Fitch Ratings has revised the Outlook on State Oil Company of the Azerbaijan Republic's (SOCAR) Long-Term Issuer Default Rating (IDR) to Positive from Stable and affirmed the IDR and senior unsecured rating at 'BB+'.
The Recovery Rating is 'RR4'.
The rating actions follow the revision of the Outlook on Azerbaijan's sovereign rating (BB+/Positive) and SOCAR's stronger credit profile, which could lead to an upward revision of its Standalone Credit Profile (SCP).
SOCAR is fully owned by the state and its rating is currently equalised with that of Azerbaijan under Fitch's Government-Related Entities (GRE) Rating Criteria. This is underpinned by state support provided to the company in the form of financial guarantees, cash contributions and equity injections, as well as SOCAR's social functions and its importance as a state vehicle for the development of oil and gas projects. We assess SOCAR's SCP at 'b+'.
Key Rating Drivers
Higher Oil and Gas Production: SOCAR's oil and gas output increased by 7% to 282 thousand barrels of oil equivalent per day in 2021 yoy with a broadly similar increase for gas and liquids. This comes on top of Azerbaijan's 1% increase in oil output and 23% higher gas production. Azerbaijan's oil production has historically decreased and we do not expect this to materially change. The higher gas output is mainly due to the start of production at Shah Deniz II field in 2018 with additional production areas subsequently added. We assume SOCAR's production will grow by 4% in 2022 and 5% in 2023, mainly due to higher natural gas output, and will remain stable thereafter.
Close Links with the State: SOCAR's rating is currently equalised with that of the state given their strong ties under Fitch's GRE Rating Criteria. We assess status, ownership and control and support track record factors as well as socio-political and financial implications of GRE's default as 'Strong', resulting in a score of 30. As the IDR reflects the combination of the strength of state linkage and SOCAR's SCP, an improvement in SOCAR's SCP coupled with the sovereign upgrade would lead to continued equalisation of SOCAR's rating with the sovereign's and the company's rating upgrade.
Most oil and gas projects in Azerbaijan operate under production-sharing agreements, in which SOCAR has a minority stake and where it also represents the state and is involved in marketing the latter's share of crude oil and gas (profit oil). In addition, SOCAR has stakes in some other major energy projects promoted by the state, such as the Southern Gas Corridor (SGC).
Performance Controlled by State: The state exercises significant control over SOCAR's profitability and balance sheet through regulation of domestic fuel prices, cash injections, government distributions and other measures. SOCAR's high leverage, albeit improving, is largely a function of the company's close links with the state, but we believe that the government has incentives to keep SOCAR adequately funded.
Supportive Business Profile: While SOCAR's leverage has been historically relatively high compared with its peer group, we expect that funds from operations (FFO) net leverage metrics will decline from 2022 onwards. This will reflect higher cash flow generation due to higher oil and gas prices as per Fitch's price deck. A record of maintaining FFO net leverage of below 4.0x coupled with satisfactory liquidity and improved financial transparency could lead to a positive reassessment of the SCP. SOCAR's SCP of 'b+' takes into account the scale of operations and is constrained by corporate governance considerations with significant limitations on the disclosure of information.
Additional Liabilities: We have historically treated the liabilities from the transactions involving disposal of certain assets to SGC and Goldman Sachs International (GSI) for a total AZN7 billion as debt-like obligations. This mainly included the sale of a 10% interest in the Shah Deniz PSA and in South Caucasus Pipeline Company to SGC, and a sale of a 13% stake in SOCAR Turkey Enerji A.S. to GSI. The latter transaction took place in 2021 with a cash outflow of AZN2.7 billion, leaving AZN4.3 billion as Fitch's adjustment to SOCAR debt at end-2021.
According to the terms of the agreement between SGC and SOCAR, SGC paid advances to SOCAR while control of the assets is expected to take place in 2023 upon meeting conditions preceding sale. We note that even if the transaction does not go through and SOCAR is obliged to return the advance payments, this would not have a material impact on SOCAR's ability to deleverage.
Derivation Summary
We currently equalise SOCAR's rating with that of Azerbaijan to reflect the strong ties between the two. We expect deleveraging and completion of sizeable projects should add to visibility of its capex programme which may lead to an upward revision of SOCAR's SCP. SOCAR's three most relevant peers rated on a top-down or constrained rating basis are Petroleos Mexicanos (BB-/Stable, top-down minus 3) in Mexico, JSC National Company KazMunayGas (BBB-/Stable, top-down minus 1) in Kazakhstan, and Petroleo Brasileiro S.A. (BB-/Stable, constrained) in Brazil.
Key Assumptions
Brent crude price: USD100/bbl in 2022, USD85/bbl in 2023, USD65/bbl in 2024 and USD53/bbl afterwards.
USD/AZN exchange rate: 1.7 over the forecast horizon.
Aggregate capex of AZN16 billion over 2022-2025
Continued support from the state
Annual dividend payment of AZN0.6 billion over 2022-2025.
RATING SENSITIVITIES
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Upgrade of Azerbaijan's rating coupled with an upward revision of SOCAR's SCP
Upward revision of the SCP could be triggered by a longer record of SOCAR's FFO net leverage being maintained below 4x, improved standalone liquidity and better transparency.
Factors that could, individually or collectively, lead to negative rating action/downgrade:
The Outlook is Positive, therefore, Fitch does not expect negative rating action at least in the short term. However, the revision of Azerbaijan's Outlook back to Stable would be replicated for SOCAR.
Downgrade of Azerbaijan would be replicated for SOCAR.
Negative revision of SOCAR's SCP, which could stem from FFO net leverage exceeding 6x over an extended period assuming no change to sovereign rating.
Weakening state support.
Azerbaijan
Factors that could, individually or collectively, lead to negative rating action/downgrade:
External Finances: Lower energy prices sufficient to have a material negative impact on external buffers
Macro: Developments in the economic policy framework that undermine macroeconomic stability, such as contributing to a rapid erosion of the sovereign's external balance sheet, with adverse effects on the economy, banking sector and public finances
Factors that could, individually or collectively, lead to positive rating action/upgrade:
Public Finances: Greater confidence that the strong public balance sheet will be preserved, for example, based on a credible medium-term fiscal strategy, stronger institutional safeguards to the fiscal rule, or prolonged high energy prices
External Finances: Further strengthening of the external balance sheet, for example, due to sustained high energy prices
Macro: Improvements in the effectiveness and predictability of Azerbaijan's policy framework, including exchange rate policy, to manage external shocks and reduce macro volatility
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
Satisfactory Liquidity: SOCAR's cash balance was AZN9 billion at end-2021 compared with AZN5.9 billion of short-term debt. We expect strong cash flow generation in 2022 and 2023 on the back of elevated oil and gas prices supporting SOCAR's liquidity.
Summary of Financial Adjustments
We treat liabilities resulting from the transactions involving disposal of a 10% interest in the Shah Deniz PSA and in South Caucasus Pipeline Company to SGC for a total AZN4.3 billion as debt-like obligations at end-2021.
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
SOCAR's IDR is aligned with Azerbaijan's sovereign rating.
ESG Considerations
SOCAR has an ESG Relevance Score of '4' for Governance Structure due to concentrated ownership and limited board independence, which has a negative impact on the credit profile, and is relevant to the rating in conjunction with other factors.
SOCAR has an ESG Relevance Score of '4' for Financial Transparency due to weak information disclosure, which has a negative impact on the credit profile, and is relevant to the rating in conjunction with other factors.
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
SOCAR INC. 
