"Fitch expects that for many refiners, weaker, cyclicality-driven, FFO will be partly mitigated by implementation of more conservative financial policies with capital expenditure cuts and reduced cash distribution to shareholders," said Arkadiusz Wicik, Director at Fitch's Corporates team. "However, if the current downturn in refining proves to be more protracted, with longer and more severe deterioration in refiners' FFO than currently envisaged by the agency, it may put pressure on mid-cycle assumptions and hence the ratings of some refiners."
Out of the 13 refining companies rated by Fitch on an international rating scale, two European entities (Polski Koncern Naftowy ORLEN S.A. (PKN, 'BB+'/Stable) and The Rompetrol Group N.V. ('B'/Negative)) were downgraded by one notch since the refining downturn began. Currently, eight refining companies have a Stable Outlook while the remaining five are on Negative Outlook. The Negative Outlook mostly reflects high financial leverage and/or substantial capex programmes over the next few years in a weaker cash flow environment.
"The current downturn in the refining sector, which started in the US in 2008 followed by Europe and Asia in H109, may be more painful for refiners than the last trough in 2002," said Mark Sadeghian, Senior Director in Fitch's Corporates team. "Refiners are likely to consider the shutdown of smaller, less efficient and weaker-positioned refineries if the current weak margins and low utilisation rates persist." Fitch expects that Asian refiners may be exposed to particular cash flow pressure as new large capacity is commissioned in 2009 and 2010, targeting not only domestic markets but also exports, while regional demand for refined products is expected to decrease despite forecasted GDP growth in China and India.
Fitch believes that many new refinery or refinery upgrade projects, especially those in the planning stage, are likely to be substantially delayed or cancelled, as companies and sponsors review their capex plans amid the challenging market environment and more difficult and expensive external funding environment. The financing environment does appear to have improved somewhat in H109, as the bond market has increasingly opened up for investment-grade issuers in the US and Europe. In Asia, local funding markets have remained open, but international bond issuance is limited. Weak refined product market fundamentals may also lengthen the payback periods for recently completed projects that had been planned earlier in the cycle.
Additional market trends reflected in Fitch's mid-term forecast of refiners' cash flow include; the collapse in crude oil spreads between low-quality and high-quality crude oil since Q408, which has weakened the competitive advantage of more complex, deep-conversion refineries; and markedly lower diesel crack spreads affecting mainly European and some Asian refineries, given their high share of diesel in the refining product slate.
