FITCH: GAZPROM WITHOUT EUROPE
The deal between Russia and China for Gazprom to supply 38 billion cubic metres (cm) of gas a year to CNPC represents a significant growth opportunity for the company, Fitch Ratings says. Gazprom could increase export volumes to China without affecting its ability to deliver to existing European customers, by developing untapped reserves in eastern Russia.
Some have portrayed the deal as Russia turning away from Europe, in light of the ongoing situation in Ukraine. While it certainly begins to give Gazprom options in where to export, the company's challenge historically has been to find ways to monetise its 23 trillion cm reserves at acceptable prices - and the best scenario for the company is an increase in production.
The deal is therefore positive for Gazprom's medium- to long-term prospects, especially if it opens the door for a further deal to sell gas from its developed western fields to China in due course. In the short term, there is a chance it may lead to higher leverage, which could weaken the company's credit profile. But this will probably not affect the rating because Gazprom's standalone credit profile is in the high 'A' range, while its rating is capped by the Russian sovereign at 'BBB'/Negative, which gives it a lot of financial flexibility at the current rating level.
While pricing has yet to be announced, it appears from headline numbers that the price will be at or above USD350 per thousand cm. This is comparable to that of Gazprom's contracts with western European customers (USD378 per thousand cm in 2013), and far above the prices at which gas can be sold in Russia. But a key difference is that gas to be sent to China will come from largely undeveloped fields, implying a significant up-front investment, which President Putin announced as USD55bn. The 38 billion cm announced is equal to about a quarter of Gazprom's annual deliveries to Europe.
This amount should be seen in the context of Gazprom's 2013 capex spending of USD40bn, over USD7bn of post-capex, post-dividend free cash flow, FFO net adjusted leverage below 1x, and over USD20bn cash on hand at end-2013. Russian officials also announced that Russia may abolish the mineral extraction tax for gas fields delivering gas to China - potentially adding around USD20 to Gazprom's EBITDA for each thousand cm sold to the country.
All of this suggests the investment will be manageable, although funding may be harder to come by than it might have been without the tensions surrounding Ukraine. Since the Ukraine crisis erupted no major Russian corporate has issued a bond internationally and western banks have been tightening lending. But even without these funding sources, which may return in time, Gazprom is likely to be able to obtain the necessary funding from state banks, other international banks, the local bond market, or ultimately the Russian state. This is assuming that CNPC does not provide prepayments as part of the deal - which press reports suggest is still under discussion.
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