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Announcement:

Moody's says challenges persist for Asian E&P sector

10 May 2010

Hong Kong, May 10, 2010 -- Moody's Investors Service maintains its negative outlook for the upstream exploration and production ("E&P") industry in Asia Pacific over the next 12-18 months. The negative view matches Moody's outlook for the sector elsewhere in the world.

"Overall demand recovery is still fragile, leading to uncertain revenue prospects for E&P companies in Asia, while rising upstream costs will likely tighten margins," says Renee Lam, a Moody's Vice President and Senior Analyst.

"Event risks associated with mergers and acquisitions are also on the rise, with more and more Asian state-owned E&P companies -- including those in China, South Korea, and Japan -- on the look-out for acquisitions to boost reserves, often under government directives," says Lam.

"Rising appetite for investments and higher costs would fuel further increases in finding and development ("F&D") costs and rising leverage in the sector," adds Lam.

Compared to their US counterparts, upstream Asian companies fare better as high natural gas inventories in the region are not plaguing the sector as they are in North America. Most Asian E&P companies should benefit from the significant rebound in oil prices since 2Q2009.

Nevertheless, the global economy is still fragile, and any reversal to the improvement seen so far will substantially affect the Asian E&P sector. For instance, while China's growth and investment surge has spurred demand for commodities, any material slowdown in Chinese demand -- which we do not currently expect - would seriously damage the region's prospects.

Ongoing oil price volatility also poses challenges. On one hand, further escalation of oil prices could hamper the fragile economic recovery. On the other hand, oil price decline would affect E&P companies' revenue stream. Currently, downside risk to oil prices includes relatively high oil supplies, weak downstream refinery demand for oil, and uncertain appetite for oil as an inflation hedge.

Rising cost base also detracts any cash margin improvements offered by price increases. With oil prices rebounding, the industry has become more confident in investing for future growth. In Asia, many upstream operators are planning for double-digit growth in E&P spending in 2010, fueling drilling demand and therefore raising operating cost base. Cost escalation for reserve replacement also stems from the need to develop reserves in more complex and less well-known geologies.

Given Asian developing economies' reliance on oil imports, many state-owned or affiliated E&P companies in the region are actively pursuing overseas acquisitions. More recent examples include KNOC's (A1/Stable) acquisition of Harvest Energy (Ba2/Stable) in Canada, CNOOC Ltd's (A1/Positive) investment in the Latin American company Bridas Corporation, and Sinopec's (not rated) US$4.65 billion investment in the oil sands project in Canada.

Such investments strategically enable reserve accretion and increased operating diversity. Nonetheless, high acquisition costs and limited experience abroad are potential challenges companies face when engaging in these cross-border investments. Furthermore, more investments coupled with rising costs will further escalate F&D costs, continuing the trend of the past several years.

High execution risks and rising appetite for investments in risky countries have weakened the credit profiles of some E&P companies. Because of the project execution and financial risks for their Iraqi investments, PETRONAS' A1 rating outlook was changed to negative, while Japan Petroleum Exploration Co Ltd (JAPEX) was downgraded to A2/Stable from A1/RFPD. Cost overruns to its major LNG expansion project by Woodside Petroleum Ltd have led to an outlook change to negative for its Baa1 rating.

Similar to other resources business, upstream E&P companies are subject to risk of regulatory changes. A change in tax regime in Kazakhstan has affected CITIC Resources Holdings Ltd's (Ba3/Stable) profitability of its major Karahanbas project.

The overall sound liquidity profiles of most investment-grade Asian E&P companies rated by Moody's provide a buffer to the sector's credit profile. Solid cash flow generation supports strong cash holdings for companies including CNOOC Ltd, JAPEX, PTT Exploration and Production Public Co Ltd (A3/Negative). Access to the bank and capital markets by most of these companies is also strong given that many are government-related entities.

Liquidity positions among non-investment grade E&P companies are weak. Certain bank loan covenants for CITIC Resources limit the company's financial flexibility, while PT Medco Energi Internasional Tbk (B2/Negative) faces refinancing risks with its several bank facilities subject to annual renewal.

For further details on the sector's issuers in the region, refer to Moody's previous regional outlook, available on www.moodys.com and published in March 2009, entitled, "Snapshot: Asia-Pacific (ex Japan) Oil, Gas, and Petrochemical Sectors".

For a global perspective, readers can access a report from March 2010, entitled, "E&P to Remain Under Pressure From Low Natural Gas Prices and Rising Service Costs".

In determining corporate ratings, Moody's uses its rating methodology on the global independent exploration and production industry, published in December 2008.

Hong Kong
Renee Lam
Vice President - Senior Analyst
Corporate Finance Group
Moody's Asia Pacific Ltd.
JOURNALISTS: (852) 2916-1150
SUBSCRIBERS: (852) 3551-3077

Sydney
Terry Fanous
Senior Vice President
Corporate Finance Group
Moody's Investors Service Pty Ltd
JOURNALISTS: (612) 9270-8102
SUBSCRIBERS: (612) 9270-8100

Moody's says challenges persist for Asian E&P sector
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