The increase in tensions between the U.S. and Iran since May 2019 has not led us to change any ratings or outlooks on corporate or infrastructure issuers we rate in the Gulf Cooperation Council (GCC) region. This is because, under our base-case scenario, we do not expect direct military conflict between the two countries or their regional allies, and we believe that the Strait of Hormuz will remain open to the global oil trade.
We also identified two hypothetical stress scenarios, described in the Appendix below. Under our hypothetical modest stress scenario (Scenario 1), which we believe is unlikely at this stage, we could see some pressure on revenue generation and access to liquidity for certain industries, but we would expect any negative rating pressure to be limited. However, under a more severe hypothetical stress scenario (Scenario 2), which we believe is quite remote, we would expect to see more pronounced rating actions in our portfolio. For more details about these hypothetical scenarios and the assumptions we have made under them, see the Appendix and "Credit FAQ: How U.S.-Iran Tensions Might Affect Gulf Sovereign Ratings," published June 11, 2019, on RatingsDirect.
We currently rate 37 public corporate issuers and infrastructure transactions in the GCC. The outlook is stable on 33 of them, while we have negative outlooks on three entities, and one issuer is on CreditWatch with negative implications.
Below, we explore investor questions about how the evolving geopolitical volatility could affect ratings.
What is the operating outlook for GCC corporate and infrastructure issuers under your current base case?
While we don't expect the current geopolitical tensions to lead to any rating actions under our base-case scenario, we do expect corporates in some sectors to face some operating weakness arising from the geopolitical tensions.
The majority of our rated portfolio falls into four key sectors: oil and gas (including petrochemicals and oilfield services) represent around 38% of the portfolio, real estate 16%, utilities 14%, and telecom operators 11%. As we expect the Strait of Hormuz will remain open under our base case, we expect the operating conditions in the oil and gas sector to remain largely unchanged. The role of international investors is quite important for key real estate markets, such as Dubai, and the heightened geopolitical risk is not supportive of investor sentiment. Real estate prices in the region have already been on a downward trend for the past few years. Similarly, a prolonged period of heightened geopolitical risk in the region is likely to have revenue implications for the region's tourism and retail industries. Given the more stable nature of the telecom and utilities industries, we do not expect any meaningful change in their operating conditions.
What effect could a hypothetical moderate stress scenario have on the ratings of GCC corporate and infrastructure issuers in the region?
Under our first hypothetical scenario of modest stress (Scenario 1), which we view as unlikely as this stage, we would expect a relatively limited negative impact on the stand-alone performance and creditworthiness of GCC corporates. Almost half of the corporate and infrastructure issuers we rate in the GCC are government-related entities (GREs), where the issuer ratings are closely linked to the ratings on the relevant sovereigns (see chart 1). We would expect any sovereign rating actions would also affect the credit ratings on most associated GREs. The stronger an entity's link to, and role for the government, according to our GRE criteria, the more likely the ratings would follow that of the sovereign.
As we've already stated in our report "How U.S.-Iran Tensions Might Affect Gulf Sovereign Ratings," we believe Abu Dhabi, Kuwait, Qatar, and Saudi Arabia would likely be better cushioned against a further rise in geopolitical tension by their large stock of government external assets, while Bahrain and Oman appear to be more vulnerable.
In hypothetical Scenario 1, GCC real estate markets, which have already faced some headwinds over the past few years, would in our opinion likely experience some additional weakness, further squeezing revenues, margins, and loan-to value-ratios. However, given that most of the property developers we rate operate under the presale model and real estate leasing companies benefit from long-term lease contracts, we would expect them to be relatively resilient, and do not envisage significant rating changes in our portfolio under this scenario.
We expect the stand-alone performance of utilities companies would remain largely unchanged under hypothetical Scenario 1, given we don't expect significant weakening of demand. Power and water projects in the region often benefit from availability-based payments, independent of dispatch, which should also be supportive. We also would expect limited impact on telecom operators, based on past experience of regional conflicts as well as the significant existing debt capacity of many rated players. As long as there are no lasting disruptions in export flows, any potential increase in oil prices due to rising geopolitical risks is likely to result in a net positive impact on national oil companies and petrochemical players.
One emerging challenge for companies would be the potential outflows of funds from the GCC banking systems (see "A Sharp Increase In Geopolitical Risk Could See GCC Banks Require Sovereign Support," published July 8, 2019). In our opinion, in the absence of external government support in the form of liquidity injections, this would noticeably limit liquidity provided by the local banks to their corporate borrowers, particularly in Qatar. We would expect this to affect primarily lower-rated entities with weaker liquidity profiles. That said, we currently assess the liquidity position of more than 90% of our rated GCC corporate issuers as either adequate or strong. We therefore believe that most rated corporates in the GCC have liquidity cushions and funding profiles that would enable them to manage a tighter liquidity situation in a hypothetical Scenario 1.
How would a hypothetical more severe stress scenario affect issuer ratings?
Under the second, more severe hypothetical scenario that envisages the Strait of Hormuz being closed for an extended period (Scenario 2), which we believe is quite remote at this time, we would expect more pronounced negative ratings actions. This could be triggered by potential negative sovereign rating actions as well as the deterioration in the stand-alone performance of the companies we rate.
The Strait of Hormuz is used as a main transportation route by corporate issuers based in Qatar, the United Arab Emirates (UAE), Bahrain, Kuwait, and Saudi Arabia that operate in the oil and gas upstream and downstream activities and commodity sectors. As a consequence, oil and gas, polymer, fertilizer, and aluminum exports pass through the Strait, along with imports of raw materials such as iron ore, bauxite, and copper. The Strait is also an important conduit for the import of soft commodities (food supplies).
Of the sectors we focus on, the most at risk of weakening stand-alone creditworthiness would be oil and gas, petrochemicals, and real estate. We think utilities, power and water projects, and telecom operators would be the least impacted, unless the physical infrastructure became a target of the conflict, like in Iraq.
Given the potentially higher level of outflows from the GCC banking systems, we would also expect to see more pronounced changes in the local liquidity available for the region's corporates, which could also create a squeeze on some of the entities we rate. In such a scenario, we would expect some GREs to generally fare much better than privately owned counterparties because they would potentially receive funding support from their respective governments.
In this hypothetical scenario 2, any companies that rely on exports through the Strait of Hormuz would be severely negatively affected since this would most certainly result in disruptions in deliveries and additional cost in seeking alternative delivery routes (truck or air freight). This would be detrimental to Kuwait, Bahrain, Qatar, and to a lesser extent Saudi Arabia and the United Arab Emirates, both of which have export pipelines and alternative ports on the Red Sea and Gulf of Oman coasts that should cushion the blow somewhat. The tourism, hospitality, and aviation industries would be severely affected, with airlines halting flights to the region, and retailers would be hit by a fall in discretionary spending.
We would expect residential price and rentals in the region to decline sharply. For residential developers, even those that rely on the presale model, we would expect an increase in customer defaults, a renegotiation of prices with existing customers, and cancellation or delay of development projects. Real estate companies exposed to speculative property development would be the most severely hit. Those companies focused on leasing of commercial assets (offices and malls) might be relatively better positioned, depending on their lease structures and tenors.
Are there any factors that could alleviate the impact of any escalation of the conflict on corporate or infrastructure issuers?
First of all, we anticipate that certain governments in the Gulf would provide financial support to their key assets.
Alternative shipping routes, as discussed earlier, could also lessen the impact of a closure of the Strait of Hormuz. Yet, in the event of a prolonged closure, downstream oil and gas and petrochemicals companies are unlikely to find alternative export routes due to the size of their production volumes. Logistics and infrastructure bottlenecks would in our view only allow for a comparatively small share of production to be exported, even though the likely resulting spike in oil and petrochemicals prices may offset higher transport costs. Some alternative arrangements could include trucking products to the west of Saudi Arabia (Yanbu at the Red Sea, for example) or to the east, to the port of Fujairah, and maximizing the capacity of the East-West pipeline in Saudi Arabia and the ADCOP crude pipeline to Fujairah.
Appendix Two Hypothetical Stress Scenarios
Scenario 1: Unlikely at this stage
Scenario 2: Quite remote at this stage
Under scenario 1, we envisage credible threats to block the Strait or even a blockage put in place for a few days. As in the past, when closure threats were made by Iran, we believe international pressure would quickly be brought to bear or, alternatively, there might be a military skirmish. Either way, due to the Strait's international significance, we would expect the threats to subside and any blockage to be resolved relatively quickly.
The Strait of Hormuz is a critical shipping route for almost one-third of the world's seaborne crude oil supplies. The vast majority of hydrocarbon exports from Saudi Arabia, Qatar (LNG), Abu Dhabi, Kuwait, Iraq, and Bahrain pass through the Strait. Oman, being outside the Strait, would not have its non-Gulf exports physically blocked by a Strait closure.
Under scenario 2, we envisage the Strait of Hormuz being closed for an extended period.
- How U.S.-Iran Tensions Might Affect Gulf Sovereign Ratings, June 11, 2019
- A Sharp Increase In Geopolitical Risk Could See GCC Banks Require Sovereign Support, Jul 08, 2019)
- Industry Report Card: GCC Capital Market Issuance Should Bounce Back This Year Following A Brief Lull In the First Quarter, April 8, 2019
- Dubai Real Estate Downturn To Continue: Projections And Ratings Impact, Feb 18, 2019
- See our latest oil podcast: https://www.spratings.com/en_US/video/-/render/video-detail/commodities-and-credit-podcast-4-july-2019
This report does not constitute a rating action.
|Primary Credit Analysts:||Timucin Engin, Dubai (971) 4-372-7152;|
|Tommy J Trask, Dubai (971) 4-372-7151;|
|Secondary Contacts:||Sapna Jagtiani, Dubai + 97143727122;|
|Sofia Bensaid, Dubai;|
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