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Announcement:

Moody's: Kunlun Energy's 2016 results are within expectations

03 Apr 2017

Hong Kong, April 03, 2017 -- Moody's Investors Service says that Kunlun Energy Company Limited's results for 2016 are within Moody's expectations and do not immediately affect its A1 issuer and senior unsecured debt ratings.

The ratings outlook remains negative.

"Kunlun Energy's 2016 results continue to reflect its slow growth in natural gas sales, its sluggish liquefied natural gas (LNG) business, and an increase in leverage arising from the capital expenditure needed for Shaan-Jing Line IV," says Osbert Tang, a Moody's Vice President and Senior Analyst.

Kunlun Energy's revenues declined by 15% to HKD81.9 billion in 2016, mainly due to (1) an average reduction rate for non-residential gas tariffs of 28% in November 2015; (2) the weak performance of its LNG operations; and (3) the depreciation of the RMB against its reporting currency of the HKD.

On the other hand, adjusted EBITDA increased 13% mainly driven by better performance of the upstream business. However, adjusted EBITDA for its natural gas distribution business stayed flat year-on-year in 2016.

As the recovery in the domestic LNG market was slower than the company had expected, Kunlun Energy made a provision of HKD4.5 billion for the impairment of its LNG processing business and related assets in 2016, but this amount did not have any impact on its operating cash flow.

"The impairment loss reflects the continued sluggish outlook for the company's LNG operations," says Tang, who is also the local market analyst for Kunlun Energy. "The negative ratings outlook incorporates our assessment that the company continues to face a challenging operating environment and the potential negative impact of unfavorable regulatory changes."

The 2016 results are based on a merger basis of accounting, fully consolidating Kunlun Gas into Kunlun Energy's financial statements, after the completion of the acquisition of the former in May 2016.

Kunlun Energy's upstream operations recorded an adjusted EBITDA of HKD701 million in 2016, against an EBITDA loss of HKD1.4 billion (before the asset impairment) in 2015. The company terminated the production contract at its Xinjiang project upon its expiry on 31 August 2016, and reported a 32% year-on-year decline in segmental revenue in 2016.

The upstream operations contributed only 3.8% of total EBITDA in 2016 and 3.1% of total assets at end-2016. Moody's expects Kunlun Energy to reduce its exposure to its upstream business gradually over the next two years.

Operationally, the performance of its LNG processing operations remained weak in 2016, against the backdrop of softer demand, overcapacity, as well as weak oil and LNG prices. Its LNG processing volume was 522 million cubic meters, down 23% year on year.

On the other hand, the gasification volume from its LNG terminal was 4.859 billion cubic metres, up 22% year on year. The second-phase projects of Kunlun Energy's Jiangsu and Dalian LNG terminals also entered into operation last year.

The company's midstream gas transmission business recorded a modest growth rate of 1.6% in sales volume given the Shaan-Jing pipelines are running close to their full capacity. Its downstream natural gas sales volume also grew 4.3%.

Its midstream operations remain the key contributor (60%) to its consolidated EBITDA of about HKD18.4 billion, followed by its downstream operations (29%) after the merger with Kunlun Gas.

Moody's notes that Kunlun Gas is the key growth driver for Kunlun Energy's consolidated downstream operations and will improve the company's business profile. The merger will further strengthen Kunlun Energy's strategic importance to China National Petroleum Corporation (CNPC, Aa3 negative) as the latter's key natural gas platform.

Kunlun Energy's total reported debt increased to HKD38 billion at end-2016, due to the capex needed for its acquisition of Kunlun Gas and its investment in Shaan-Jing Line IV, from HKD25 billion at end-2015. Moody's also notes that Kunlun Energy had issued RMB3.35 billion convertible bonds to finance its acquisition payment of Kunlun Gas in July 2016.

Moody's expects the company's debt/EBITDA to be at 2.3-2.8x in the next 12-18 months, up from 2.0x reported for 2016. Its debt/capitalization will be at 36-39% over the same period, compared with 36% reported for 2016. This moderation in credit metrics will be mainly driven by the acquisition of Kunlun Gas and the planned capital expenditure for Shaan-Jing Line IV.

Moody's note that Kunlun Energy's financial profile may deteriorate, depending on the impact of the new gas transmission tariffs regulations.

The National Development and Reform Commission announced the latest regulations on 12 October, 2016 and they were effective 1 January, 2017. Under the regulations, the new after-tax regulated return of 8% is lower than the current levels for inter-provincial natural gas pipelines, and will likely result in lower tariffs for mid-stream operators.

However, Moody's notes that there is still lack of transparency over the implementation of the regulations and this remains a constraint for Kunlun Energy's ratings. Moody's will continue to closely monitor developments and their resultant impact on the company. Key credit metrics that could lead to a rating downgrade include debt/EBITDA rising above 3.0x, and/or retained cash flow/debt falling below 25% over a prolonged period.

The negative outlook also reflects the consideration that Kunlun Energy's ratings, which incorporate parental support and uplift, could be impacted by potentially weaker support from CNPC in the future, given the negative outlook on China's Aa3 sovereign rating.

The principal methodology used in these ratings was Natural Gas Pipelines published in November 2012. Please see the Rating Methodologies page on www.moodys.com for a copy of this methodology.

Kunlun Energy Company Limited is mainly engaged in: (1) natural gas transmission via Shaan-Jing Lines I, II, and III; (2) LNG processing and storage; (3) downstream gas operations; and (4) the exploration and development of oil and gas.

At end-2016, the Chinese state-owned China National Petroleum Corporation effectively owned 61.76% of Kunlun Energy, mainly through its listed subsidiary, PetroChina Company Limited.

The Local Market analyst for these ratings is Osbert Tang, +86 (21) 2057-4019.

This publication does not announce a credit rating action. For any credit ratings referenced in this publication, please see the ratings tab on the issuer/entity page on www.moodys.com for the most updated credit rating action information and rating history.

Ivy Poon
Asst Vice President - Analyst
Project & Infrastructure Finance
Moody's Investors Service Hong Kong Ltd.
24/F One Pacific Place
88 Queensway
Hong Kong
China (Hong Kong S.A.R.)
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077

Terry Fanous
MD-Public Proj & Infstr Fin
Project & Infrastructure Finance
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077

Releasing Office:
Moody's Investors Service Hong Kong Ltd.
24/F One Pacific Place
88 Queensway
Hong Kong
China (Hong Kong S.A.R.)
JOURNALISTS: (852) 3758 -1350
SUBSCRIBERS: (852) 3551-3077

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