Gazprom after the 1Q 2015: An energy behemoth or state-run hedge fund?
By Chris Weston, CEE Consulting Group
Russian gas giant Gazprom`s 1Q results would appear to defy expectations in the light of sanctions and the country`s economic decline. But how true is this?
Gazprom`s revenues rose 16 percent to RUB 1.65 trln while net profit registered an impressive 71% rise to RUB 382 bln (USD 5.97 bln), according to the financial statements for the three month period ended March 31, 2015. So far, so good and the naysayers are silenced. But a closer inspection of the results and a reality check suggest that this may be a lull, albeit a profitable one, before the storm.
First of all, exports to Europe which is Gazprom`s most lucrative market, fell 16 percent due in part Â to increased competition, increased wariness over the reliability of the Russian supplier, and customers deferring purchase of gas in anticipation of a fall in gas prices to match the significant drop in oil prices. Sales in the three months to March 31 were at prices almost twice the January oil price of around USD 50 a barrel. Gazprom also faces increased domestic competition from Novatek, an entity closely linked to Gennady Timchenko, who is subject to both EU and US sanctions arising from the Russian-Ukraine conflict.
The Russian Economy Ministry has forecast that this year Gazprom`s output will fall around 7 percent to 414 bln cubic meters which is an all-time low. Deliveries to Europe and Turkey have picked up in July which might render this forecast pessimistic but they will be taking place on a much lower gas price that reflects recent falls in oil prices.
First quarter financial statements provide no substantive further discussion on the EU commission proceedings or the arbitration claims involving Ukraine above (with the exception of Gazprom updating its claim against Naftogaz to USD 29.2 bln) Â and beyond that set out in the 2014 annual report.
But a closer look inside the financial statements highlight some interesting facts about Gazprom`s first quarter:
- Operating profit was down notwithstanding the increase in sales due to a loss on trading activities.
- Interest paid and interest received on loans obtained and provided has registered little change but the company has incurred substantial fluctuations in foreign exchange losses and gains. These arose as a result of the depreciation of the EUR against the Russian rouble and the appreciation of the dollar against the Russian rouble. (Indeed, the rouble has lost about half its value since last year, thus compensating for the volumes falls to increase its sales).
Gains and losses primarily related to the revaluation of borrowings denominated in foreign currencies from rates prevailing at the year-end â€“ when the rouble collapsed up to March 31, 2015, when the rouble had essentially recovered.
The magnitude of the figures involved (gain of RUB 654,715 mln and a loss of RUB 669,808 mln), particularly in the context of the net profit of just RUB 389,618 mln show how essential hedging is to Gazprom.
By hedging, I mean ensuring that any foreign currency borrowings are more than covered by foreign currency earnings.
A failure to do so leads to a â€śnaked positionâ€ť whereby a company sells for domestic currency but is still borrowing in, say, dollars. An adverse move in foreign exchange rates can lead to a crippling debt burden â€“ those Polish mortgage holders who borrowed historically in Swiss Francs will surely attest to this fact.
As of March 31, 2015, Gazprom`s RUB denominated liabilities accounted for just under 10 percent of total – i.e. 90 percent foreign currency denominated borrowing, while domestic sales in rouble accounted for about 30-35 percent i.e. foreign sales in foreign currency are 65-70 percent.Â Borrowings come to approximately 34 percent of total revenues.
Indeed, Gazprom has recently taken out further foreign currency loans. On August 10, it reported that it had borrowed USD 760 mln and EUR 240 mln (USD 263.1 mln) from Sberbank last month, plus another USD 310 mln from Gazprombank (its subsidiary), without elaborating on the purpose of these loans. These additional loans look odd given Gazprom is sitting on substantial cash reserves of more than RUB 1.2 trln as of March 31, 2015 and that there is a mixed outlook for future sales.
Thus, Gazprom is seeking to implement its strategy but this is not without risk, given domestic sales are facing competitive pressures while foreign sales are set to decrease in price let alone in volume. In a sense, it has become a hedge fund with gas pipelines, as it seeks to rebalance its business model in the face of uncertain competitive pressures with its very real and substantial foreign currency denominated borrowings.
Photo courtesy of Gazprom.