July 29, 2016 - 2:45 PM EDT
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Fitch Affirms Pan American Energy's IDR at 'B+'; Upgrades Bonds to 'BB-/RR3'

Fitch Ratings has taken the following rating actions on Pan American Energy LLC (PAE):

--Long-Term Foreign Currency (LT FC) Issuer Default Rating (IDR) affirmed at 'B+'; Outlook Stable;

--Long-Term Local Currency (LT LC) IDR upgraded to 'BB' from 'B+'; Outlook Stable;

--Pan American Energy LLC Sucursal Argentina's (PAME) senior unsecured notes due 2021 upgraded to 'BB-/RR3' from 'B+/RR4'.

The PAME notes' above-average Recovery Rating of 'RR3' reflects good recovery prospects in the event of default given the company's solid balance sheet and cash flow generation. Fitch believes that a default, should it occur, would most likely be driven by transfer and convertibility restrictions imposed upon the payment of foreign debt, not by a material deterioration of the company's business or financial profile.

The upgrade of the LC IDR reflects the company's protections against sovereign turbulence, as historically a significant portion of the company's revenues has been related to exports. Fitch expects the company's export volumes will continue to represent approximately 30% of the company's total oil production. PAE's significant proportion of exports, strong foreign parent ownership, robust liquidity position, coupled with the country's capital investment needs in the sector support the company's LC IDR.

Fitch believes an exporter would likely do significantly better than a company more dependent on the local economy in a scenario of a sharp devaluation with both issuers having FC debt to service. An exporter generally competes on a global basis and usually benefits from a depreciating local currency, which could lower its cost structure and reduce the burden of its LC debt obligations.

The FC IDR, one-notch-higher than the country ceiling of Argentina, is supported by Pan American's reliable strong cash flow generation, dollar-denominated export revenues relative to total debt, ownership by a strong parent, and a good track record of payment during stressed sovereign scenarios. Positively, Pan American has ample liquidity and proven access to the financial markets.

KEY RATING DRIVERS

The primary factor negatively impacting PAE's ratings is its exposure to political interference in Argentina. Companies face a volatile domestic business environment and inflationary pressures on their cost structures. In comparison with its Argentine peers, PAE's ratings are supported by its stronger business position, large reserves base, low leverage and strong operating performance.

EXPOSURE TO GOVERNMENT INTERFERENCE

The Argentine government has a history of significant interference in the oil and gas sector. Via Decree No. 1277, the government set regulations related to investment levels in the oil and gas sector and domestic price reference points. In 2012, via Law No. 26,741, the government nationalized Argentina's largest energy company, YPF S.A. Although in recent years, government regulations maintained domestic crude oil prices significantly below world prices, these same regulations have kept Argentine crude oil prices above global prices, despite the global price decline seen during the last year.

SLIGHTLY POSITIVE REGULATORY CHANGES

Given PAE/PAME's large oil export program, the global oil price decline has had a negative impact on the company's export sales; recent government moves have been positive in this regard. Under the Crude Oil Production Stimulus Program implemented in February 2015, the Argentine government agreed to provide an export stimulus of up to USD3/barrel of oil (bbl) exports for companies participating in the program when the company's quarterly production of crude oil is equal or greater than the base production level under the program (December 2014 is the baseline). If the beneficiary companies manage to satisfy all the demand of all of the domestic refineries, then they can export this petroleum and receive an additional payment equivalent to USD2- USD3/bbl. During 2015, the company received USD71.3 million under this program for sales in the first six months of that year. In the past, when international prices were high, Argentine producers were subject to an export price cap of USD70/bbl.

Additionally, during 2015 and as a response to the decline in international oil prices, the government reduced the export taxes to 1% from the 11% - 13% that was applied in the past.

Fitch believes the recent export stimulus plan approved in 2016 is an effort by the Macri administration to compensate upstream players for the windfall taken by the previous administration during the high oil price environment. Res 21/2016 was further implemented by the government in an attempt to protect upstream producers from cutting jobs that could have hurt the national economy as well as the provinces that rely on oil and gas production. Under this stimulus plan, exporters would receive USD7.5/bbl from the national government and USD2.5/bbl from the province when Brent is below USD47.5/bbl or USD47.2/bbl, respectively. As oil prices recover, this stimulus plan will have a negligible positive impact on the company. Fitch believes more flexible regulations removing export controls would benefit the industry; these changes are not expected at least in the short term.

STRONG BUSINESS POSITION

Pan American has a strong business position in the Argentine market and its credit metrics are expected to remain strong. Ownership by a strong parent, reliable cash flow generation, and significant levels of exports support PAE's LT FC IDR, which is rated one notch above Argentina's country ceiling. PAE is 60% owned by BP (rated 'A'/Stable Outlook) and 40% owned by Bridas Corporation (Bridas). Bridas is 50% owned by Bridas Energy Holdings Ltd (BEH) and 50% by China National Offshore Oil Corporation Limited (CNOOC, rated 'A+'). During 2015, approximately 30% of PAME's oil volume was exported, representing 21% of the company's revenues. PAME's export revenues decreased to USD0.8 billion from US$1.7 billion in 2014 as a result of depressed international hydrocarbon prices.

Historically, PAME's exports have represented between 40%-55% of the company's revenues. Fitch expects this trend to continue as international prices recover. PAME's historical exports compare favorably to its long-term debt maturities. In addition, the company has a track record of meeting payments during stressed sovereign scenarios.

PAE's gas production for 2015 represented 50% of its total production. Fitch believes that due to a more favorable environment for natural gas prices in Argentina, PAE's business position will further strengthen.

LARGE RESERVE BASE AND STRONG CAPITAL STRUCTURE

As of December 2015, PAME was Argentina's largest proved reserves holder, with oil and gas reserves of 1.55 billion barrels of oil equivalent (boe), of which 66% is oil, equivalent to 16 years of production (22 years for oil, 11 years for natural gas). PAME's leverage is low at approximately USD1.85 of debt per barrel of proved reserves as of December 2015. The company has historically increased reserves and production volumes sustainably, despite operating in a challenging environment.

STABLE PRODUCTION

As expected by Fitch, the company's production remained stable despite a double-digit inflation rate and a difficult economic climate in Argentina, with average production of 244,200 boe/d in 2015 (up 6% year-over-year). Approximately 50% of the company's production and 70% of its revenues were related to oil. During 2015, the company increased its capex investments by 13% in dollar terms, maintaining a reserve replacement ratio of 135% for the year. Fitch expects 2016 production levels to remain flat with a 2%-3% increase in production for 2017-2019.

FINANCIAL STRENGTH CONTINUES

PAE's ratings reflect the company's robust metrics and Fitch's expectations for low leverage during the next three years despite increased capex needs. As of the last 12 months ended March 31, 2016, PAE's EBITDA remained relatively flat at US$1.9 billion compared with 2014. EBITDA margin of 50.7% was up from 33.5% in 2012. Fitch is conservatively assuming annual capex to amount USD1.5 billion - USD1.8 billion over the next three years, with gross leverage to remain below 1.0x.

KEY ASSUMPTIONS

Fitch's key assumptions within the rating case for PAE include:

--Production growth in the low single-digits per year;

--Long-term energy prices converge with world prices over the next five years;

--EBITDA margins remain at an average of 50%;

--Conservative annual capex USD1.5 billion- USD1.8 billion;

--Gross leverage metrics below 1.0x in the short- to medium-term.

RATING SENSITIVITIES

PAE's ratings could be negatively affected by a combination of the following:

--Argentina's credit quality deterioration;

--A material increase in the government's interference in the sector;

--Total Debt/EBITDA greater than 3.5x and EBITDA/interest coverage below 4.5x could be viewed negatively.

An upgrade of Argentina's ratings and country ceilings may result in a positive rating action.

LIQUIDITY

ADEQUATE LIQUIDITY: PAME's total cash and equivalents amounted to approximately USD235 million as of March 31, 2016, which is approximately 30% of short-term debt totalling USD571 million. Given the company's strong operational track record along with strong parent company support, Fitch does not anticipate any difficulties for the company in tapping local debt markets in order to refinance short-term debt.

FULL LIST OF RATING ACTIONS

Fitch has taken the following rating actions:

PAE

--LT FC IDR affirmed at 'B+';

--LT LC IDR upgraded to 'BB' from 'B+'.

PAME

--International senior unsecured bond ratings upgraded to 'BB-/RR3'.

The Rating Outlook for the IDRs is Stable.

Date of Relevant Rating Committee: July 28, 2016

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

Additional Disclosures

Dodd-Frank Rating Information Disclosure Form
https://www.fitchratings.com/creditdesk/press_releases/content/ridf_frame.cfm?pr_id=1009730

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https://www.fitchratings.com/gws/en/disclosure/solicitation?pr_id=1009730

Endorsement Policy
https://www.fitchratings.com/jsp/creditdesk/PolicyRegulation.faces?context=2&detail=31

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Fitch Ratings
Primary Analyst
Cinthya Ortega, +1-312-606-2373
Director
Fitch Ratings, Inc.
70 W. Madison St.
Chicago, IL 60602
or
Secondary Analyst
John Wiske, +1-212-908-9195
Analyst
or
Committee Chairperson
Lucas Aristizabal, +1-312-368-3260
Senior Director
or
Media Relations, New York
Elizabeth Fogerty, +1-212-908-0526
[email protected]


Source: Business Wire (July 29, 2016 - 2:45 PM EDT)

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