Fitch Ratings has assigned ratings to the planned 30-billion-rouble bond issuance by Gazprom Capital in the domestic market.

The expected senior unsecured local currency rating is BBB (EXP), and the expected senior unsecured rating is AAA(rus) (EXP).

The bonds will be issued in 04 series, 05 series, and 06 series under the debt issuance program of Gazprom with capitalization of 30 billion roubles that is rated BBB7 and AAA(rus). Gazprom Capital LLC is a 100-percent subsidiary of Gazprom. Bonds will be guaranteed by Gazprom in full until the maturity of each security series plus one calendar year. It is expected that the proceeds from the sale of the bonds will be used for general corporate purposes of Gazprom. The final rating is contingent upon the receipt of final documents, which should substantially conform to the information already received. Also, the rating may be adjusted after the agency receives coupon payment information.

Key rating factors

Gazprom’s operating performance reflects a strong profile. Gazprom looks favorably in comparison to major international and domestic gas companies based on its position as the leading gas company in the world. Gazprom accounted for 16 percent of global gas production and 27 percent of the European gas market in 2011. Other favorable factors include Gazprom’s low-cost production, high rate of return on stocks, and a good reserve replacement ratio. Fitch believes that increased geographic diversification with gas supplies to China and the sales of LNG will further enhance the strong position of the business group. According to the Russian law on gas exports, Gazprom has been granted the exclusive right to export natural gas produced in Russia. In line with long-term price agreements, Fitch expects that Gazprom will continue to benefit from the sales of gas for export to Europe at prices mostly tagged along with the price of oil, at least in the medium term. The agency predicts that there will be pressures on the pricing terms of long-term European contracts of Gazprom in the short to medium term in view of the difficult economic environment. At the same time, Fitch believes that the financial and operating policies of the company are sufficiently flexible to enable it to make a number of potential concessions without jeopardizing its creditworthiness. According to Fitch, Gazprom’s contracts provide the necessary balance between the large capital requirements for gas projects and the customers’ needs for stable and reliable gas supplies. In addition, such contracts become even more important in gas markets with limited liquidity, scale, and a concentrated structure of supply. Fitch notes that Gazprom still faced weak demand for gas in Western Europe, one of its key markets, where gas sales in 2012 decreased by seven percent to 140 billion cubic meters from 150 billion cubic meters in 2011.

The agency forecasts that, gas demand will remain weak in 2013, with the expected reduction of the eurozone’s GDP by 0.1 percent in 2013. Still, gas demand will start to grow in 2014, as the eurozone’s GDP is predicted to increase one to two percent in 2014.

The liberalization of domestic gas prices is expected to be offset by an increase in tax, according to Fitch. The ratings agency thus believes that the positive impact of the liberalization of the gas market in Russia will not affect Gazprom’s financial performance due to the increase in taxes for the gas industry. The agency expects that the domestic market will continue indexing gas prices at 15 percent per year in 2013 and 2014. At the same time, the extraction tax was increased by 61 percent in 2011 over the previous year and by 115 percent in 2012. In 2013, the tax is expected to increase by 14 percent. Fitch forecasts a gradual decrease in the volume of sales in the domestic market due to greater energy efficiency of the Russian economy and increased competition from independent gas companies. Additionally, Fitch expects that the financial performance of Gazprom will be supported by a gradual transition to market pricing of gas sales in the republics of the former Soviet Union. These developments will help the company maintain its cash flow and EBITDA figures in the medium term. The strong creditworthiness of Gazprom is also supported by the company’s credit metrics, as indicated by its positive free cash flow in the past, its relatively low leverage, and its consistent repayment of secured debt, all of which compare favorably with the results of similar oil and gas companies in Russia and abroad. Fitch expects that the rate of adjusted leverage for Gazprom (funds from operations) will fluctuate in a narrow range of 1.2 to 1.3 in 2012-2015. At the same time, Fitch expects that the net adjusted leverage will remain below or at the level of about 1 in 2012-2015.

Gazprom’s large investments

Gazprom intends to invest about 31 to 35 billion roubles per year between 2012 and 2015. The company’s annual capital investments in the gas sector are projected at 700-900 billion roubles annually from 2012 to 2030, nearly half of which will be used for pipeline projects. Fitch believes that the risks of the plans and cost overruns inherent in large-scale investment program of Gazprom are smoothed out by the company’s high degree of flexibility in capital investment, as the company may delay its expansion projects in the event of changes in market conditions.

Adequate liquidity

Gazprom’s liquidity is adequate for current ratings. On September 30, 2012, the company had cash and cash equivalents in the amount of 471 billion roubles, which was sufficient to cover short-term debt in the amount of 386 billion roubles. Gazprom’s debt maturity structure is not burdensome. At the end of 2011, maturity dates on most loans were in 2014-2016. Fitch expects that the company will continue to have access to international debt capital markets, allowing it to refinance these balances.