Appropriate response to challenges
December 22, 2020
Published in corporate Gazprom Magazine Issue 12, interview conducted by Sergey Pravosudov
- Mr. Sadygov, what year-end financial results does the Gazprom Group expect in 2020?
All companies in the oil and gas sector have been exposed to significant pressures in 2020. The first six months saw an unprecedented drop in the oil and gas prices, which affected all market players without exception. In addition to the coronavirus pandemic, the European gas market was influenced by abnormally warm weather, substantial reserves of gas in storage facilities, and an oversupply of LNG. In the second half of the year, there has been a recovery in the market environment, which will have a positive effect on the year-end results for 2020.
Nevertheless, the dynamics of energy prices compared to last year are going to have a negative impact on the financial results of the Gazprom Group. To counter that, we have developed a number of optimization measures that we are now successfully implementing.
Specifically, we are using an integrated approach to curbing the rate of cost growth, which includes optimizing expenses at the initial stage of budget preparation, devising and implementing cost-cutting measures for Gazprom’s subsidiaries, optimizing costs in various sectors, and employing competitive procedures in procurement.
In the gas segment, the greatest effect in 2020 is expected to come from optimizing expenses on gas purchased from third-party producers, gas transportation through foreign territories, and gas storage services at foreign UGS facilities, as well as on geological exploration, repairs, and heat supplies.
In the oil business, the most effective optimization method will be to diversify the basket price of oil and its derivatives while maintaining the existing sales volumes.
The Gazprom Group’s EBITDA in 2020 can be expected to total some RUB 1.3 trillion
Besides the operating expenses, significant revisions have been made to capital costs. As a result, Gazprom’s investment program for 2020 has been reduced by 30 per cent against 2019 to RUB 922 billion (compared to last year’s RUB 1,323 billion).
Importantly, our optimization measures are based on the understanding that the reduction in operating and capital costs should in no way affect the implementation of production plans and the stability of gas supplies to consumers.
Taking into account the ongoing optimization measures, the Gazprom Group’s EBITDA in 2020 can be expected to total some RUB 1.3 trillion.
- Please tell us about the parameters of Gazprom’s budget for the upcoming year.
When drawing up the budget, we were moderately optimistic in assuming that the global gas market in 2021 would gradually transition from the “perfect storm” scenario that occurred this year.
The 2021 budget is based on the assumption that gas exports to Europe will see a moderate growth to 183 billion cubic meters, up by 13 billion cubic meters compared to this year’s budget. The average price of gas exports to Europe in the 2021 budget stands at USD 170 per 1,000 cubic meters, a rise of USD 44 (35 per cent) from the price indicated in this year’s budget.
Supplies to China via the Power of Siberia gas pipeline are going to double in 2021, while amounts exported to the former Soviet Union will remain roughly the same as this year.
Domestic gas sales are planned to increase by 5.1 billion cubic meters versus the 2020 budget to 225.2 billion cubic meters. As a result, we will essentially go back to the amounts planned in the pre-COVID period. The domestic prices will be indexed by 3 per cent from July 2021 in strict compliance with the draft federal budget.
In view of these amounts and prices, the proceeds from gas sales in 2021 are bound to grow by more than RUB 800 billion compared to the current year.
The “stress test” that our Company passed this year (as did the entire global economy) has encouraged us to make more active and systematic efforts towards reducing expenses, which we are currently doing with great results. For instance, when allocating expenditures for the 2021 budget we took the same approach as in the current year and put strict limits on the operating costs, calculating the expenses based on the reductions made in 2020.
Accordingly, the cash flow from operations for 2021 was calculated from two baselines: compared to this year, proceeds are going to rise by 15 per cent while payments will go up by a mere 4 per cent.
Based on a conservative estimate of expenses coupled with an expected recovery in income levels, we can predict that EBITDA for 2021 will increase considerably (by about 50 per cent)
Based on a conservative estimate of expenses coupled with an expected recovery in income levels, we can predict that EBITDA for 2021 will increase considerably (by about 50 per cent).
Our approach to capital expense planning is equally conservative. As you know, most energy majors are choosing the same strategy today. I have already mentioned that Gazprom’s investment program for 2020 was reduced by 30 per cent compared to last year. Next year, we are planning to keep the investment spending of the head company at nearly the same level as this year. As a consequence, the approved investment program of Gazprom for 2021 totals RUB 902 billion. I would like to stress that this is caused by optimization and not a mechanistic approach to cutting investment spending: the commissioning timeframes for the key facilities will remain exactly the same as previously scheduled.
The investments into our oil and power businesses in 2021 will also stay at roughly the same level as in the current year. Because of this, we expect overall investments across the Gazprom Group to be slightly higher than in 2020 and reach about RUB 1.5 trillion (net of VAT) due to increased funding for gas infrastructure programs in Russian regions on the part of Gazprom Mezhregiongaz.
This amount of investments will be fully covered by the operating cash flow, which will generate a positive free cash flow for the Gazprom Group in 2021. The budget also envisages a recovery of the reserve fund, which was partly used this year due to the crisis, from some RUB 400 billion to more than RUB 900 billion!
- What will happen with the debt burden of the Gazprom Group in 2020 and 2021?
Controlling the debt burden is a key priority of our financial policy, especially considering the weakened external markets. We decided to reduce Gazprom’s borrowings for 2020 by 15 per cent (from RUB 583 billion to RUB 501 billion, excluding intra-Group loans) down to the amount required for planned repayment and debt servicing. We took the same approach to budgeting for 2021: the external borrowing program totals upward of RUB 510 billion.
Our subsidiaries operate within the preset limits for debt ratios and financial & economic indicators. They also coordinate their borrowing programs and specific transactions with the head company in compliance with the limits and financial targets. All these companies are pursuing targeted policies to bring down the debt portfolio servicing cost by refinancing the existing loans and borrowings.
In 2020, we also actively worked to expand the list of the debt instruments we use by turning to, among other things, perpetual ruble bonds and Eurobonds.
As of the end of Q3 2020, the most relevant indicator of debt burden is net debt (including deposits) to EBITDA in dollar terms, which stands at 2.9. This figure grew primarily due to a decline in operating profit caused by market factors, as well as a reduction in liquid assets on the books after a major payout, namely the dividend payout of RUB 360 billion that took place in August. We expect the overall indicator of debt burden for 2020 to be about 3.
Of course, we do not consider this level of debt burden to be comfortable, but it remains manageable through measures that allow us to maintain the cash flow and apply a conservative method to managing debt and liquidity.
Based on the projected cash flows, we expect the net debt of the Gazprom Group in 2021 to remain about the same as this year. Thanks to the significant growth of EBITDA, the key indicator of net debt/EBITDA will be at a comfortable level of about 2 at the end of 2021.
It should be noted that even at this time of instability in the energy markets all three largest international rating agencies have confirmed that Gazprom’s credit ratings stand at the investment-grade level, which proves our high creditworthiness.
- Why did Gazprom issue perpetual Eurobonds?
In October 2020, we became the first Russian company to place a hybrid instrument of this kind in the international debt market.
On the one hand, this was in response to increased investor interest in hybrid instruments amid the global trend towards lowering interest rates. On the other hand, this instrument, which was new to us, turned out to be fully compatible with our approach to managing the Group’s debt and liquidity.
The correct structure of the transaction, drawing on the best practices of international capital markets, allows Gazprom to include its perpetual bonds in its equity capital in accordance with IFRS. This will help decrease the net debt and the net debt/EBITDA ratio.
Through sustained work with the investment community, we engaged a wide range of investors from the USA, Europe, and Asia in this issue. As a result, we attracted USD 1.4 billion and EUR 1 billion, and the volume of investor demand was almost three times as high as the announced volume. By placing these instruments, Gazprom managed to secure quasi-equity financing at attractive rates. The success of the placement is evident from its moderate spread with regard to our regular Eurobonds, which was smaller than those of hybrid issues placed by foreign companies in 2020.
The attracted funds will be used for general corporate purposes, and also partly for refinancing the current debt obligations, which will help optimize our debt portfolio both in terms of duration and servicing cost.
- The possibility of issuing perpetual bonds for gas infrastructure expansion is under discussion. What will that entail?
Expanding gas supplies and gas infrastructure in Russian regions is a priority task for Gazprom.
We are planning to issue perpetual bonds denominated in rubles with a view to providing financing for the gas infrastructure expansion program in Russian regions. Gazprom Capital, a wholly-owned subsidiary of Gazprom focused on debt financing, will act as the issuer. In November 2020, the Bank of Russia registered a bond issue program of 001B series with a total par value of RUB 150 billion. The placement of bond issues under the program is scheduled to commence in 2021.
Proceeds from the placement of these perpetual bonds will be allocated to Gazprom Mezhregiongaz and invested in the construction of gas supply facilities.
By financing the program for gas supply and gas infrastructure expansion in Russian regions through the issuance of perpetual bonds, the Gazprom Group maintains its debt burden at adequate levels because, as I have already explained with regard to perpetual Eurobonds, such instruments are classified as equity in the Group’s IFRS statements. Besides, such debt financing instruments will help boost the Company’s credit ratings.
Due to the national significance of the gas infrastructure expansion program in Russian regions, the issuance of such bonds is partly supported by the government through potential compensation of coupon payments in case the bond issuer refuses to pay the coupon yield.
- Please elaborate.
Under the instruction issued by the Russian Government, the Ministry of Finance and the relevant federal executive bodies joined forces with Gazprom to devise a mechanism of government compensation for investors’ lost income in case the issuer of perpetual bonds unilaterally refuses to pay interest on such bonds. The mechanism will facilitate the placement of bonds in the volume necessary to finance nationwide gas infrastructure expansion at lower rates.
- Please tell us about the plans to attract project financing.
By using project financing methods, Gazprom diversifies its loan sources and improves the efficiency and transparency of its key investment projects further. We plan to expand our project financing activities.
It should be pointed out that our project financing transactions are very advanced: for instance, the project financing deal for the construction of the Amur Gas Processing Plant (GPP) has received recognition from the international financial community, which underscores its strong structure and significance. The deal received the Russian ECA-backed Deal of the Year Award in the annual TXF Perfect 10 Export Finance Deals of the Year competition, as well as the Proximo EMEA (Europe, Middle East and Africa) Deals of the Year 2019 Award in the Eurasian Oil & Gas category.
As a reminder, the deal on securing project financing for the construction of the Amur GPP, the largest deal for Gazprom and one of the largest in Europe over the last few years, was successfully completed in December 2019 with the signing of project finance documentation for the total amount of debt financing of EUR 11.4 billion. The funds are provided by 22 European, Asian and Russian banks. Such a wide array of participants reflects the interest of the international financial community in collaborating with the Group, which has excellent credit solvency. Gazprom Pererabotka Blagoveshchensk acts as the borrower. The deal involves 14 banks from Europe and Japan providing up to EUR 3.66 billion under the insurance coverage offered by Western export credit agencies for a tenor of 17 years. Gazprom Pererabotka Blagoveshchensk became the first Russian company to raise project financing under ECAs’ cover for such a long tenor, thereby ensuring Gazprom’s leadership in the Russian financial market. An additional EUR 1 billion for 15 years will be provided on an uncovered basis.
The construction of the Amur GPP, which is going to be one of the largest gas processing plants in the world, is in full swing. By now, the project is 70.5 per cent complete, and the first production trains will be put onstream next year.
We are also implementing another major gas processing project. Together with RusGazDobycha, RusKhimAlyans as a project company, as well as financial advisers (Gazprombank and VEB.RF), Gazprom is currently making efforts to leverage project financing to build the complex for processing ethane-containing gas near Ust-Luga, Leningrad Region. Funds will be procured both from Russian and foreign credit institutions, including loans covered by export credit agencies. We are looking forward to the successful completion of the transaction that will expand our project financing portfolio.
As for hydrocarbon production projects, negotiations are currently underway with potential creditors to attract project financing for RusGazAlyans. It is expected that leading Russian banks will act as the original creditors for the project; the signing of the loan agreement is scheduled for late 2020. The project is run in partnership with RusGazDobycha; the maximum output within Phase 1 of the development of the Semakovskoye field will be up to 7.5 billion cubic meters per year, and it is expected to start producing gas in the fourth quarter of 2022.
The work on attracting project financing for Achim Development, a joint venture with Wintershall Dea that develops blocks 4A and 5A of the Achimov formations of the Urengoyskoye field, is well on track. At the moment, a strategy to attract long-term project financing for the company is being developed and negotiated with the German partner along with the deadlines and volumes of financing.
Besides, great efforts are being made to relieve the pressure on Gazprom’s investment program for 2021–2025. As a result of these efforts, project and structured financing will replace significant volumes of investments and will also be used to refinance the previously incurred costs. When structuring projects, great attention will be paid to the deconsolidation of the accumulated debt burden from the balance sheet of the Gazprom Group.
These measures will have a positive impact on the Company’s free cash flow and will increase its financial flexibility. We have compiled a list of top-priority projects that are expected to start paying off as early as 2021 and we will report on it after the review of the adjusted investment program of Gazprom in the middle of next year.
Dividends and capitalization
- What are the Company’s plans on paying out dividends for 2020?
As has been said on many occasions, we consider dividend payouts to be a crucial factor in the Company’s investment attractiveness.
I would like to remind you that this year we fulfilled our obligation to pay out at least 30 per cent of the adjusted net profit for 2019 in dividends; we even exceeded this level by paying out 36 per cent, or RUB 360 billion.
Against the backdrop of ruble volatility in 2020, which has adversely affected the Company’s net profit, the use of “non-cash” adjustments, primarily for currency exchange differences, will be really supportive in maintaining the current dividend amount. This confirms the validity of the dividend policy with respect to calculating the dividend base.
The amount of dividend payouts will depend on Gazprom’s financial results for 2020. It should be noted that, according to the dividend policy, in the event that the debt burden threshold, i.e. the net debt/EBITDA ratio, exceeds 2.5, the Board of Directors may take into account some additional factors when assessing the amount of dividends.
The debt burden for 2020 will no doubt exceed 2.5 due to the decline in global oil and gas prices. However, we do not recommend that the high level of debt burden above the threshold be used by the Board of Directors as a pretext for reducing the amount of dividends. Based on the year-end results for 2020, we consider it possible to pay out 40 per cent of the adjusted net profit in dividends in full compliance with the dividend policy.
Let me also remind you that the dividend policy envisages paying out at least 50 per cent of the adjusted net profit attributable to shareholders under IFRS from 2021 onward.
Based on the year-end results of 2020, we consider it possible to pay out 40 per cent of the adjusted net profit in dividends in full compliance with the dividend policy
- Are there any factors that can boost Gazprom’s capitalization?
We are convinced that Gazprom’s shares have substantial potential for further growth. In 2020, following the general market trend, our shares were very volatile due to extremely adverse conditions in the oil and gas markets.
Nevertheless, thanks to its fundamental competitive advantages and its ability to promptly respond to the dire situation in the markets this year, Gazprom has managed to retain its leadership positions in all of its key markets. We are confident that this will be reflected in the stock quotes when the uncertainty in the capital markets and the global economy begins to dissipate. Moreover, the growth of gas prices at European hubs, in our opinion, has not yet been duly taken into account in the market quotations of Gazprom’s shares.
In the long term, the fundamental value of Gazprom’s shares will rise due to an increase in the Group’s free cash flow that will be caused by the following factors:
- completion of construction and continued utilization of capacities of such gas transmission projects as Nord Stream 2 and TurkStream will allow us to reduce transmission costs related to gas exports to Europe;
- ramp-up of annual gas supplies to China via the Power of Siberia gas pipeline to 38 billion cubic meters in 2025, with an option for raising them to 44 billion cubic meters if the appropriate agreements are reached;
- stepping up of gas processing volumes with the commissioning of the Amur GPP and the LNG/GPP complex near Ust-Luga;
- growth of income from the Group’s oil business;
- implementation of a number of smaller projects and comprehensive improvement of efficiency at all levels, which is an essential part of the Group’s strategy.
In addition, our strong commitment to the dividend policy is also an important positive sign for investors. Based on the results of 2021, we will provide our shareholders with dividends in the amount of 50 per cent of the adjusted net profit under IFRS. Later on, the growth in free cash flow will correlate with profit increases, which will have a positive impact on the shareholders’ income.
Investors are placing greater emphasis on sustainable development every year, and we maintain a proactive attitude in this regard, developing all aspects of activities in this field.
Even in the face of COVID-related restrictions, we are paying great attention to our relationship with the investment community by using digital technologies and demonstrating our transparency and readiness to engage in an ongoing dialogue.
And I must add that even amid the turbulence in the oil and gas markets, most investment bank analysts still give the recommendation “to buy” with regard to Gazprom’s shares, as they observe strong upside potential for our securities.
The high quality of our assets coupled with a conservative approach to our financial policy allow Gazprom to remain a reliable and sustainable company in any market environment and also, which is vital, to make prompt and appropriate responses to the challenges that we face as one of the world’s leading energy companies.