Russia’s Gazprom left wounded by gas price plunge – Financial Times

By Jack Farchy

Novy Urengoy is the town that gas built. Just 35 kilometres from the Arctic Circle, there was little more than ice and gas here when Soviet geologists first arrived 50 years ago. Workers still refer to the rest of Russia as “earth”, as if they were on a mission in space.

Today, Novy Urengoy is the heartland of Gazprom, the state-controlled energy company that is the world’s largest gas producer. The town of 100,000 residents in northern Siberia sits next to the world’s third largest gasfield, which has made Gazprom an important driver of Russia’s economy and a powerful instrument of the Kremlin’s influence abroad.

But now the company is facing up to the prospect of a prolonged spell of low gas prices. Analysts say Gazprom will be forced in the next few years to scale back its investments, which include grand political projects such as pipelines to China and Europe, or to dramatically increase its leverage.

In this austere environment, Gazprom is under growing pressure from critics both at home and abroad, with some domestic opponents pressing for a break-up of the company.

It helps the critics’ cause that Gazprom’s financial performance is deteriorating — in Russian roubles, operating profit fell 6 per cent last year. For the first time in at least a decade, analysts predict Gazprom will report negative free cash flow this year as its operating profit will not be enough to cover spending.

The company’s market capitalisation has fallen 86 per cent in dollar terms since a peak in 2008, and earlier this year it was briefly overtaken by Rosneft, the Russian oil producer and its great rival, as the country’s most valuable group.

“[Gazprom] got used to living by the communist ideal that everything is in abundance — they never experienced a real deficit in funds,” says Ildar Davletshin, analyst at Renaissance Capital, a Russian investment bank. “They could afford anything. Very soon you will have to rethink everything.”

The catalyst for the shift in Gazprom’s fortunes has been the plunge in gas prices since 2014.
In the so-called spot market, prices of gas for immediate delivery in Europe, Gazprom’s most important source of revenues, have more than halved in the past two years. Chinese demand for energy has weakened, and there is also the likelihood of increased supplies of liquefied natural gas, notably from the US.

Gazprom’s own budget, drawn up at the start of the year, envisages that its export prices will fall this year to the lowest level in a decade, and this is forcing the company to pay more attention to its spending.

The pressure for cuts is most focused on the company’s enormous investment programme, which peaked at $53bn in 2011 and last year represented 2 per cent of Russia’s gross domestic product.

Gazprom’s capital spending plans “are experiencing difficulties in the current economic conditions”, said Valery Golubev, a company executive, this month.

Analysts at Sberbank CIB estimate that Gazprom will be forced to borrow heavily unless it radically revises its spending plans. They anticipate that the company’s net debt, which stood at $29bn at the end of 2015, will double over the next three to four years.

Speaking last month to investors after Gazprom published its 2015 results, Igor Shatalov, deputy finance chief, conceded that the company may be forced to increase its leverage, which is currently relatively low, with net debt just 0.9 times core earnings at the end of December.

“For certain periods we do allow ourselves to have negative cash flow while we’re dealing with the very serious challenges the company faces — investments into our priority projects,” he said.

A person close to Gazprom says the company has reintroduced a system of ranking projects that it last employed during the 2008 financial crisis, with some being delayed or cancelled.

The implications of a future in which Gazprom has less financial clout are likely to be significant — both for the Russian economy and the global gas market.

The pressure for cuts is most focused on the company’s enormous investment programme, which peaked at $53bn in 2011 and last year represented 2 per cent of Russia’s gross domestic product.

Gazprom’s capital spending plans “are experiencing difficulties in the current economic conditions”, said Valery Golubev, a company executive, this month.

Analysts at Sberbank CIB estimate that Gazprom will be forced to borrow heavily unless it radically revises its spending plans. They anticipate that the company’s net debt, which stood at $29bn at the end of 2015, will double over the next three to four years.

Speaking last month to investors after Gazprom published its 2015 results, Igor Shatalov, deputy finance chief, conceded that the company may be forced to increase its leverage, which is currently relatively low, with net debt just 0.9 times core earnings at the end of December.

“For certain periods we do allow ourselves to have negative cash flow while we’re dealing with the very serious challenges the company faces — investments into our priority projects,” he said.

A person close to Gazprom says the company has reintroduced a system of ranking projects that it last employed during the 2008 financial crisis, with some being delayed or cancelled.

The implications of a future in which Gazprom has less financial clout are likely to be significant — both for the Russian economy and the global gas market.

Meanwhile in Europe, after years of battling Brussels over its gas prices and agreements with customers, Gazprom is showing signs of becoming more amenable.

Last year it launched its first ever gas auction — in line with the EU’s aims to move the market towards spot pricing.

In the past two months Gazprom has agreed to revise contracts with two of its largest customers — Eon of Germany and Engie of France — in deals which people familiar with them say involve significant concessions from the Russian company, either by lowering prices or by linking them more closely to the spot market.

At home in Russia, Gazprom’s domestic rivals and political opponents are pushing for it to be stripped of its pipeline export monopoly or even broken up into separate production and pipeline companies.

While there is no sign that the Kremlin is planning any imminent move to challenge Gazprom’s current structure, the company said in a bond prospectus in March that “there is no assurance that we will not face [a] state-led reorganisation into several smaller and less powerful production and transportation companies”.

For the cash-strapped Russian government itself, the woes of one of its largest taxpayers are a further drain on its resources. The government had hoped to force Gazprom to pay 50 per cent of its profit in dividends this year, but last week the company announced a much lower payout.

The new financial reality is also being felt by the gas workers in Novy Urengoy. “It means we’re holding off on investments to maintain production,” says Andrei Nikitin, technical director at Gazprom’s Urengoy subsidiary. ““When prices fall, investment falls.”