stable in 1H22, as production began at Dana Petroleum plc's Tolmount field.

Near-Term Positive Free Cash Flow: KNOC's free cash flow turned positive in 2021, with higher oil and gas prices and we expect the company to maintain positive free cash flow for the next two to three years, despite expectations of higher capex and declining prices. We forecast capex to range from KRW600 billion-680 billion over the next two to three years.

Weak Standalone Credit Profile: The company's 'b' Standalone Credit Profile (SCP) reflects its high leverage and weak business profile due to the high cost nature of its production assets. This is mitigated by robust financial flexibility as a major Korean GRE. We expect EBITDA net leverage to improve to around 8x in 2022, from 14x in 2021, amid robust oil and gas prices. It is expected to start deteriorating from 2023 with lower price assumptions.

Derivation Summary

KNOC's ratings are equalised with those of Korea due to its status as a strategically important state-owned enterprise. We assess the likelihood of state support as strong and similar to that of other Fitch-rated state-owned enterprises whose ratings are equalised with the state, such as Korea Electric Power Corporation (KEPCO, AA-/Stable) and Korea Gas Corporation (KOGAS, AA-/Stable).

We assess KNOC's status, ownership and control as 'Very Strong', against 'Strong' for KEPCO and KOGAS. The government fully owns KNOC, which differentiates the company from the two peers, which are listed companies and therefore have lower government ownership. KNOC's support record is assessed as 'Moderate', as it has received periodic equity injections, but its SCP has remained at a weaker level compared with KEPCO and KOGAS, which are assessed at 'Strong' for support record.

We assess all three peers as having 'Very Strong' socio-political and financial implications of default, as a default by KNOC, KEPCO or KOGAS would disrupt Korea's energy security, power supply and supply of natural gas, respectively. The three companies are also major borrowers in the international and domestic bond markets; a default would significantly impact GREs' access to funding and borrowing costs.

Key Assumptions

Fitch's Key Assumptions Within Our Rating Case for the Issuer:

Brent oil prices of USD100/barrel (bbl) in 2022, USD85/bbl in 2023 and USD65/bbl in2024, as per Fitch's price assumptions; see Fitch Ratings Cuts Near-Term Gas Price Assumptions, Oil Prices Unchanged

Production volume of 116,000 barrels of oil equivalent a day in 2022 and 114,000 in 2023-2024

Capex of KRW600 billion in 2022, KRW617 billion in 2023 and KRW684 trillion in 2024

RATING SENSITIVITIES

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

Positive rating action on the sovereign, provided the likelihood of sovereign support remains intact.

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

Negative rating action on the sovereign.

Weakening of the sovereign's likelihood to support KNOC.

For the sovereign rating of Korea, the following sensitivities were outlined by Fitch in its rating action commentary of 28 September 2022:

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

Public Finances: A significant rise in government debt/GDP, for example as a result of sustained increases in fiscal deficits or materialisation of contingent liabilities.

Economic or financial sector distress resulting from impaired household debt-servicing ability; for instance, from a structural deterioration in the labour market.

Structural: A rise in geopolitical risks on the Korean peninsula sufficient to severely worsen Korea's economic metrics or security situation.

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

Structural: A structural easing of geopolitical risk to levels more in line with rating peers.

Structural: Improved governance standards, for example through reforms to reduce ties between politics and business.

External: Continued current account surpluses that contribute to a sustained improvement in the net external creditor position, and greater resilience to external financial shocks.

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

Adequate Liquidity: KNOC's short-term debt was KRW3.0 trillion as of June 2022, against readily available cash of KRW916 billion. However, we believe KNOC will retain its ability to refinance its debt due to its access to global capital markets and Korea's specialty bond market as well as its well-spread maturity profile. The company is a frequent issuer in the global capital markets. KNOC also had committed credit lines of USD233 million as of June 2022, of which USD76 million was undrawn.

Issuer Profile

KNOC is a 100% government-owned energy oil and gas company, focusing on upstream exploration and production. It also manages Korea's strategic oil reserves and engages in fuel marketing.

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

KNOC's ratings are equalised with those of its major shareholder, Korea, as per Fitch's GRE Rating Criteria. This reflects the high likelihood of state support given the company's strategic importance.

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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