OREANDA-NEWS. April 14, 2016. Fitch Ratings has assigned Gaz Capital S.A.'s loan participation notes (LPNs) a final senior unsecured 'BBB-' rating. The CHF500m 3.375% notes due 2018 are the 38th series issued under Gaz Capital's USD40bn debt issuance programme rated 'BBB-' by Fitch.

The LPNs are issued on a limited recourse basis for the sole purpose of funding a loan by Gaz Capital to PJSC Gazprom (BBB-/Negative). The proceeds from the loan are being used by Gazprom for general corporate purposes. The noteholders rely solely on Gazprom's credit and financial standing for the payment of obligations under the notes.

Gazprom's ratings reflect Fitch's expectation that the company will remain a vital gas supplier to Europe in the medium term despite competitive and political pressures. Gas off-takers, especially in central and eastern Europe, are still limited in their ability to diversify imports as indigenous European production is falling. Falling oil-linked gas prices make Russian gas in Europe competitive with LNG imports, while infrastructure constraints mean the European market remains fragmented.

Gazprom's access to international banks and debt capital markets improved in 2015 despite geopolitical tensions over Ukraine, and its liquidity is currently strong. We also believe the latest US sanctions against the Yuzhno-Kirinskoye oil and gas field should not materially affect Gazprom's operations.

Gazprom is Russia's largest state-owned energy company, engaged in natural gas production, transportation and distribution, as well as crude production and refining, heat and electricity generation. It is also the largest publicly listed oil and gas company in the world by hydrocarbon reserves and production. In 2015, Gazprom produced 418.5 billion cubic metres (bcm) of natural gas.

KEY RATING DRIVERS
European Volumes Stable, Prices Falling
In 9M15, Gazprom's gas sales to Europe (including Turkey) were 125bcm, up 2% yoy. Its 9M15 average gas prices in Europe fell nearly 30% yoy to the lowest level in years - USD252 per thousand cubic meters (mcm) - and are still falling. We expect Gazprom to maintain its market position in Europe by volume, but forecast Europe's gas prices to remain below USD200/mcm in 2016-2017 under Fitch's oil prices deck, recently lowered to USD35 per barrel (bbl) of Brent in 2016 and USD45/bbl in 2017.

Rouble Depreciation Supports Earnings, FCF
Gazprom's earnings are supported by the flexible national currency exchange regime in Russia. The rouble depreciation helps mitigate the negative impact from falling oil and export natural gas prices, as Gazprom's share of rouble-denominated opex exceeds that of rouble-denominated revenues (60% and 35%, respectively). The falling rouble also helps reduce capex (in dollar terms) and supports free cash flow. However, most of Gazprom's debt is foreign currency-denominated, which limits the positive effect of the rouble depreciation on the company's leverage. In our forecasts we assume that the rouble will continue to be closely correlated with oil prices, as described below in Key Assumptions.

Weak FSU and Domestic Markets
Gazprom's 9M15 gas sales volumes to former Soviet Union (FSU) countries and in Russia collapsed 26% and 5% respectively on 9M14, reflecting a continuous gas conflict with Ukraine, which significantly reduced gas purchases from Russia in 2015, a weakening Russian economy and intensifying competition from domestic producers. FSU gas prices collapsed in line with Europe's, while domestic gas sales prices increased insignificantly yoy in rouble and fell 40% in dollar terms to USD60/mcm, the lowest level in years.

Leverage Up but Within Guidelines
We forecast Gazprom's funds from operations (FFO) adjusted net leverage to have increased to 1.4x at end-2015 and to rise further to between 2.0x and 2.5x in 2016-2017, from 1.1x at end-2014. This is due to weak forecast oil and gas prices and rouble, but also high capex for 2016-2017 associated with major pipeline projects, e.g. the Power of Siberia pipeline to China. Nevertheless, net leverage is still within our negative rating trigger of 2.5x.

Pipeline Projects Increase Capex
Gazprom announced two prospective pipeline projects that, if completed, would allow it to reduce gas transit via Ukraine, which still accounts for nearly half of Russian gas transit to Europe. The first is the 32bcm (previously planned - 63bcm) capacity Turkish Stream (via the Black Sea and Turkey to Southern Europe) announced in December 2014, in place of the defunct South Stream. The second is Nord Stream II, the 55bcm capacity Lines 3 and 4 of Nord Stream, doubling its total capacity to 110bcm. In September 2015, Gazprom signed a shareholder agreement with E.ON SE (BBB+/Stable), Royal Dutch Shell plc (AA-/Negative), OMV AG (A-/Negative), BASF SE (A+/Stable) and ENGIE Group to establish a joint venture for the implementation of Nord Stream II.

KEY ASSUMPTIONS
Fitch's key assumptions within our rating case for the issuer include:
- Fitch's Brent price deck: USD35/bbl in 2016, USD45/bbl in 2017, USD55/bbl in 2018 and USD65/bbl in the long term.
- Flat European, Russian and FSU gas volumes.
- European gas prices follow Brent with a six-to-nine month lag.
- Broadly stable natural gas and liquids output in 2016-2019 with a higher share of production coming from JVs.
- USD/RUB exchange rate: RUB75 per 1 USD in 2016, RUB68 in 2017, RUB62 in 2018 and RUB57 in the long term.
- Strong access to domestic banks.

RATING SENSITIVITIES
Negative: Future developments that may, individually or collectively, lead to negative rating action include:
- Negative rating action on Russia, stemming from financial sector instability, depressed oil prices, larger-than-forecast international reserves, intensification of sanctions and/or geopolitical tensions (for more details see 'Fitch Affirms Russia at 'BBB-'; Outlook Negative', dated 16 October 2015 at www.fitchratings.com).
- Material deterioration of credit metrics, e.g. FFO adjusted net leverage above 2.5x and FFO interest cover of below 8x (2015E:13.2x) on a sustained basis due to a prolonged decline in oil and gas prices, aggressive capex or sizable acquisitions.
- Significantly falling gas sales to Europe not offset by gas sales to China and/or LNG production.
- Prolonged interruptions in gas transit via Ukraine to Europe.
- Deteriorated liquidity.

Positive: Future developments that may, individually or collectively, lead to positive rating action include:
- An upgrade is unlikely at present, given the sovereign's rating and Outlook, which constrain Gazprom's ratings. Positive triggers for the Russian sovereign rating are: easing of macroeconomic and financial sector stress, progress in reducing inflation, the avoidance of further significant depletion in international reserves, and consolidation of public finances. Further evidence that economic growth prospects and external finances are resilient to constraints on foreign financing, or the unwinding of sanctions, would also be positive.

LIQUIDITY
At 30 September 2015, Gazprom had RUB1,135bn in cash and short-term investments and large committed credit lines from state-owned Russian banks, sufficient to cover RUB680bn of short-term debt. However, without new borrowings Gazprom's strong end-3Q15 liquidity position could worsen in 2017. Our base case scenario is for Gazprom to cover possible liquidity shortfalls in 2017 by attracting new loans from domestic and, possibly, Chinese banks, as well as by issuing international bonds.

While Gazprom is currently exempt from US/EU financial sanctions, its oil subsidiary JSC Gazprom neft (BBB-/Negative) is subject to US and EU financial and sectoral sanctions. We consider stringent US and EU sanctions against Gazprom unlikely, but the range of company's funding options has reduced since mid-2014.