Fitch Ratings has affirmed the Long-Term Foreign- and Local-Currency Issuer Default Ratings (IDRs) on China National Petroleum Corporation (CNPC), CNPC Finance (HK) Limited (CPFHK) and PetroChina Company Limited at 'A+'.

The Outlooks on the IDRs are Stable. At the same time, Fitch has affirmed the senior unsecured rating and the rating on all outstanding bonds at 'A+' and PetroChina's Short-Term Foreign- and Local-Currency IDRs at 'F1+'.

CNPC is wholly owned by China's central State-owned Assets Supervision and Administration Commission, and its ratings are capped by the sovereign (A+/Stable) under Fitch's Government-Related Entities (GRE) Rating Criteria. CNPC's Standalone Credit Profile (SCP) is assessed at 'aa-', which is supported by its very large scale, integrated business model with a strong market position, and robust balance sheet through the commodity cycle. CNPC's IDR will remain equalised with that of China even if its SCP deteriorates, given the state's very strong incentive to support the company.

We use a consolidated approach to rate CNPC's 83.62%-owned subsidiary PetroChina, based on 'Open' legal ring-fencing and 'Open' access and control under the stronger subsidiary path in Fitch's Parent and Subsidiary Linkage (PSL) Rating Criteria. PetroChina's SCP is assessed at 'aa-.' CPFHK's ratings are equalised with CNPC's under the PSL criteria as CNPC's group funding vehicle.

Key Rating Drivers

Large Integrated Company: CNPC is one of the largest Fitch-rated energy companies globally with oil and gas production of 6.36 million barrels of oil equivalent per day (mmboe/day) in 2021 (2020: 6.20 mmboe/day). CNPC's operations are highly integrated. Its key subsidiary, PetroChina, processed about 56% of upstream production through its own downstream refining and chemical segment and has a 35% market share of refined retail products in China and a dominant position in the natural gas wholesale market.

'Very Strong' State Linkages: Fitch assesses CNPC's status, ownership and control as 'Very Strong', with the state having firm control over its board and management and strong influence over its operations and strategy in light of the group's strategic importance to national energy security. It is one of China's three-biggest functional central state-owned enterprises by revenue and assets. We assess its support record as 'Very Strong' and expect extraordinary support to be forthcoming, if required.

'Very Strong' Impact of Default: The socio-political impact of a default is assessed as 'Very Strong'. CNPC plays vital roles in energy security, accounting for about 52% of total crude oil and 66% of natural gas output domestically, and in implementing China's energy transition. The financial implications of a default are assessed as 'Very Strong' as CNPC and its subsidiaries are active bond issuers domestically and overseas. A default would severely hurt other Chinese GREs' funding access as investors regard CNPC's bonds as government proxies.

Integrated Model Smooths Profit Volatility: CNPC's integrated business model enables smoothing of price-driven profit fluctuations between upstream and downstream operations over the commodity-price cycle. Fitch expects strong performance from the upstream segment, driven by both volume and realised price growth, to help offset weaker downstream performance in 2022.

Downstream Absorbs Higher Import Costs: CNPC's downstream refining margins would contract on the inability to fully pass through higher crude costs under the current pricing mechanism in addition to slower product demand growth yoy. Profitability of its natural gas sales would also decline. We think it is unlikely to fully pass through the steep rise in gas import costs in 2022 due to weaker consumption year to date and the company's role in providing affordable gas to residential users.

Further Deleveraging Ahead: We expect CNPC's EBITDA net leverage to drop to an average of 0.3x in the medium term from 0.7x in 2021 on our forecast of almost 30% yoy EBITDA growth in 2022 and stable budgeted capex. It will also maintain solid EBITDA interest coverage of more than 20x. CNPC's strong financials and its large integrated business scale support its 'aa-' SCP profile.

Low Capex for New Energy: Fitch expects CNPC's capex to stay stable in 2022 with most of it allocated to the company's upstream segment, followed by the downstream business. Capex for decarbonisation efforts, including the new energy business and technological investments, would increase from a low base, although their share of total capex will remain at single digits over the next two-three years.

Consolidated Approach for PetroChina: PetroChina is CNPC's main operating entity, accounting for about 72% of CNPC's production and 80% of EBITDA in 2021. Its 'aa-' SCP reflects its large integrated operations, strong proved reserve life of about 11.4 years and low net debt/EBITDA of 0.5x at end-2021.

There is no covenanted or regulatory ring-fencing mechanism to limit the parent's access to PetroChina's cash, other than dividends and allowed related-party transactions under listing rules. CNPC has strong effective control over PetroChina through its large shareholding and board representation. PetroChina's funding and cash management are assessed as 'Porous' with a mixture of external and inter-company funding. CNPC and its subsidiaries provide 39% of PetroChina's borrowings and hold 22% of the company's cash deposits.

Derivation Summary

CNPC's 'Very Strong' assessment for the status, ownership and control factor is similar to that for State Grid Corporation of China (SGCC, A+/Stable), which is also wholly state-owned.

Petroliam Nasional Berhad (PETRONAS)'s (BBB+/Stable) assessment is 'Strong' as the Malaysian government exerts significant influence through operating and financial policies, but CNPC and SGCC have exceptionally high state involvement in investment decisions and management appointments. We assess the support record as 'Very Strong' for CNPC and SGCC due to substantial and consistent government support, which have been sufficient to keep their financial positions at an exceptionally strong level. In comparison, PETRONAS has not received material tangible financial support, although we expect this to be forthcoming in the event of stress.

The socio-political impact of a default is also assessed as 'Strong' for SGCC because the company is responsible for settling payments to power generators and a default would disrupt power supply, affecting 88% of the Chinese population. However, we think a default by CNPC would impair its ability to procure crude and gas to satisfy domestic demand. The financial impact of a default is assessed as 'Very Strong' for CNPC, SGCC and PETRONAS because they are large, regular issuers in the international bond market, and are seen as proxy borrowers of the state.

Key Assumptions

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

Fitch oil price deck: USD105/barrel (bbl) in 2022, USD85/bbl in 2023, USD65/bbl in 2024 and USD53/bbl thereafter

Flat-to-low-single-digit oil production growth; mid-single-digit gas production growth over the medium term

Crude processing volume growth to stay at around low-to-mid single digits over the medium term

Domestic gas sales volume growth at around mid-single digits over the medium term

PetroChina's capex to be maintained at CNY250 billion in 2022 (2021: CNY262 billion); capex intensity (capex/total revenue) maintained at around 10%-12% thereafter

RATING SENSITIVITIES

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

Positive 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

Ratings on PetroChina and CPFHK will move in tandem with any change in CNPC's ratings, provided CNPC's access and control, and incentive to support remain intact.

For the rating on China, the following sensitivities were outlined by Fitch in our rating action commentary of 2 June 2022:

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

Structural Features: A continued rise in macro-financial risks, for example through failure to maintain credit growth at a level close to nominal GDP growth over the next few years.

Public Finances: A sharp upward trend in government debt/GDP or a crystallisation of contingent liabilities that leads to a significant rise in government debt relative to 'A' peers.

External Finances: Sustained capital outflows sufficient to erode China's external balance-sheet strengths relative to 'A' peers, which would cause the removal of the +1 Qualitative Overlay (QO) notch on External Finances.

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

Structural Features: A material reduction in macro-financial risks and associated contingent liabilities facing the sovereign, for example, by maintaining credit growth below nominal GDP growth over a multi-year period, which would cause the removal of the -1 QO notch on Structural Features.

External Finances: Widespread adoption of the Chinese yuan as a reserve currency, as reflected in a substantial increase in the share of yuan-denominated claims in the IMF's currency composition of official foreign exchange reserves (COFER) database.

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

Comfortable Liquidity, Strong Flexibility: Fitch regards CNPC as a proxy borrower of the state. The company has maintained a high level of unencumbered assets, strong access to domestic banks, and listed platforms among its subsidiaries (including PetroChina) to raise capital when necessary. CNPC has very comfortable liquidity, with cash and cash equivalents amounting to CNY569.02 billion at end-2021, more than covering its short-term borrowings of CNY456.35 billion.

Issuer Profile

CNPC is a national oil company whose operations cover the entire oil and gas value chain from upstream exploration and production to downstream refining, petrochemicals and marketing. It is also the largest gas producer and wholesaler in China.

Summary of Financial Adjustments

For CNPC's financial institution operations, we have treated deposits at banks and other financial institutions as cash, as they are quite liquid and short-term in nature, while we treat borrowings from banks and other financial institutions as borrowings.

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

CNPC's rating is capped by China's sovereign rating under the GRE criteria. PetroChina's rating is equalised with CNPC's under a consolidation approach. CPFHK's rating is equalised with CNPC as the parent's group funding vehicle.

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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