gazprom pjsc...2020/06/08 · liquefied natural gas, additional demand destruction via covid-19,...

Gazprom PJSC

Primary Credit Analyst:

Elena Anankina, CFA, Moscow (7) 495-783-4130; [email protected]

Secondary Contact:

Alexander Griaznov, Moscow (7) 495-783-4109; [email protected]

Table Of Contents

Credit Highlights

Outlook

Our Base-Case Scenario

Company Description

Peer Comparison

Business Risk

Financial Risk

Liquidity

Environmental, Social, And Governance

Government Influence

Issue Ratings - Subordination Risk Analysis

Ratings Score Snapshot

Related Criteria

WWW.STANDARDANDPOORS.COM/RATINGSDIRECT JUNE 8, 2020 1

Gazprom PJSC

Business Risk: SATISFACTORY

Vulnerable Excellent

Financial Risk: SIGNIFICANT

Highly leveraged Minimal

bbb- bbb-bbb

Anchor Modifiers Group/Gov't

Issuer Credit Rating

Foreign Currency Rating

BBB-/Stable/A-3

Local Currency Rating

BBB/Negative/A-2

Credit Highlights

Overview

Key strengths Key risks

Solid competitive position, supported by vast

reserves, large-scale production, vertical integration,

and a high 36% market share in Europe.

Very challenging export gas markets: record low gas prices, structural global oversupply of

liquefied natural gas, additional demand destruction via COVID-19, uncertainty about the

pace of market recovery and the long-term role of gas in the global and especially

European energy balance.

Relatively low production costs and revenue-linked

taxes, which should support profitability despite

ongoing pressures on oil and gas prices.

Our expectation of weakening financial metrics, with FFO to debt dipping below our 30%

threshold in 2020, with gradual recovery in 2021-2022.

Our expectation of financial policy focused on

deleveraging through planned cuts in capital and

operating expenditures, or potential asset sales.

Sizable (though somewhat flexible) capex needs and a financial policy focused on

increasing dividend payout to 50% of net income.

Our expectation of an extremely high likelihood of

support from the Russian government, Gazprom's

controlling shareholder.

Risks of operating in Russia, including lack of predictability in domestic price and tax

regulations, a relatively weak banking system, and geopolitical pressures.

Structural challenges on the oil and gas markets are likely to hit Gazprom's 2020 performance, with expected FFO to

debt dipping below our 30% threshold. We expect gas markets to remain very difficult in 2020, reflecting structural

oversupply due to massive liquefied natural gas (LNG) capacity additions versus only moderate demand growth and

full storage in Europe, even before the pandemic, in 2019. Additional demand destruction from COVID-19 has pushed

spot gas prices to record lows (with Title Transfer Facility [TTF] at below $2 per million Btu [mmBtu] in May 2020,

compared with above $8 in late 2018 and $4 average in 2019). This has pressured Gazprom's 2020 export volumes,

while low oil prices and the OPEC++ oil-production-cut agreement hit the EBITDA contribution from Gazprom's

sizable oil business. Despite 20% cuts in capital expenditure (capex) and operating expenditure (opex) announced by

Gazprom's management, we expect Gazprom's funds from operations (FFO) to debt to plunge to 20%-25% in 2020.

A 2021-2022 recovery in metrics will depend on the market revival and on the company's mitigation steps. Although

the gas market is extremely volatile and the impact of COVID-19 on energy demand remains highly uncertain, we

expect markets to gradually recover in 2021-2022, if low gas prices finally trigger shut-downs of high-cost LNG

production, and if post-pandemic economic growth brings gas demand in Europe and Turkey closer to historical

levels. We expect the market rebalancing to be only gradual, given full gas storage in Europe, intense competition,

apparent low supply and demand sensitivity to prices, and the risk of long-lasting COVID-19 impact on gas demand


fundamentals. We expect 2021-2022 FFO to debt to be in the 25%-35% range and we understand that Gazprom's

management aims to eventually bring leverage in line with its financial policy targets, including non-negative free

operating cash flow (FOCF) and net debt to EBITDA below 2x (corresponding to S&P Global Ratings-adjusted FFO to

debt of 35%-40%), through capex and opex cuts, or potentially asset sales.

Completion of Nord Stream 2 will have little bearing on credit quality. While we believe that sanctions could result in

delays and cost overruns, Nord Stream 2 was 94% constructed in December 2019 when the sanctions were imposed,

meaning that most costs are sunk. We believe that Gazprom's 2020-2021 exports are constrained by demand rather

than by pipeline availability, because ample transit capacity is already available thanks to the five-year transit

agreement with Ukraine and Turkstream commissioning in January 2020. We note that broad sanctions on Russia's

energy exports are not part of our base-case scenario for Gazprom, for Russia, or for the European energy sector in

general.


Gazprom PJSC

Outlook: Negative

The negative outlook on the 'BBB' local currency rating reflects our view of the reduced headroom in Gazprom's

stand-alone credit metrics and continuing uncertainty in the global oil and gas markets. We would lower the local

currency rating if our stand-alone credit profile (SACP) on Gazprom deteriorates from the current 'bbb-' to 'bb+'.

We view FFO to debt sustainably above 30% as commensurate with a 'bbb-' SACP. We expect Gazprom will be

below this threshold in 2020, but will restore its credit metrics in 2021-2022 on the back of market recovery and

the company's deleveraging efforts.

The stable outlook on the 'BBB-' foreign currency rating mirrors that on Russia and reflects our view of the

extremely high likelihood the state would support Gazprom and that such support would offset a potential

deterioration in the SACP.

Downside scenario

If our SACP on Gazprom were to deteriorate by one notch to 'bb+', we would lower our local currency rating to

'BBB-' and affirm our foreign currency rating at 'BBB-'. This could happen due to weakening liquidity or if FFO to

debt were to stay consistently below 30% due to persistently low gas prices and export volumes,

larger-than-expected investments or dividends, or potential contingent liabilities on joint ventures and ship-or-pay

contracts. A major shift in European gas markets might lead us to reassess Gazprom's business strength, and could

therefore also weigh on the local currency rating.

We would lower both local and foreign currency ratings on Gazprom if we downgraded the sovereign.

Assuming the sovereign rating and the likelihood of extraordinary state support remain unchanged, the SACP

would have to decline to 'b+' in order to pressure the foreign currency rating, a situation which is still very far from

our base case.

Upside scenario

We could revise the outlook on the local currency rating to stable from negative only if market conditions

strengthened significantly and Gazprom displayed comfortable headroom in its financial metrics, with FFO to debt

sustainably above 30%.

We would raise the foreign and local currency ratings if we upgraded the sovereign, but this is not our base-case

scenario.

Our Base-Case Scenario

Assumptions

• 2020 gas exports volumes to decline to $166.6 billion cubic meters (bcm), and prices to $133/million cubic meters

(mcm), compared with 192.6 bcm net of repo transactions and $211/mcm in 2019, in line with management


Gazprom PJSC

guidance; 2021-2022 export volumes and realized prices to gradually recover to 185-195 bcm and $150-180/mcm,

as European spot prices gradually recover to about $4 in 2021 and $4.5 in 2022.

• Crude oil production to decline by up to 15% in 2020 and a further 2% in 2021, reflecting Russia's oil production cut

commitments under the OPEC++ agreement, followed by up to 20% growth in 2022 when the agreement expires.

• Domestic gas sales volumes to decline about 5% in 2020 and recover in 2021, in line with our forecast for Russian

GDP of minus 4.8% in 2020 and 4.5% growth in 2021.

• Capex cuts for Russian ruble (RUB)216 billion for the gas business, about RUB100 billion for the oil business and

additional opex cuts of RUB140 billion, in line with management's announcement.

• Dividends: 30%-40%-50% payout in line with Gazprom's dividend policy.

• No material asset sales or acquisitions, in the absence of immediate plans by management.

Key Metrics

Gazprom PJSC--Key Metrics*

2019A 2020E 2021F 2022F

Brent crude price (bil. US$) 64.2 33.0 50.0 55.0

Average US$/RUB exchange rate 64.7 74.0 71.0 71.5

EBITDA (tril. RUB) 2.1 About 1.3 1.6-1.8 2.1-2.3

Capext(tril. RUB) 1.8 About 1.3 About 1.3 About 1.5

FOCF (tril. RUB) 0.1 About -0.3 About 0 0.1-0.3

FFO/Debt 0.5 20-25% 25-35% 30-40%

Debt/EBITDA 1.7 3.5-3.7 2.5-3 2-2.5

A--Actual. E--Estimate. F--Forecast. FFO--Funds from operations. Capex--Capital expenditure. FOCF--Free operating cash flow. RUB--Russian

ruble.

We expect weak European prices and volumes to hit Gazprom's EBITDA in 2020, but gas price realizations to remain

above spot prices. We expect Gazprom's realized gas prices to be above record low European spot levels, because a

significant part of its gas exports is under oil-indexed, hybrid, gas forward prices, or via Gazprom's electronic sales

platform with a premium above spot. In 2019, Gazprom's average realized prices were $211 per mcm versus about

$140-$150/mcm ($4/mmBtu) spot, and in 2020, Gazprom's management expects $133 compared with spot prices

below $80 in May 2020. On top of lower demand caused by a warm winter and the pandemic-related economic

recession, Gazprom's export volumes will be hit by lower offtake under the company's oil-indexed contracts, Europe's

full storage, and intense competition with LNG. Effectively, Gazprom will have to bear a large share of the market

rebalancing burden through lower exports.

The pace of EBITDA recovery in 2021-2022 will depend on gradual market rebalancing and post-COVID-19 economic

growth. Despite extreme volatility in the gas market, we expect Gazprom's prices and volumes will demonstrate

visible recovery in 2021-2022 from extremely low 2020 levels. Still, we do not necessarily assume that Gazprom would

be able to retain price realizations as much above spot levels as in 2019. Additional EBITDA contributions should

come from oil price recovery (with our Brent price assumption of $50 already in 2021) and ramp-up of gas exports to

China in line with Gazprom's contract with CNPC (to about 5 bcm in 2020, 10 bcm in 2021, and eventually 38 bcm in

2025), where potentially higher costs should be offset with favorable price realizations and tax holidays.

Gazprom plans to cut capex by 20% in 2020 and potentially in 2021, but longer term, new strategic projects may

emerge. We understand that Gazprom's management plans to cut 2020 capex to RUB1.3 trillion from the RUB1.8

trillion peak in 2019, which reflects commissioning of several large projects in late 2019-early 2020 (first stage of


Gazprom PJSC

Power of Siberia-1, Turkstream pipeline to Turkey), lower production needs in 2020-2022, and the company's policy

and track record of adjusting capex in line with operating cash flow. Still, fundamentally, Gazprom has large

maintenance capex and needs to continue heavy investments in ongoing related projects (notably the pre-contracted

Amur gas-processing plant and the second stage of Power of Siberia). Longer term, if and when pressures on operating

cash flows ease, Gazprom may invest in new projects such as the Power of Siberia-2 gas pipeline from Western Siberia

to China, Kharasavey gas field, a gas chemical plant in Yamal, and Ust-Luga LNG and gas processing facility (the latter

is to be constructed by Gazprom's 50:50 joint venture with Rusgasdobycha).

Dividends are set to increase in relative, not necessarily absolute, terms. We understand that Gazprom will stick to its

new dividend policy approved in December 2019, which focuses on gradually increasing the dividend payout to 30%,

40%, and 50% of 2019, 2020, and 2021 net income, respectively. Management clarified that while the payout ratio

goes up, the actual dividend amount could go down if net income declines, and that the board can decide to skip

dividends if reported net debt to EBITDA is above 2.5x. Our base case therefore assumes that dividends will not

increase in absolute terms in 2019-2021, but we do not currently assume skipping dividends if, in line with our

projections, in 2020 net debt to EBITDA is close to 2.5x and gas markets are on a positive trend.

Company Description

Gazprom is the world's largest vertically integrated gas company by the volume of its reserves, production, exports,

and transportation. At year-end 2019, its total proven hydrocarbon reserves were 126.1 billion barrels of oil equivalent

(boe), of which 91% was gas. Gazprom's 2019 production was massive, at 11.1 million barrels per day in 2019, of

which about 85% was gas. The company controls 172,600 kilometers (km) of gas trunk-lines. Gazprom's 96%-owned

subsidiary, Gazprom Neft, is Russia's third-largest oil company, with a profitable production and refining business (see

"Russian Oil Producer GazpromNeft 'BBB-' Ratings Affirmed Amid Lower Oil Prices And Oil Production Cuts; Outlook

Stable," published May 19, 2020, on RatingsDirect). With 40 gigawatts of electric power generation capacity, Gazprom

is Russia's leading electricity producer. The group also has equity stakes in other businesses, including Gazprombank,

Russia's third-largest bank. All of Gazprom's key assets are located in Russia. The Russian government controls the

majority of Gazprom, and the rest of Gazprom's shares are free float.

Historically, most of Gazprom's EBITDA came from gas exports. With ongoing pressures on gas markets, we expect a

higher share of EBITDA coming from oil and domestic gas in 2020, with gas export EBITDA picking up in 2021 and

beyond (chart 1).


Gazprom PJSC

Chart 1

Peer Comparison

Table 1

Gazprom PJSC--Peer Comparison

Industry sector: Integrated oil and gas

Gazprom PJSC

Rosneft Oil Co.

PJSC

NOVATEK

PJSC Equinor ASA

Royal Dutch Shell

PLC

Ratings as of June 8, 2020 BBB/Negative/A-2 (LC)* BBB-/Stable/-- BBB/Stable/-- AA-/Negative/A-1+ AA-/Negative/A-1+

--Fiscal year ended Dec. 31, 2019--

(Mil. US$)

Revenue 122,963.9 138,125.1 13,896.3 64,358.0 344,877.0

EBITDA 33,025.2 30,649.7 4,404.3 24,945.0 57,940.0

Funds from operations

(FFO)

25,037.5 22,484.0 2,534.0 14,379.0 44,302.0

Interest expense 3,836.2 5,862.6 171.7 2,409.0 5,594.0

Cash interest paid 2,754.6 4,509.7 131.1 1,203.0 4,896.0

Cash flow from operations 30,100.9 14,302.1 4,820.4 13,269.0 38,440.0

Capital expenditure 28,603.0 13,931.7 2,666.7 9,724.0 22,971.0

Free operating cash flow

(FOCF)

1,497.9 370.4 2,153.7 3,545.0 15,469.0


Gazprom PJSC

Table 1

Gazprom PJSC--Peer Comparison (cont.)


Gazprom PJSC

Rosneft Oil Co.

PJSC

NOVATEK

PJSC Equinor ASA

Royal Dutch Shell

PLC

Discretionary cash flow

(DCF)

(4,617.8) (5,782.1) 348.4 (239.0) (11,628.0)

Cash and short-term

investments

22,979.6 11,709.1 2,206.4 12,051.0 18,055.0

Debt 54,644.3 73,247.7 874.2 23,870.5 101,746.3

Equity 235,400.3 82,978.1 26,849.9 41,159.0 190,463.0

Adjusted ratios

EBITDA margin (%) 26.9 22.2 31.7 38.8 16.8

Return on capital (%) 8.2 14.6 26.0 21.7 9.1

EBITDA interest coverage

(x)

8.6 5.2 25.6 10.4 10.4

FFO cash interest

coverage (x)

10.1 6.0 20.3 13.0 10.0

Debt/EBITDA (x) 1.7 2.4 0.2 1.0 1.8

FFO/debt (%) 45.8 30.7 289.9 60.2 43.5

Cash flow from

operations/debt (%)

55.1 19.5 551.4 55.6 37.8

FOCF/debt (%) 2.7 0.5 246.4 14.9 15.2

DCF/debt (%) (8.5) (7.9) 39.9 (1.0) (11.4)

*Local currency (LC) rating: BBB/Negative/A-2; foreign currency rating: BBB-/Stable/A-3.

Compared with international peers, Gazprom is well positioned regarding the size of reserves and production, but very

much focused on Russia, which we view as a high risk country, while international majors are well diversified by

country. While Gazprom's credit metrics compared well with international peers in 2019, we expect it will be more

exposed to the weak gas market in 2020 and potentially beyond, as illustrated by FFO to debt dynamics (chart 2).


Gazprom PJSC

Chart 2

Business Risk: Satisfactory

Gazprom faces structural pressures on the European gas market. Compared with international majors and domestic

peers, Gazprom is more exposed to gas market challenges, with 85% of its production being gas. Even before the

pandemic, global gas markets were in structural oversupply due to a massive increase in LNG capacity, two warm

winters (2018-2019 and 2019-2020), a relatively slow increase in global gas demand, and full storage, especially in

Europe, leading to record low gas prices, well below most producers' full costs (see chart 3). In addition, gas prices are

increasingly volatile, due to an increasing share of hub-linked pricing, broken historical correlation between gas and

oil, and low price elasticity demonstrated by both supply and demand.


Gazprom PJSC

Chart 3

We expect European gas markets to gradually rebalance after 2020, as low gas and oil prices eventually remove some

high-cost production from the market. Although direct COVID-19-related demand destruction for gas is less

pronounced than for oil (5% versus 9% in 2020 globally, according to the IEA's May 2020 report), the pandemic could

affect future macroeconomic conditions and therefore, gas demand recovery. We believe that European gas demand

may take time to recover to 2018-2019 levels, in line with GDP dynamics and because Europe aims to make a green

agenda core to its post-COVID-19 economic stimulus package. S&P Global Ratings expects EU GDP to contract by

7.3% in 2020, followed by 5.6% growth in 2021 and 3.7% in 2022.

We believe that at least in the next five years, demand for Gazprom's gas is supported by Europe's falling indigenous

production (notably, the large Groningen gas field should be closed by 2022). The plans to phase-out coal and nuclear

generation in some European countries, paired with the lack of commercial energy storage solutions, supports the

need for gas-fired baseload to complement intermittent renewables. Gazprom faces competition from other energy

sources, notably renewables and cheap, but environmentally unfriendly, coal.

The longer-term future of gas in Europe will depend on post-pandemic economic recovery and on decarbonization

policies to be adopted in line with the EU's 2019 "Green Deal," development of energy storage, and potential hydrogen

solutions. We understand that although coal-to-gas switching reduces CO2 emissions about 2x, this might not be


Gazprom PJSC

sufficient to achieve Europe's net-zero 2050 greenhouse gas emissions target, and gas is not part of Europe's Green

Taxonomy.

Low full costs, export sales structure, and diversification into oil, domestic gas, and electricity help Gazprom weather

market pressures. In particular, we expect the following factors will support resilient profitability:

• Gazprom's export price realizations should be well above spot (as illustrated by management's expectation of $133

average realization compared with $70 spot and about $140 forward), because a large portion of sales are under

long-term oil-linked contracts, or pegged to forwards that are above spot (chart 4).

• Gazprom's full costs are competitive in the global context, thanks to favorable geology, the cheap ruble, and existing

infrastructure. We estimate Gazprom's total costs in 2020 conditions at about $75-$103 per thousand cubic meters

(/mcm) (about $2.1-2.8/million Btu), including about $12/mcm production, $10 mineral extraction tax (down from

$18 in 2018 due to the tax formula and cheaper ruble), $30-$50 transportation cost depending on the distance, and

30% export duty. We believe that marginal cost is even lower, closer to $60/mcm (1.6/mmBtu) depending on the

destination, because a large part of transit cost is prepaid. According to our estimates, Gazprom's full cost is below

that of many competitors, including some LNG suppliers and pipeline gas from the Southern Gas Corridor. The

anticipated gradual increase in Gazprom's costs caused by the ongoing move to more difficult fields should be offset

by regional tax holidays in Yamal and Eastern Siberia, and by the fact that export duty and mineral extraction tax

are revenue-linked.

• Gazprom's profitable oil and electricity segments provide a solid and increasing contribution to the Gazprom group's

EBITDA and essentially all of the group's consolidated FOCF while gas markets are depressed. In 2019,

Gazpromneft's FOCF was RUB164 billion, compared with RUB93 billion for the consolidated group. The oil

business benefits from low costs and revenue-linked taxes, and from our expectations of oil price recovery to $50

already in 2021. The electricity segment benefits from sizable capacity revenue and relatively low volatility of

Russia's power market, and has limited capex needs.

• Domestic sales, which are low-margin, but stable. While historically, the Russian regulator set domestic prices well

below export levels, the recent fall in export prices reduced the gap, when adjusted for 30% export duty and transit

cost. Although other Russian producers--such as Novatek and Rosneft--supply about half the domestic gas needs,

they focus on industrial customers and LNG, while Gazprom supplies gas to socially sensitive customers, addresses

seasonal demand fluctuations, and has a legal monopoly on pipeline gas export which we don't expect will change

in the next three to five years. We believe that the domestic gas market, and especially the power and heating

segments served by Gazprom, is much less sensitive to COVID-19 pressures than exports. Domestically, vertical

integration between gas production and transportation underpins Gazprom's critical importance to the Russian

economy.


Gazprom PJSC

Chart 4


Gazprom PJSC

Chart 5

Massive size, vertical integration, and competitive costs support Gazprom's role in Europe. Gazprom benefits from a

solid market share in Europe (36% in 2019). We believe that despite the current surge in LNG supplies to Europe,

Gazprom's massive size and competitive full costs make it difficult to replace. Gazprom benefits from over 30 years of

proven reserve life, with additional upside on probable and possible reserves, and significant underutilized capacity in

production and export to Europe and Turkey (estimated at about 40-60 bcm in 2019).


Gazprom PJSC

Chart 6


Gazprom PJSC

Chart 7

High exposure to gas and low regulated domestic prices depress unit profitability. Gazprom's realizations per unit of

production are below peers, because of higher exposure to lower-priced gas and to low (but stable) regulated domestic

gas prices.


Gazprom PJSC

Chart 8

Russia country risks, geopolitical, transit, and regulatory factors continue to constrain the rating. Gazprom's position

as a large government-related entity (GRE) in Russia exposes it to the risks of negative sovereign interference and to

geopolitical factors. We understand Russia's largest banks--Sberbank, VTB, and Gazprombank--as well as some of

Gazprom's large construction counterparties, are sanctioned by the U.S. and the EU. In addition, we believe Gazprom

faces political and regulatory pressures because of Europe's concerns about energy dependency on Russia.

The U.S. Protecting Europe's Energy Security Act, adopted in December 2019, imposes sanctions on entities providing

services for the Nord Stream 2 pipeline construction, which delayed the commissioning of a 94% constructed pipeline.

The German regulator's decision not to grant Nord Stream 2 exemption from the third-party access rule could

additionally pressure profitability of the pipeline if and when it is commissioned. Still, we believe that the new transit

contract signed with Ukraine in December 2019 (with capacity booking of 65 bcm in 2020 and 40 bcm in 2021-2025)

and the recently completed 32 bcm Turkstream pipeline, leaves Gazprom with sufficient export pipeline capacity.

Financial Risk: Significant


Gazprom PJSC

We believe that Gazprom has limited financial headroom for the rating, with 2020 metrics below our 30% FFO to debt

threshold. We expect metrics to recover in 2021-2022 on the back of market rebalancing and the company's

mitigating steps.

Gazprom has substantial flexibility in capex and asset disposals. This is illustrated by historical capex adjustments in

line with operating cash flow (chart 9) and the sale of a 6.5% treasury stake in 2019 for RUB326 billion. We understand

that Gazprom's management aims to bring metrics back in line with the company's financial policy of net debt to

EBITDA below 2x, which corresponds to about 35-40% FFO to debt, and positive FOCF. Management has already

announced cuts of RUB316 for capex and RUB140 billion for opex for 2020, and noted that 2021 capex could stay low

if needed too.

In 2020, Gazprom plans to cut capex to RUB1.3 trillion, compared with 2019's peak of RUB1.8 trillion, to offset

pressures on leverage, similar to most international oil majors. Also, 2019 was a peak capex year as Gazprom

completed two major projects, the first stage of Power of Siberia (2,200 km pipeline and Chayanda gas field) and

Turkstream (930 km, $7 billion, 32 bcm pipeline from Russia to Turkey and Southern Europe, via the Black Sea), and

funded most of the €9.5 billion total project cost for Nord Stream 2. We understand that in 2020-2021, Gazprom will

focus on maintenance capex as well as investments in projects in already committed projects, notably the second

stage of Power of Siberia (including the Amur gas-processing plant, an 800 km link to the Kovykta gas field, loopings,

and compressor stations) in line with its contractual obligations to ramp up gas supplies to China to 38 bcm by 2025.

Some of Gazprom's large noncore assets are potentially liquid; for example, equity stakes in Gazprombank or in the

Russian gas producers Novatek, (valued at RUB211.2 and RUB380.3 billion, respectively, on Dec. 31, 2019).

Furthermore, Gazprom has been historically able to sell stakes in its core upstream assets like Achimgas, and currently

holds 96% of Gazpromneft while a 75%+1 share would be sufficient for essentially full control under Russian corporate

law. We don't include these assets in liquidity sources at this stage because there is currently no strategy to sell them.

We understand that although Gazprom plans to stick to its newly adopted dividend policy to increase payout to 40%

and 50% of adjusted net income in 2021 and 2022, respectively, the absolute amount of dividends could decline if net

income is low.


Gazprom PJSC

Chart 9

Gazprom remains exposed to the risks of large Russian banks, where it keeps most of its sizable cash balances. In

particular, out of RUB1.4 trillion of cash reported on Dec. 31, 2019, Gazprom keeps about RUB1.0 trillion with its

equity affiliate Gazprombank. Although we view the Russian banking system as relatively weak, we continue to treat

this cash as available for debt repayment, and therefore deduct it when calculating adjusted debt.

Longer term, we see risks related to joint ventures and a possibility of new strategic projects if and when gas markets

stabilize. For example, Gazprom has decided to invest in the large Kharasavey gas field in Yamal (up to 32 bcm

annual production), and may start new projects such as the western pipeline to China ("Power of Siberia-2") if a gas

sales contract is in place, or a new large LNG or gas processing plant in Yamal. In addition, Gazprom has a number of

joint ventures and undisclosed commitments under ship-or-pay arrangements with European gas pipeline operators.

We understand that Gazprom will have only a 50% share in the large Ust-Luga gas-processing and LNG facility, so that

most of the preliminary estimated RUB750 billion project cost will be at the joint venture level.

Financial summaryTable 2

Gazprom PJSC--Financial Summary


--Fiscal year ended Dec. 31--

2019 2018 2017 2016 2015

(Mil. US$)

Revenue 7,634,666 8,242,192 6,529,791 6,114,433 6,077,022


Gazprom PJSC

Table 2

Gazprom PJSC--Financial Summary (cont.)


--Fiscal year ended Dec. 31--

2019 2018 2017 2016 2015

EBITDA 2,050,492 2,622,949 1,536,911 1,530,130 2,048,137

Funds from operations (FFO) 1,554,542 2,145,043 1,147,907 1,251,242 1,775,097

Interest expense 238,187 249,802 223,801 225,772 292,192

Cash interest paid 171,028 173,174 161,455 183,312 168,311

Cash flow from operations 1,868,927 2,034,576 1,431,311 1,569,932 1,996,328

Capital expenditure 1,775,923 1,639,474 1,405,780 1,369,052 1,641,024

Free operating cash flow (FOCF) 93,004 395,102 25,531 200,880 355,304

Discretionary cash flow (DCF) (286,715) 206,789 (166,344) (117,457) 184,602

Cash and short-term investments 1,426,773 1,673,850 1,229,592 908,209 1,371,665

Gross available cash 1,426,773 1,673,850 1,229,592 1,094,475 1,503,257

Debt 3,392,789 2,907,629 2,685,497 2,185,669 2,783,719

Equity 14,615,687 13,776,153 12,015,481 11,441,839 10,914,622

Adjusted ratios

EBITDA margin (%) 26.9 31.8 23.5 25.0 33.7

Return on capital (%) 8.2 13.6 7.8 6.8 11.2

EBITDA interest coverage (x) 8.6 10.5 6.9 6.8 7.0

FFO cash interest coverage (x) 10.1 13.4 8.1 7.8 11.5

Debt/EBITDA (x) 1.7 1.1 1.7 1.4 1.4

FFO/debt (%) 45.8 73.8 42.7 57.2 63.8

Cash flow from operations/debt (%) 55.1 70.0 53.3 71.8 71.7

FOCF/debt (%) 2.7 13.6 1.0 9.2 12.8

DCF/debt (%) (8.5) 7.1 (6.2) (5.4) 6.6

ReconciliationTable 3

Gazprom PJSC--Reconciliation Of Reported Amounts With S&P Global Ratings' Adjusted Amounts (Mil. US$)

--Fiscal year ended Dec. 31, 2019--

Gazprom PJSC reported amounts

Debt

Shareholders'

equity EBITDA

Operating

income

Interest

expense

S&P Global

Ratings'

adjusted

EBITDA

Cash flow

from

operations

Reported 3,863,904.0 14,104,833.0 1,859,817.0 1,119,857.0 76,426.0 2,050,492.0 1,709,384.0

S&P Global Ratings' adjustments

Cash taxes paid -- -- -- -- -- (324,922.0) --

Cash interest paid -- -- -- -- -- (171,028.0) --

Reported lease liabilities 247,513.0 -- -- -- -- -- --

Postretirement benefit

obligations/deferred

compensation

265,137.0 -- 9,271.0 9,271.0 7,245.0 -- --


Gazprom PJSC

Table 3

Gazprom PJSC--Reconciliation Of Reported Amounts With S&P Global Ratings' Adjusted Amounts (Mil.US$) (cont.)

Accessible cash and liquid

investments

(1,426,773.0) -- -- -- -- -- --

Capitalized interest -- -- -- -- 154,516.0 -- --

Dividends received from

equity investments

-- -- 181,404.0 -- -- -- --

Asset-retirement

obligations

223,916.0 -- -- -- -- -- --

Nonoperating income

(expense)

-- -- -- 298,053.0 -- -- --

Reclassification of interest

and dividend cash flows

-- -- -- -- -- -- 93,543.0

Noncontrolling

interest/minority interest

-- 510,854.0 -- -- -- -- --

Debt: Guarantees 219,092.0 -- -- -- -- -- --

Operating cash flow: Other -- -- -- -- -- -- 66,000.0

Total adjustments (471,115.0) 510,854.0 190,675.0 307,324.0 161,761.0 (495,950.0) 159,543.0

S&P Global Ratings' adjusted amounts

Debt

Shareholders'

equity EBITDA

Operating

income

Interest

expense

S&P Global

Ratings'

adjusted

EBITDA

Cash flow

from

operations

Adjusted 3,392,789.0 14,615,687.0 2,050,492.0 1,427,181.0 238,187.0 1,554,542.0 1,868,927.0

Liquidity: Adequate

We view Gazprom's liquidity as adequate, based on our estimate that liquidity sources will cover liquidity uses by more

than 1.2x in the 12 months starting Dec. 31, 2019, and closer to 1.0x in the second year. We believe that Gazprom has

generally prudent risk management and good access to financing from domestic state-owned banks. Compared with

other Russian entities, Gazprom is relatively well positioned to access international capital markets as a GRE, exporter,

and one of the largest Russian borrowers. Gazprom is not currently subject to any financial sanctions by the U.S. or

EU, unlike its subsidiary Gazprom Neft or its affiliate Gazprombank. Nevertheless, we believe that, in line with other

Russian issuers, Gazprom's access to international capital markets could be affected by geopolitical factors. We also

note that the company is heavily exposed to large Russian banks where it keeps most of its cash balances (mostly

Gazprombank).

Gazprom's key liquidity sources and uses for the 12 months started Dec. 31, 2019 are listed below.

Principal Liquidity Sources Principal Liquidity Uses

• Cash of RUB696 billion, short-term financial assets

of RUB57.6 billion, short-term deposits of RUB673.1

billion.

• Short-term debt of RUB774 billion; another RUB448

billion matures in the second year.

• Capex of about RUB1.3 trillion.


Gazprom PJSC

• About RUB570 billion of funds raised in

January-May 2020, including $2 billion of

Eurobonds placed in February, €1 billion Eurobond

placed in April, €3.1 billion long-term loan for Amur

gas processing plant, RUB40 billion in domestic

bonds, RUB30 billion and €150 million Russian bank

debt, and €87.5 million long-term funding from

European energy companies for Nord Stream 2.

• About RUB150 billion of available committed

long-term bank lines.

• Our expectation of FFO of about RUB0.9

trillion-RUB1 trillion.

• Dividends of RUB367 billion on 2019 income, as

approved by the board.

Debt maturitiesTable 4

Gazprom PJSC--Debt Maturities*

Period Bil. RUB

2020 774.2

2021 448.8

2022 711.0

2023 547.6

2024 378.6


Gazprom PJSC

Environmental, Social, And Governance

Similarly to oil and gas peers, the future of Gazprom's core business is significantly shaped by environmental

factors, notably the EU's targets to achieve net-zero emissions by 2050. CO2 emissions from natural gas are about

twice below coal, although methane leaks also have a powerful greenhouse gas effect. How long Europe continues

to use gas as a bridge low-carbon baseload complementing intermittent renewables, will depend on the

development of energy storage and on the implementation of the 2019 "Green Deal." Any regulations on gas

infrastructure, gas-fired generation, or mixing natural gas with hydrogen in existing pipelines will also be a factor.

On the other hand, the focus on transitioning from coal to cleaner gas fuel in China and other Asian markets will

create future export opportunities for Gazprom. With about 90% of production being gas, Gazprom:

• Ranks below most oil majors on CO2 emissions for its gas business (including its vast gas network but excluding

electricity generation segment);

• Is in compliance with applicable environmental regulations;

• Has publicly communicated targets to reduce greenhouse gas emissions; and

• Is working on gas decarbonization technologies, such as hydrogen.

Gazprom's export business is also exposed to social sensitivities and political concerns about European

dependency on Russian gas (36% of Europe's gas in 2019, and well over 50% in some Eastern European countries).

Gazprom's role as a provider of gas for domestic needs, a large employer, and a big customer for certain local

industries is typical of large Russian GREs. This might reduce the company's flexibility in opex and capex, but also

creates incentives for government support.

On governance, similarly to other large Russian state-owned companies and to oil majors operating in emerging

markets, Gazprom is exposed to contracting and execution risks on a number of large projects and joint ventures,

such as the finalization of Nord Stream 2, the Ust-Luga LNG project, and potentially the next stages of Power of

Siberia and the Amur gas processing plant. Also, we note reported spending inefficiencies, corruption allegations,

and a lack of transparency in certain transactions. Gazprom is a public joint-stock company, with a relatively

autonomous management team and the majority of board members representing the government. Gazprom's IFRS

disclosure is comparable with peers' in terms of timeliness and detail.

Government Influence

We expect Gazprom to continue enjoying an extremely high likelihood of extraordinary state support, reflecting our

view of:

• Gazprom's critical role for the Russian economy as the owner of Russia's gas-transportation network and supplier of

gas to domestic customers, and as one of the country's largest exporters, taxpayers, employers, and borrowers.

Gazprom is one of the government's key assets in the country's strategic hydrocarbon sector, and the country's

largest corporate borrower on the international debt market. In our view, if Gazprom were to default, it would have

material negative consequences for the government and other Russian companies and financial institutions.


Gazprom PJSC

• Gazprom's very strong link with the Russian government. By law, state control of Gazprom cannot fall below 50%.

We understand that the government is actively involved in defining the company's strategy, as illustrated by the

government's heavy involvement in Ukraine transit negotiations, and has a track record of support to various

systemically important entities. Still, the government only controls a marginal majority stake, and the company's

operations are sizable and fairly autonomous. The Russian economy relies heavily on oil and gas, which may

increase the correlation between the financial performance of Gazprom and Russia.

Issue Ratings - Subordination Risk Analysis

Capital structure

Gazprom's capital structure includes mainly parent-level debt (including loan participation notes [LPNs] issued by Gaz

Capital S.A. and Gaz Finance PLC, Russian bonds, and bank debt). Of RUB3.9 trillion total reported debt as of Dec. 31,

2019, we estimate that much less than 50% was priority-ranking at the subsidiary level. Loan participation notes issued

via Gaz Capital under the medium-term note program equaled about half the group's total reported debt.

Analytical conclusions

The rating on the LPNs mirrors the long-term foreign currency issuer credit rating on Gazprom. We understand that

the LPNs are backed by Gazprom's senior unsecured obligations with equivalent payment terms, and that Gaz Capital

S.A. as well as Gaz Finance PLC are strategic financing entities for Gazprom set up solely to raise debt on behalf of the

Gazprom group. We believe that Gazprom is willing and able to support Gaz Capital and Gaz Finance to ensure full

and timely payment of interest and principal when due on the LPNs, including payment of any expenses of those

financing entities.

We rate the notes in line with our issuer credit rating on Gazprom, because no significant elements of subordination

risk are present in the capital.

Ratings Score Snapshot


Foreign Currency: BBB-/Stable/A-3

Local Currency: BBB/Negative/A-2

Business risk: Satisfactory

• Country risk: High

• Industry risk: Intermediate

• Competitive position: Strong

Financial risk: Significant

• Cash flow/leverage: Significant

Anchor: bbb-

Modifiers


Gazprom PJSC

• Diversification/portfolio effect: Neutral (no impact)

• Capital structure: Neutral (no impact)

• Financial policy: Neutral (no impact)

• Liquidity: Adequate (no impact)

• Management and governance: Fair (no impact)

• Comparable rating analysis: Neutral (no impact)

Stand-alone credit profile : bbb-

• Group credit profile: bbb-

• Related government rating: BBB

• Likelihood of government support: Extremely high (+1 notch from SACP)

Related Criteria

• Criteria | Corporates | General: Corporate Methodology: Ratios And Adjustments, April 1, 2019

• Criteria | Corporates | General: Reflecting Subordination Risk In Corporate Issue Ratings, March 28, 2018

• General Criteria: Methodology For Linking Long-Term And Short-Term Ratings, April 7, 2017

• General Criteria: Rating Government-Related Entities: Methodology And Assumptions, March 25, 2015

• Criteria | Corporates | General: Methodology And Assumptions: Liquidity Descriptors For Global Corporate

Issuers, Dec. 16, 2014

• Criteria | Corporates | General: Corporate Methodology, Nov. 19, 2013

• General Criteria: Country Risk Assessment Methodology And Assumptions, Nov. 19, 2013

• General Criteria: Ratings Above The Sovereign--Corporate And Government Ratings: Methodology And

Assumptions, Nov. 19, 2013

• General Criteria: Methodology: Industry Risk, Nov. 19, 2013

• General Criteria: Methodology: Management And Governance Credit Factors For Corporate Entities, Nov. 13, 2012

• General Criteria: Stand-Alone Credit Profiles: One Component Of A Rating, Oct. 1, 2010

• General Criteria: Use Of CreditWatch And Outlooks, Sept. 14, 2009


Gazprom PJSC

Business And Financial Risk Matrix

Business Risk Profile

Financial Risk Profile

Minimal Modest Intermediate Significant Aggressive Highly leveraged

Excellent aaa/aa+ aa a+/a a- bbb bbb-/bb+

Strong aa/aa- a+/a a-/bbb+ bbb bb+ bb

Satisfactory a/a- bbb+ bbb/bbb- bbb-/bb+ bb b+

Fair bbb/bbb- bbb- bb+ bb bb- b

Weak bb+ bb+ bb bb- b+ b/b-

Vulnerable bb- bb- bb-/b+ b+ b b-

Ratings Detail (As Of June 8, 2020)*

Gazprom PJSC


Foreign Currency BBB-/Stable/A-3

Local Currency BBB/Negative/A-2

Senior Unsecured BBB-

Issuer Credit Ratings History

27-Feb-2018 Foreign Currency BBB-/Stable/A-3

21-Mar-2017 BB+/Positive/B

20-Sep-2016 BB+/Stable/B

27-Mar-2020 Local Currency BBB/Negative/A-2

27-Feb-2018 BBB/Stable/A-2

21-Mar-2017 BBB-/Positive/A-3

20-Sep-2016 BBB-/Stable/A-3

Related Entities

Gaz Capital S.A.


Gaz Finance PLC


Gazprom Capital OOO


Foreign Currency BBB-/Stable/--

Local Currency BBB/Stable/--

Gazprom Neft PJSC

Issuer Credit Rating BBB-/Stable/--


GPN Capital S.A.


Mosenergo PJSC

Issuer Credit Rating BBB-/Stable/--

Sogaz Insurance

Financial Strength Rating



Gazprom PJSC

Ratings Detail (As Of June 8, 2020)*(cont.)



TGC-1 PJSC

Issuer Credit Rating BBB-/Stable/A-3

*Unless otherwise noted, all ratings in this report are global scale ratings. S&P Global Ratings’ credit ratings on the global scale are comparable

across countries. S&P Global Ratings’ credit ratings on a national scale are relative to obligors or obligations within that specific country. Issue and

debt ratings could include debt guaranteed by another entity, and rated debt that an entity guarantees.

Additional Contact:

Industrial Ratings Europe; [email protected]


Gazprom PJSC


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