OREANDA-NEWS. Fitch Ratings says that despite weaker profits and declining gas prices in Europe in 1H14, OAO Gazprom's (BBB/Negative) liquidity at end-June 2014 was a record RUB969bn, including RUB26bn in short-term investments. Gazprom also reported strong positive free cash flows over this period.

Fitch view the record cash pile as a response to the US and EU sanctions announced in March 2014, which have effectively kept Gazprom, a key Russian corporate borrower, away from the international debt capital markets since the spring. Fitch also note that Gazprom currently has arguably the best access to available sources of funding among Russian corporates.

By mid-2015, Gazprom needs to repay or refinance RUB295bn and then another RUB264bn by mid-2016. Its subsidiary JSC Gazprom Neft (BBB/Negative) is prohibited by the US and the EU sanctions from raising new equity or debt in the west, in addition to obtaining any services or equipment that relate to exploration and production from the Arctic shelf or shale oil deposits. To counter the effect of financial sanctions, Gazprom Neft started borrowing from domestic banks in 2014. In 3Q14 it raised USD and RUB loans from several domestic banks, while Gazprom drew on a syndicated two-year EUR500m loan from European banks at EURIBOR + 0.9%. Fitch note that as of 30 June 2014, 40% of Gazprom's cash was with affiliated Gazprombank (BBB-/Negative), which is prohibited from tapping international capital markets because of the sanctions.

Fitch view Gazprom's 1H14 operating and financial performance as mixed. While it reported a 5% decline yoy in the US dollar-denominated gas price in Europe, its principal market by value, and a 25% drop in operating profit yoy, its funds from operations (FFO) were up 3% and it generated strong positive free cash flows (FCF) in excess of RUB250bn.

Gazprom's European gas sales were up 1% at 86 billion cubic meters (bcm), but the average price dropped 5% to USD366 per thousand cubic meters, reflecting competitive pressures from other suppliers such as Norway's Statoil AS that supply gas at predominantly spot prices, as opposed to Gazprom's mainly oil-linked long-term prices. Declining gas prices in Europe would be a concern for Gazprom, but unless they fall significantly beyond the current levels eg, following the expected entry of US LNG into Europe later next year, they are unlikely to have a rating impact on Gazprom. We believe that Gazprom's financial profile is strong enough to absorb significant gas price shocks in the next 24 months.

Gazprom's total gas sales volumes in 1H14 were down 2% yoy at 242bcm, reflecting weaker domestic sales where the company has been losing market share to OAO Novatek (BBB-/Stable) and OJSC OC Rosneft. In our view domestic gas sales are not critical for Gazprom's creditworthiness as they accounted for only 28% of its total gas sales by value compared with 52% of sales volumes in 1H14. To address falling domestic market share, Gazprom has proposed to offer gas price discounts to its largest industrial customers of up to 7%; this proposal is currently being reviewed by the State Antimonopoly Committee. Gazprom's operating profit for the period was down 25%, due to inflationary pressures in Russia and also due to a RUB178bn (USD5.1bn) provision for doubtful receivables from NJSC Naftogaz of Ukraine (CCC).

Following the ground-breaking gas supply deal between Gazprom and China National Petroleum Corporation (CNPC, A+/Stable) signed in May 2014 for the supply of 38bcm of gas per annum via the Power of Siberia pipeline or 'eastern route' to China, Gazprom is said to be mulling over various funding options that involve Chinese off-takers and banks. One option is issuing bonds in renminbi for the equivalent of USD500m, to be led by Industrial and Commercial Bank of China (ICBC, A/Stable). Fitch note that discussions are still ongoing between Gazprom and CNPC on the USD25bn pre-payment for future gas deliveries. Fitch believe that this pre-payment is likely to be linked to the proposed additional 'western route' gas pipeline to China from Western Siberia's gasfields. Overall, we view Gazprom's ability to raise funds from a number of counterparties as a testament to its strong credit quality.