CORRECTION TO HEADLINE AND TEXT: MOODY'S ASSIGNS Baa1 RATING TO 144A SENIOR NOTES OF EMPRESA NACIONAL DEL PETROLEO (ENAP)
New York, October 29, 2002 -- Moody's has assigned a Baa1 foreign currency bond rating to up to US$293 million of 144A senior unsecured notes to be issued by Empresa Nacional del Petroleo (ENAP). This is the first time Moody's has rated ENAP's debt securities. The new notes will be placed in privately negotiated transactions without registration under the Securities Act of 1933 under circumstances reasonably designed to preclude a distribution in violation of the Act. The issuance has been designed to permit resale under SEC Rule 144A.
ENAP's Baa1 rating reflects its strategic importance to the Chilean economy, its 100% ownership by the Chilean government, its dominant market position within Chile, the high quality of its refined products, its ability to generate stronger and more stable operating margins than many of its refining company peers, its reasonable financial leverage targets, and the government's conservative financial policies. At the same time, the rating also considers ENAP's small size, its exposure to volatile commodity prices, its declining domestic oil production and heavy reliance on crude oil imports, its strategy to grow more aggressively its international oil and gas reserves, its exposure to the political and economic crisis in Argentina, and its high tax and dividend rates. ENAP's rating is equivalent to the Baa1 long-term foreign currency rating of the Republic of Chile.
With assets of US$1.86 billion, ENAP is the second-largest state-owned company in Chile and the fourth-largest company in Chile based on revenue. ENAP's three refineries supply about 87% of the country's petroleum product requirements. While the Chilean government owns 100% of ENAP, it does not guarantee the company's financial obligations. However, Moody's believes that in light of the strategic importance of ENAP to the Chilean economy, ENAP benefits from implicit government support. The indenture governing the notes includes a change of control provision that gives noteholders the right to require that ENAP redeem the notes in the event that ENAP is privatized.
ENAP's refined product output is of high quality, consisting of over 50% gasoline and diesel. Fuel quality standards are relatively high in Chile and are expected to become more stringent over the next several years. Sulfur content targets for gasoline and diesel are similar to those in the US and Europe and must be achieved by 2004. The company is pursuing a number of investment projects to improve refined product quality and to increase the conversion capacity of its refineries to process larger quantities of heavier, less expensive crudes.
With total refining (crude distillation) capacity of 214,000 barrels per day, ENAP is smaller than its investment-grade refining company peers. On the other hand, ENAP has consistently generated wider and more stable refining margins than many of its peers, mainly because it lacks competition from other domestic refiners, it has a favorable domestic pricing mechanism, and its refineries produce a high-value product slate. The company's transportation network and Chile's increasingly stringent environmental requirements create high entry barriers. Also, the company uses a price mechanism that sets refined product prices at the level of international prices (US Gulf Coast) plus transportation costs (from the Gulf Coast). ENAP also benefits from its proximity to Argentina's oil producing regions, which currently supply over 75% of its crude imports. Moody's notes that any disruptions of crude deliveries from Argentina, or the imposition of additional taxes on Argentine crude exports, could weaken the company's refining margins. On the other hand, Chile is Argentina's most important oil export market, accounting for over 50% of Argentina's total oil exports.
Similar to other refiners, ENAP is exposed to commodity price fluctuations. It sets its refined product prices weekly to reflect import parity with the US Gulf Coast. Completely separate from ENAP's commercial operations, the National Commission of Energy operates a self-funding oil stabilization fund that uses a price band to even out price volatility for the end-user. ENAP functions as an intermediary in transferring funds to and from the oil stabilization fund and its clients.
ENAP relies on imports for nearly all of its crude oil requirements. Production from its small base of domestic oil reserves, which accounts for only 3% of its crude supplies, has been declining, although this decline has been offset by growing production outside of Chile. The company's international exploration and production (E&P) operations currently supply about 12% of its crude requirements. ENAP's five-year plan calls for larger international upstream investments to increase the value of its upstream operations and to reduce its dependence on crude imports from third parties. ENAP's international exploration activity will continue to be concentrated in Latin America (Argentina, Colombia and Ecuador), but management also plans to increase investments in the Middle East (e.g. Iran) and North Africa (e.g. Egypt).
ENAP currently faces political and economic risks that may adversely affect its E&P operations in Argentina, which account for approximately 22% of its assets. Moody's believes ENAP will be subject to further technical, operational and political risks as it seeks to increase reserves through drilling programs in regions in which it has not operated previously. In addition, the company intends to finance a portion of its exploration and development projects with debt. However, these risks are partially mitigated by management's fairly conservative exploration strategy, by the company's practice to enter into projects with partners, by ENAP's position as a state-owned company, and by the government's conservative financial policies.
ENAP has a relatively high tax burden, and it distributes a substantial portion (typically 100%) of its annual net income to the government in the form of dividends. In view of the limited opportunities for growing ENAP's equity base, its financial leverage may rise in the near to medium term as it seeks to expand its international oil and gas reserves. The company's current five-year plan, which is subject to annual government review, calls for total investments of US$1.35 billion between 2002 and 2006, an increase of 45% over the previous five-year plan. Of this amount, over half will be allocated to E&P investments. However, management's financial targets, which are also subject to review and reaffirmation by the government, are within ranges Moody's considers appropriate for the Baa1 rating, and Moody's assumes ENAP will manage its capital spending to stay within these targets.
Because a substantial portion of ENAP's operating expenses (including crude import costs) and its debt is denominated in foreign currency, devaluations of the Chilean peso could adversely affect its performance and increase its financing costs. However, the weekly indexation of all of the company's revenues from refined products (97% of total revenues) to the US dollar through the import parity pricing mechanism offsets virtually all of the negative effects of a devaluation on its financial position.
Empresa Nacional del Petróleo (ENAP) is Chile's national oil company. It is headquartered in Santiago, Chile.
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