National oil companies (NOCs) have some of the world's strongest credit ratings, but politics and strategy mean they also appear across the credit spectrum. NOCs typically have a privileged position in terms of access to reserves, and the lifting costs for many are also among the lowest globally. Nevertheless, this doesn't necessarily translate into a strong financial or credit profile for every NOC, S&P Global Ratings said over the weekend on its report on NOCs. The travails and default of PDVSA — in spite of Venezuela reporting the world's largest oil reserves — show this all too clearly. It signals that NOCs' strategies and social mandates—as well as geopolitics—can be very important. For several NOCs, the 2014-2016 oil price crash actually improved profits, as cheaper imports reduced losses in domestic fuel retail operations. S&P Global Ratings analyzes both the NOC's businesses as well as its role and links with its sovereign government. Unsurprisingly given their importance to national finances, NOCs in the Middle East have close links with government and critical, or very important roles, meaning their credit ratings are often closely related to the sovereign rating. Outside the Middle East, where economies may be more diversified, as in Brazil or Norway, factors other than the government rating become more important, namely the NOC's own strengths and weaknesses. "Consequently, we don't always rate NOCs at the same level as the sovereign rating. We also don't usually rate an NOC above its government, as a state ultimately has oversight of strategy and finances for most. This is important for our rating opinions on NOCs' creditworthiness," the report said. As an NOC's headline credit rating, or issuer credit rating (ICR), is influenced by its host country's sovereign rating, there can be a sizable discrepancy between the rating and an NOC's underlying, stand-alone credit profile (SACP). In the case of Pemex, for example, our view on almost certain government support means the rating is much higher than the underlying operational and financial challenges would suggest. This reliance on—or exposure to—one national government is a key difference between NOCs and the geographically diversified international oil companies, the IOCs. Another is the upstream focus of some of the largest NOCs, in terms of production and cash generation, with often a greater dependence on oil and oil prices rather than gas. More recently, the rate of change and interest in NOCs' investments beyond their borders and in other activities has been increasing as peak oil and the energy transition have a more direct impact on strategies. These strategic shifts recognize that just adopting a "last man standing" approach supported by multi-decade reserves lives and low production costs, may not be optimal. In tandem with national strategies to diversify economies, NOCs are seeking earnings from new sources and markets. A typical route is by moving along the oil value chain, to capture more value from each barrel. This can include trading activities or seeking direct sales to crude oil users. A more capital-intensive option is to build or buy refining assets and petrochemical plants at home or near product markets. Even if this is often affordable and can make strategic sense, as for any venture outside a company's core activities, the certainty and level of returns is typically lower and the risks can be difficult to manage. Oil producers are essentially price takers whereas the skill-sets required for successful trading or downstream businesses in competitive environments are different. Such expansion can be organic or through acquisitions. One example of mixed success in this sort of strategy is SOCAR, which has been backing off its established trading and retail businesses outside Azerbaijan even as it invests heavily in refining and petrochemical assets in Turkey. However, a high capacity, modern global refinery or integrated chemical plant doesn't come cheap. Even where a government or NOC could fund such an investment itself, an established approach is to raise external debt in the form of bank loans or bonds. This often has less to do with running an efficient balance sheet than allowing the NOC's cash generation to continue flowing to the government. It could also allow the investment to go ahead sooner. The form and structure that the external capital takes can be informative about a government's approach, just as the institutional framework is. For example, are investments made by the parent or holding company, or are special entities created? Will other investors participate and inject capital or provide guarantees for the debt? It's also a function of the amount of funding required and the usual trade-off between terms, disclosures and pricing. Banks will often lend based on confidential information, but international equity and debt markets require comparable disclosures to evaluate any investment. NOCs may cede control not so much of information but rather construction and operations if they use project finance debt. A benefit can be a very structured project delivery that is separate from the parent and less open to non-commercial considerations, as well as longer-term debt than loans or bonds typically provide. Middle Eastern NOCs are typically lightly leveraged, but debt burdens vary considerably elsewhere. Whatever the capital structure, NOCs are making strategy shifts to prepare for an uncertain, but likely more challenging, future. Many are doing this sooner rather than later while options remain and while still underpinned by cash flows from upstream production. In any case, NOCs' earnings and credit profiles will likely remain underpinned by their core operations for many years. — SG
