Strong cash flow, low leverage, capital expenditure, and an abatement strategy. These attributes mean the 13 oil and gas producers we rate in Asia-Pacific are well placed to preserve their creditworthiness during the transition to a world of net-zero emissions. Demand for their products will persist for the foreseeable future.

How they adapt to the transition is not without risks--regulatory, technological, and refinancing. Abatement strategies are not final; there is potential for stranded assets; and the volume of long-dated debt is high. These factors could bite if the transition takes unforeseen turns.

Long-Dated Debt Exposes Investors To Risks From Changes In Business Models

The transition to a low-carbon economy creates challenges for the business models of Asia-Pacific oil and gas companies. Much of the substantial debt issued by them is very long-dated. And while positive for the issuers because it reduces refinancing risks, it nevertheless creates inherent exposure to the energy transition for debt investors (see chart 1).

At the extreme, Thailand-based producer PTT Public Co. Ltd. has a US$700 million issue maturing in 2070 and a US$100 million tranche maturing in 2110. Other oil and gas issuers in Asia-Pacific have debt maturing in the 2040s and 2060s whereas they have set their Scope 1 and 2 net-zero targets at 2050 or 2060.

Chart 1

Investment-Grade Credit Profiles Imply Resilience And Support

Low leverage and strong cash flow mean we consider these companies to be well placed to sustain creditworthiness and manage the long-dated refinancing risks embedded in their capital structures.

Eleven of the 13 issuers have stand-alone credit profiles that are investment grade. These credit profiles incorporate our view of the resilience of these businesses to manage economic challenges, including the energy transition. Healthy balance sheets will also support these issuers as they invest to decarbonize and defend their market competitiveness in the net-zero world.

This group includes 10 national oil companies (NOCs), all of which have investment-grade issuer credit ratings. The ratings factor in extraordinary credit support from their governments, as measured by adjustment of 1-8 notches from their stand-alone credit profiles (see table 5 in the Appendix). Independent of government support, most of the NOCs have stand-alone credit profiles that are typically investment grade.

Also investment grade are the two investor-owned Australian companies Woodside Energy Group Ltd. and Santos Ltd., which sell mostly into Asia, contributing to regional energy security.

As the energy transition unfolds, the role these companies play in their respective economies could evolve. For example, a NOC that fails to adapt to the net-zero world might lose its market advantage and competitiveness; consequently, diminished relevance to the country's energy policies could lead to changes in the level of extraordinary government support.

Crucial Role Of Issuers Gives Them Time To Adapt

Material demand for oil and gas in Asia will persist. S&P Global Commodities Insights projects that substantial demand for hydrocarbons is likely to exist up to 2050.

Chart 2

Apart from power, another demand-factor that suggests oil and gas issuers have time to adapt is their role in providing feedstocks for the petrochemical industries. For example, Malaysian NOC Petroliam Nasional Bhd. (Petronas), Thai NOC PTT, and China National Petroleum Corp. (CNPC) have vertically integrated operations that provide feedstock for their petrochemical businesses. PTT sells about 12% of its natural gas and byproducts as petrochemical feedstocks.

Robust Balance Sheets Equal Capacity To Adapt

Several balance-sheet factors underpin the credit strength of Asia-Pacific oil and gas producers we rate. These include:

• Their underlying size;
• Production profiles;
• Reserve base;
• Robust cash flow; and
• Ability to maintain relatively low leverage.

Additionally, issuers have used the strong oil prices of the past two years or so to deleverage. Some have repaid large amounts of debt. Cumulative adjusted debt in the Asia-Pacific oil and gas sector has declined by about US$65 billion from 2019 to US$125 billion in 2023. China National Offshore Oil Corp. (CNOOC) and Petronas essentially operate with net cash. Consequently, for most issuers across the region we see debt-to-EBITDA ratios averaging at about 2.5x

Chart 3

Additionally, rated issuers' strong cash flow generation and relatively low leverage will provide some buffer as the producers invest to address the energy transition and navigate the consequent changes in their business models. At the same time, they will fulfill their debt and interest payment obligations, and distribute shareholders returns. This strong cash flow means that issuers could potentially repay their outstanding debt.

Chart 4

Chart 5

In the case of NOCs, their ability to generate strong cash flow is a key attribute of their stand-alone credit profiles. This is because, compared with privately owned companies, NOCs have less flexibility in how they use cash, in our view. It's somewhat of a juggling act. NOCs are expected to allocate capital according to the multiple objectives set out by their respective governments. These include:

• Ensuring energy security;
• Ensuring steady dividend payments to fund government programs; and
• Ensuring contribution to national decarbonization and energy transition plans.

Another factor that supports our view of the creditworthiness of rated NOCs is their steady sales volume. This is backed by dominant market share in their respective countries, ranging from 30% to more than 50%. Such steady sales will support aggregate operating cash flow generation of about US$150 billion-US$160 billion annually from 2024 to 2026.

The Pace of Decarbonization Also Depends On Shareholders

Notwithstanding the primacy of energy security and reliability, NOCs in Asia-Pacific will play a crucial role in helping their respective countries meet net-zero targets in the next 25-35 years. We note that all the rated entities, including the NOCs, are committed to Scope 1 and Scope 2 decarbonization targets, albeit with varying degrees of ambition (see table 1).

However, the commitment to reduce Scope 3 emissions seems to be pale in comparison across all rated entities and their sovereign states.

Table 1

The decarbonization goals of rated NOCs vary from being in line with to being slightly more aggressive than their respective countries' net-zero commitments (see table 1). Among the factors that will determine each country's pace of and willingness for decarbonization are:

• Energy security;
• Meeting domestic energy demand; and
• The availability of fossil energy in their home countries.

CNPC and Indonesia-based Pertamina (Persero) PT, for example, set their net-zero target as 2060--about a decade later than that of their regional peers. For both entities, this reflects the Chinese and Indonesian governments' priority of national energy security; in the case of Pertamina, it also incorporates the company's public service obligation in providing subsidized fuel in Indonesia.

Non-NOCs such as Woodside and Santos are under more pressure from shareholders and investors to decarbonize their operations, in our view. We note that these two Australian issuers are at a more advanced stage than their regional peers when it comes to decarbonization projects.

Stranded Assets Become Front-of-mind Risk For Many Producers

The decarbonization goals of the issuers and their respective sovereign governments may put carbon-intensive projects at risk of becoming stranded assets. More aggressive decarbonization-related regulations and policies could heighten this risk.

Incorporating decarbonization plans into the development of their fossil resources will be a key focus of oil and gas companies, in our view. We believe this is likely the first strategy most producers will pursue on their decarbonization journey, given that any delay may reduce the prospect of these assets being monetized.

Table 2

While stranded asset risks may emerge in the future, with at least two decades away from their carbon emissions reduction goals and the need to ensure their countries' energy security, the primary capex focus of Asia-Pacific issuers remains their traditional hydrocarbon businesses. We project annual spending of US$110 billion over the next three years. The three Chinese entities account for about 70% of this amount. Examples of major projects include CNPC's projects to develop domestic basins in Songliao, Tarim, and Sichuan; and Japan-based Inpex Corp.'s Ichthys liquefied natural gas (LNG) terminal project in Australia.

A key strategy to decarbonize the carbon-intensive assets is carbon capture and storage (CCS), and carbon capture utilization and storage (CCUS) technology. While all rated producers are exploring commercial arrangements and suitability of projects, some are further ahead. Santos's development of its Moomba CCS project is well advanced, and the company expects a first injection in the third quarter of 2024.

Evolution To Decarbonization Begins With Non-Hydrocarbon-Related Capex

Aside from investment to develop traditional assets, companies are investing 10%-15% of their committed capex, on average, in new net zero carbon emission or renewable projects on low-carbon energy projects over the next five years.

Chart 6

Table 3

We note that the current estimated spend among rated issuers for new and renewable projects can vary widely and that generally the current committed capex to such projects remains considerably lower than each respective company's budgeted spend.

Diverting away from the petroleum and energy business is another strategy that oil and gas producers are considering to adapt to the transition. Some producers--especially those with integrated downstream business--have entered the electric vehicle (EVs) sector. In a more extreme case, a few producers aspire to expand into entirely different industries. PTT, for example, has invested in life science and pharmaceutical businesses in the past three years to reduce its reliance on petroleum-based revenue over the next decade.

Not All Green Projects Will Turn A Buck

The challenge rated producers face is simultaneously netting off their carbon emissions and incrementally transforming their business models while continuing to operate highly profitable fossil assets.

The flipside to pledging large amounts of capital to net-zero projects is the potential for lower returns. The case of Woodside is instructive. Its internal rate of return hurdle for oil projects is greater than 15% with a five-year payback. In contrast, the requirements for gas and new energy projects are, respectively, greater than 12% and seven years; and greater than 10% and 10 years.

Woodside is exploring non-hydrocarbon opportunities and has committed to spending US$5 billion on new energy projects by the end of the decade. However, even at these lower returns that reflect lower capital requirements and more stable returns, it has yet to commit material levels of capital to any major new energy projects.

Risks That May Hasten The Transition Deadline

Several evolving risks could shorten the adaptation period thereby affecting the business risk profiles of oil and gas companies we rate. Trends that may affect structural supply and demand for hydrocarbons and accelerate the energy transition in the region include:

Regulatory pressure on more ambitious climate policies in the region.  They may align their decarbonization targets to the 2050 target of most of the developed economies.

Potential expansion of carbon tariffs such as a cross border adjustment mechanism.  As nations with more aggressive decarbonization timelines increasingly progress, it is unclear to what extent they will impose more draconian carbon tariffs.

Technological risks.  Any material structural cost differential that emerges between renewables and hydrocarbon-based energy sources may not only compress timelines for adaptation but spur more competition for oil and gas companies. For instance, we note the rapid evolution of battery companies with respect to energy density and cost and the convergence to price parity of EVs to internal combustion engine models.

In addition, increased use of storage to support renewable electricity could narrow the gas bridge between coal and renewable power. Accordingly, companies that trail in their evolution could lose share in energy-supply markets.

Refinancing and access to capital.  While we see no immediate shortage of capital in Asia, including debt financing, some lenders are scaling back or are no longer willing to support the fossil fuel industry. Moreover, getting funding for industries that rely on fossil fuels is becoming more uneven across countries. This is because regions are moving toward net-zero goals at different speeds.

This trend is becoming more visible between developed and emerging markets. In our view, in coming years, an absence of a credible decarbonization strategy may attract a risk premium to debt funding--if not fewer willing lenders.

Since most climate-risk investments in the Asia-Pacific are still in the early stages, it's hard to predict which companies will succeed or fall behind in the next decade.

Creditworthiness is no guarantee of a smooth transition but it's a crucial building block.

Appendix

Table 4

Table 5

Writer: Lex Hall

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