Baku, Azerbaijan, July 29
Fitch Ratings has affirmed OAO Gazprom's Long-term foreign currency Issuer Default Rating (IDR) at 'BBB'. The Outlook is Negative and capped by Russia's sovereign Outlook.
Gazprom's ratings reflect forecasts that Gazprom will remain a vital gas supplier to Europe despite competitive and political pressures. European off-takers are presently limited in their ability to diversify gas imports as Europe is coping with declining indigenous gas production and high global LNG prices. Gazprom has sufficient headroom to finance new projects eg, the Eastern Gas Program to develop East Siberia's gas fields and supply gas to China and the APAC region, as well as the new LNG plants, without putting stress on its rating. Fitch believes that the new projects should secure the sustainability of the company's operations in the long term through export diversification to burgeoning Asian gas markets.
Gazprom is Russia's largest state-owned energy company, engaged in natural gas production, transportation and distribution, as well as crude production and refining, heat and electricity generation. In 2013, Gazprom produced 488 billion cubic meters (bcm) of natural gas and generated RUB2,068bn (USD63,187m) in EBITDA. Its end-2013 funds from operations (FFO) adjusted net leverage was 0.7x, meaning it has remained one of the least leveraged oil and gas companies in the world.
KEY RATING DRIVERS
Strong Operating Profile
Gazprom's ratings reflect its strong operations. It accounts for 15% of the world's natural gas production and meets nearly one-third of Europe's gas demand. It benefits from low lifting costs, and a high reserve life and replacement rate. Fitch believes that Gazprom's increasing sales diversification into China and LNG would enhance its business profile in the medium term. Gazprom currently has an exclusive right to export pipeline natural gas from Russia. The Russian government is now considering allowing other companies to export gas from fields in Eastern Siberia and the Far East, but Fitch believes it should not affect Gazprom's monopoly on selling pipeline gas to Europe.
CNPC Deal Diversifies Exports
In May 2014, Gazprom and China National Petroleum Corporation (CNPC, A+/Stable) announced the 30-year 38bcm per year gas deal worth USD400bn with first supplies expected in 2018-2020. The gas price is believed to be linked to the oil product prices, similar to European contracts, and the base contract price was not disclosed and is estimated in the range of USD350/mcm to USD400/mcm. This compares well with an average USD378/mcm price that Gazprom received from European off-takers in 2013. According to Gazprom, the respective capex may reach USD55bn and Fitch believes it will be financed from a combination of operating cash flow and borrowed funds, as well as possibly a yet undetermined USD25bn prepayment from CNPC, which Fitch is likely to treat as a debt-like instrument, depending on yet undisclosed terms and conditions.
Strong European Demand Helps
In 2013, Gazprom's exports to Europe increased 15% to 160bcm, or around 30% of total gas consumption in Europe. In 2004-2013 EU's indigenous gas production fell by 53bcm or 17%, mainly in the UK, while Norway's incremental 30bcm over the same period was insufficient to offset the UK's output fall. Gazprom's 1H14 exports to Europe increased by 2.5% yoy despite a relatively mild 2013/14 winter. For 2014, Fitch expects strong exports depending on weather conditions during the rest of the year.
There are several factors that help Gazprom maintain its market share in Europe. They include Europe's declining indigenous gas production, troubles in North Africa, Europe's traditional alternative gas supplier, and high LNG prices in Asia that contributed to the drop of European LNG imports in 2013 on 2012. Fitch believes that presently Europe has a limited ability to diversify away from the Russian gas. Further escalation of the Ukrainian crisis might result in short-term negative pressures on Gazprom's exports to Europe eg, by diverting some LNG from the premium Asian market to Europe, although this is currently not our rating case and Fitch does not believe it will significantly affect Gazprom's position over the medium term.
Pressure on Gas Pricing Continues
In May 2014 Italy's Eni SpA (A+/Negative) became the latest European utility to report an agreement with Gazprom to lower gas prices and change some other contractual terms, including indexation of gas prices to those of oil products to 'fully align it with the market'. While Fitch anticipates continued pressure from off-takers on gas pricing and other contract terms, such as take-or-pay volumes, agency believes that Gazprom has sufficient flexibility to accommodate some additional concessions to buyers without jeopardising its credit metrics.Fitch forecasts declining European gas export prices in line with declining oil price deck for Brent of USD96 per barrel of oil (bbl) for 2014, USD91/bbl for 2015, USD85/bbl for 2016 and USD80/bbl thereafter.
Domestic Market Under Pressure
In 2013, Gazprom's domestic sales dropped to 234bcm, down nearly 10% on already depressed 2009 levels. Gazprom has been steadily losing its domestic market share to 'independent' gas producers, mainly OAO Novatek (BBB-/Stable) and OJSC OC Rosneft. These companies have been fairly successful in winning 'premium' accounts - large industrial customers eg, power and heat utilities and chemical companies - away from Gazprom. Fitch believes that domestic regulated gas tariffs are unlikely to increase by more than 5%-7% p.a. in the medium term. Although Fitch views Gazprom's domestic position as weakening, this has a limited impact on its overall performance as these sales command low margins.
No Immediate Impact from Ukrainian Conflict
Presently, in our view there is no immediate threat that the on-going conflict in Ukraine will impact the flow of Russian gas to Europe, at least over the next few months, as the gas storage facilities in Ukraine and Europe are now full. This is despite the fact that Gazprom stopped all gas supplies for Ukraine in mid-June 2014 following an unresolved gas price dispute and payment arrears. Currently, Gazprom only supplies gas for transit to Ukraine, which is still responsible for about half of the transit of Russian gas to Europe, or about 80bcm per annum, although the transit volumes have declined yoy.
Currently, Gazprom is proceeding with its 63bcm South Stream project that would, bypassing Ukraine, deliver gas to countries in Central and Southern Europe, including Austria and Italy. The company expects the pipeline will be brought on-line by end-2015. Fitch believes that project delays are possible due to the political pressure.
Sovereign Caps Rating
Fitch rates Gazprom on a standalone basis. Gazprom's standalone ratings are in the high 'A' category, limited by country-specific corporate governance issues and regulatory risks, and its concentration of production in one country. Gazprom's ratings and the Outlook are capped by those of the Russian Federation (BBB/Negative), its majority shareholder, as the state may materially affect Gazprom's profitability through taxation and regulation.
It is impossible to predict with certainty any likely future sanctions in relation to the Ukraine crisis, although Fitch sees stringent sanctions against Gazprom as less likely than some other measures given European countries' high reliance on Russian gas. However, action cannot be ruled out. Possible measures include ones which would hinder Gazprom's ability borrow from Western institutions or to deliver and sell gas in Europe, and these could have an impact on the company's rating. Following any specific sanctions our analysis would focus on the profitability and cash flow impact of such sanctions; consideration of Gazprom's strong current liquidity and potential alternative sources; Russia's response to any sanctions; and the possibility for more direct support from the Russian Federation than we have seen in the past.
LIQUIDITY AND DEBT STRUCTURE
Fitch views Gazprom's liquidity at end-2013 (the latest available IFRS accounts) as very solid, with RUB689bn in cash and RUB150bn of committed credit lines from the state-owned Russian banks, which are more than sufficient to cover its short-term obligations of RUB332bn at the same date. It notes that Gazprom held RUB366bn of cash with Gazprombank (BBB-/Stable), a related party, at end-2013.
Fitch considers Gazprom's debt maturity structure as comfortable. Gazprom's access to the international capital markets is hindered at the moment by the political crisis between Russia and the West over Ukraine. In our estimates, the company has sufficient liquidity to forgo new borrowings until at least end-2015. Even if international debt markets remain closed, Gazprom has access to domestic borrowings and, to a limited extent, Asian markets eg, China.