Fitch Assigns First-Time ‘BBB+’ IDR to Petroleos del Peru S.A. – Petroperu S.A.

Link to Fitch Ratings' Report: Petróleos del Perú – Petroperú S.A.

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=876328

Fitch Ratings has assigned the following ratings to Petroleos del Peru S.A. - Petroperu S.A. (Petroperu):

--Foreign Currency (FC) long-term Issuer Default Rating (IDR) 'BBB+';

--Local Currency (LC) long-term IDR 'A-'.

The Rating Outlook is Stable.

PetroPeru's ratings reflect its ownership by the Peruvian government, the company's strong strategic ties with the state, and its strategic importance to assure the country's energy supply. As a state-owned company, PetroPeru's FC IDR is strongly linked with the credit profile of the Peruvian sovereign (FC IDR 'BBB+', LC IDR 'A-', Outlook Stable). The government support has been evidenced through multiple recent actions including the decrees promulgated to transfer all the company's pension liabilities to the state, and recover the value added tax (IGV for its Spanish acronym) for the company's operations in the Amazonian region. This has been further evidenced as the Republic of Peru has provided a financial guarantee of up to USD 1 billion to support the financing of the Talara project.

KEY RATING DRIVERS

Government Support: PetroPeru's ratings reflect its strong linkage with the government of Peru (FC IDR 'BBB+', Outlook Stable). It is a stated-owned entity that is crucial to the national energy matrix given it is the largest hydrocarbon refiner in Peru, and its five refineries are strategically located throughout the country.

Government Financial Guarantee: The company's credit linkage to the sovereign is further evidenced by the explicit support of the government through a financial guarantee for up to USD1 billion to support the financing of the modernization of the Talara refinery (PMRT).

Weak Capital Structure: Absent government support, PetroPeru's credit metrics are not consistent with the assigned rating. As of LTM ended Sept. 30, 2015 the company reported total debt of USD1.07 billion and total net debt/EBITDA of 5.6x compared with 18.7x in 2014. Fitch believes the company will be required to incur additional debt to finance the PMRT, potentially increasing Petroperu's leverage above 9.0x until the project is finalized. Talara's refining margins for 2014 and June 2015 stood at USD6.9/barrel and USD10.26/barrel respectively, compared with USD3.35/barrel, and USD7.24/barrel of Brent cracking.

Cash flows Under Pressure: PetroPeru's cash flow generation is expected to remain under pressure from Peruvian Sol depreciation and the decline in oil prices, exacerbated by the company's ambitious capex plan related to PMRT. Negative FCF is expected for the next couple of years as a result of compressed margins and aggressive capex investments.

High Volatility Sector: PetroPeru's sales prices are set based on international crude oil and derivatives prices and exposed to the cyclicality and volatile nature of the industry. Refining is subject to periods of boom and bust, as well as sharp swings in crack spreads depending upon market conditions. The last major bust period was 2008-2009, when collapsing oil prices and lagging costs led industry margins to collapse. Crack spreads have significantly improved in 2015 due to the decrease of oil prices and higher margins in realized prices for crude and oil products.

Political Risk: PetroPeru is exposed to different changes in the Peruvian Technical Normativity, as occurred in 2010 with the prohibition of commercializing diesel with more than 50ppm of sulfur in Lima and Callao and then extended to other regions. This norm affected PetroPeru's cost of sales, (+12% YoY in 2013) and led the company to decide to invest USD2.7 billion in Capex for the PMRT, including the expansion of the refinery and the inclusion of the desulfurization unit. The total investment of the PMRT, including pre-operative interest and fees is USD 4 billion.

KEY ASSUMPTIONS

--Petroperu's ratings assume the implicit support from the government would materialize should the company need it;

--WTI oil prices of $50/bbl in 2015, $50/bbl in 2016, and $60/bbl in 2017;

--2015-2018 capex of $3.5 billion mainly related to the modernization of the Talara refinery;

--Crack spreads that revert to inflation adjusted historical averages over the forecast period;

--Additional debt issuance of $2.5 - $3 billion

RATING SENSITIVITIES

Negative Actions: A negative rating action could be triggered by a downgrade of the sovereign's rating, the perception of a lower degree of linkage between PetroPeru and the sovereign, and/or a substantial deterioration in the company's credit metrics.

Positive Actions: An upgrade of PetroPeru could result from an upgrade of the sovereign coupled with a continued strong operating and financial performance.

LIQUIDITY

Petroperu's liquidity position is considered weak for the rating level. As of Sept. 30, 2015 PetroPeru had USD35 million in cash and cash equivalents compared with approximately USD600 million (PEN1.837 billion) of short-term debt. The company's liquidity position and exposure to refinancing risk is mitigated by the company's government support and the potential refinancing of the short-term debt.

Date of Relevant Rating Committee: Dec. 17, 2015

Additional information is available on www.fitchratings.com.

Applicable Criteria

Corporate Rating Methodology - Including Short-Term Ratings and Parent and Subsidiary Linkage (pub. 17 Aug 2015)

https://www.fitchratings.com/creditdesk/reports/report_frame.cfm?rpt_id=869362

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=997670

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