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Fitch Upgrades Naftogaz of Ukraine To 'BB-'; Outlook Stable

January 24, 2005 | Cbonds

Fitch Ratings, the international rating agency, has today upgraded Naftogaz of Ukraine’s Senior Unsecured rating to 'BB-' (BB minus) from 'B+'. The Outlook is Stable.

The rating action follows the recent upgrade of Ukraine’s sovereign rating to 'BB-'('BB minus')/Stable from 'B+'/Stable. Ukraine's sovereign ratings had previously been constrained at the 'B+' level by Fitch's long-standing view that there was a material risk of significant political instability associated with the presidential elections. Although political risk remains significant, it is now diminishing as Ukraine emerges from its political crisis.

The Stable Outlook foresees continued stability in Ukraine's macroeconomic environment, which has benefited Naftogaz. Additionally, Ukraine's increasing level of oil and gas transportation and the country’s significant geographical position mean that Naftogaz will continue to play a key role in Ukraine's energy policy. Its importance to the state also indicates that Naftogaz is likely to be able to rely on a favourable regulatory framework that will ensure sufficient export revenues to cover its financing and operating costs.

Against this, Naftogaz currently operates solely in Ukraine, and is therefore constrained by the domestic economic environment. Furthermore, it plays a significant social role that still requires it to sell gas at artificially low prices domestically that are regulated by the National Commission on Regulation of Power Energy of Ukraine. In Fitch's opinion, such regulations and heavy state control potentially limit the company's cash flow-generating ability. Naftogaz has, however, recently announced plans to ask for approval of an increase in gas prices for individual consumers by 25% in 2005, but this price increase is not yet certain.

Additionally, Naftogaz has recently negotiated to purchase 36 billion cubic metres (bcm) of Turkmen gas in 2005 at USD58 per 1000 cm, up from USD44 per 1000 cm last year. This cost increase, however, was viewed as necessary in order to prevent gas supply shortages in Ukraine; an event which would have significantly more negative rating implications than the additional costs incurred as a result of the price increase.

Downward rating pressure on Naftogaz would likely result from any additional debt-financed acquisitions or capital spending beyond those already planned by the company. Naftogaz has recently announced its intention to borrow between USD300 million and USD500m from the capital markets in 2005 to fund upcoming projects. However, deputy CEO Igor Voronin has indicated that the success of the company’s fundraising will depend directly on changes in the domestic gas price policy. Fitch will continue to closely monitor these developments.

Key factors supporting the ratings include Naftogaz's close link to the state, as it generates approximately 10% of GDP and 11% of the government’s budget revenues. Additionally, the company enjoys a monopoly position in supplying natural gas and crude oil to the country's consumers, and has a strategic role in the transportation of oil and gas to western markets. This dominant position helps to ensure the company's strategic importance to the state (since gas represents 40-45% of primary energy consumption in the country), and prevents new market entrants from directly competing with Naftogaz.


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