OREANDA-NEWS. Fitch Ratings says there is no immediate rating impact on Australia-based Woodside Petroleum Ltd (Woodside; BBB+/ Stable), from its non-binding bid for Oil Search Limited (Oil Search).

On 8 September 2015, Woodside confirmed it had provided Oil Search with a confidential and non-binding proposal to merge through a scheme of arrangement under the Papua New Guinea (PNG) Companies Act. Oil Search shareholders will receive all shares consideration of one Woodside shares for every four Oil Search shares and become shareholders of the combined entity.

Fitch notes that Oil Search's initial response was to consider the proposal, however, there is no certainty that this offer and these discussions will result in a transaction. The proposal is also subject to regulatory approvals from the PNG government and satisfactory due diligence, should there be an agreement on the final terms by both companies.

The rating impact of such a proposal would ultimately depend upon the final terms of an agreed offer. Fitch would assess the potential impact on Woodside' operating and financial risk profile, including the increased earnings exposure across a weaker geo-political jurisdiction, Oil Search's relatively more aggressive financial profile, and future capital requirements.

Oil Search has high EBITDA-leverage of about 3.5x - relative to less than 2x for Woodside. The merger would result in deterioration of the merged entity's financial risk profile. Woodside's rating could come under pressure as it already has reduced headroom within its 'BBB+' from lower cash flows from liquefied natural gas (LNG) amid low oil prices and the debt-funded acquisition of Apache Corporation's (Apache, 'BBB+'/Stable) equity in two LNG projects in April 2015. Woodside faces lower oil-linked LNG revenues in FY15 amid the low oil price environment and lagged effect of oil prices which is typical of Asian LNG contracts.

Woodside, however, stands to benefit from increased operational and earnings diversity from the merger, in particular, from Oil Search's 29% interest in the 6.9 million tonnes per annum PNG LNG facility, which has been in operation since May 2014. Oil Search's FY15 production guidance is 26 million barrels of oil equivalent (mmboe) to 28mmboe, including about 21 mmboe from the PNG LNG facility. Fitch notes that the PNG LNG facility is an attractive cost-competitive LNG production facility, which will benefit further from brownfield expansion. The transaction, however, would increase Woodside's exposure to increased geo-political risks.

Fitch previously noted that Woodside has a sizeable development programme of gas resources located in the north and north-west of Australia. Exploration capex is also expected to remain high as Woodside ramps up presence across a number of locations in Africa, Asia and Europe. Uncommitted growth capex remains sizeable in the medium term. Fitch may take a negative rating action if Woodside's adjusted net funds from operations (FFO) leverage rises above 2.5x, and FFO fixed charge coverage falls below 5.0x, both on a sustained basis (0.5x and 8.8x respectively for FY14). Fitch will treat a commitment to any significant debt-funded project as a rating event.