Limitations and Disclaimers

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2 Limitations and Disclaimers For convenience of proper understanding and using of credit rating report (hereinafter " Report") by Dagong Global Credit Rating Co., LTD. (hereinafter referred to as Dagong ), statements are shown below. 1. The only relationship between Dagong, its analysts, reviewers and rated subject is entrustment relationship caused by this rating engagement. Or relationships which may have impact on objectivity, independence and impartiality of rating do not exist. 2. The conclusion of this rating report was produced independently by Dagong based on established ratings methodology and criteria. No opinion on rating is modified in any form or by any means by undue influence of any person or organization. 3. Client information cited in this report is provided by client mselves. Dagong does not make any explicit and implicit statement on aunticity, timeliness and completeness of this information. This part of information is provided "as is" without warranty of any kind. 4. The analysis and conclusion of this report are statements of opinion and not statements of fact, nor are y recommendations to make any investment decisions, such as purchase, holding or selling of securities. 5. Within terms of validity for this report, Dagong has rights to produce surveillance credit rating reports, to adjust ratings, and to make public announcements. 6. The copyright of this report belongs to Dagong. No content may be copied, reproduced, resold and disseminated by any organization or person without prior written permission of Dagong. If in any circumstances this report is cited or published, in whole or in parts, references are required. Misrepresentation may result in legal action.

3 Credit Rating Report for Gazprom Gazpro om DAGONG 2015 Credit rating report DGConCYO [2015] 005 Long Term Issuer Default Ratings Analyst Contact Local currency long term rating/outlook Foreign currency long term rating/outlook Rating Date AAA/ stable AAA/ stable Team leader: PAN Weizhi Analyst: GUO Zengjin Contact: JI Yuanqing Tel: Fax: Support: E mail address:rating@dagongcredit.com Add: 8/F, Unit A, Eagle Run Plaza, No.26 Xiaoyun Road, Chaoyang District, Beijing, P.R.China, Rationale Dagong assigns Open Joint Stock Company Gazprom (hereinafter referred to as Gazprom or Company ) a long term credit rating of AAA for both local currency and foreign currency, and outlooks for both ratings are stable. The ratings reflect comprehensive analysis of Gazprom s debt repayment environment, wealth creation capacity, debt repayment sourcess and debt repayment capability. The main drivers of rating are as follows: Debt repayment environment: The political environment of Russia is relatively stable and sustainable, and immediate adjustment of energy strategies taken by Russian Federation Government alleviates crash from western sanctions to energy industry. The tension in credit environment will be eased along with recovery of Russia s macroeconomy, and changes in credit environment pose little effect on Company s repayment capability. Wealth creation capability: The Company has a wide and increasing market demand, and Eastward Development strategies will create more opportunities to Company s development. The strong production capacity and stable sales secure leadership position among its international peers. Debt repayment sources: The Company s degree of deviation 1 is quite low, about 1.7, between available repayment sources and wealth creation capability, which indicates that Company s repayment sources are mainly from its wealth creation. With 1 For definition of index please refer to appendix 7. 1

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5 Credit Rating Report for Gazprom Guide to Credit Rating Report The credit rating assigned by Dagong is an opinion on debtor s capability to service debt. This credit rating report for Gazprom is based on guidelines set in Dagong Credit Rating Principles. We assess credit risk of issuer by analyzing following four aspects: debt repayment environments, wealth creation capability, sources of debt repayment and repayment capability. Dagong Credit Rating Principles stipulates that debt repayment environment is macro institutional environment that imposes on debtors and impacts debtors wealth creation capability as well as debt repayment sources. Wealth creation capability, key rating driver in principle, is most sustainable source for debt repayment by any debtor and hencee basiss for any creditors lending decisions. Differentiating riskss between various repayment sources is crucial in order to form an opinion on debtor s capability of repayment. The degree of deviation between a debt repayment source and wealth creation capability of debtor reflects sustainability of each debt repayment source. Generally, larger degree of deviation, less stable repayment sources, and degreee of safety of outstanding debt, and vice versa. After adjusting degree of deviation risk by adopting risk factors of repayment sources, we analyze debt status and determine debt repayment safety degree of debtors. Ultimately, we determine credit ratings hereby. The higher debt repayment safety degree is, higher credit rating is. The analyses of individual factors are as followed: The role of a debt repayment environment in rating is to analyze impact of a nation s superstructure, political, legal and credit environments and economic base on a debtor s wealth creation capability and sources of repayment. Wealth creation capability as key criteria for assessing solvency of any debtor can truly reveal credit risk, it analyzes to what extent profitability of debtors can contribute to repayment sources. By analyzing primary repayment sources, cash outflow and accessible repayment sources, repayment source estimates reliability of repayment capital source. It measures risk of available repayment source using degree of deviation between accessible repayment source and wealth creation capability. Repayment capability, through risk adjustment of degree of deviation of available repayment source, aims to define degree of protection that available repayment source can provide to serving a particular debt and adjust repayment capability of debtors. 3

6 Credit Rating Report for Gazprom 1. Company Profile Business background: The Company was restructured from USSR Gas Industry Ministry in 1989 as Gazprom State Gas Concern. The Company was later partially privatized, after changes in ownership and capital through years. In 1993, Company started share offering and was later traded on St. Petersburg Stock Exchange (SPBEX); at present Company is listed on MICEX with stock symbol GAZP, and also has ADR/GDR programs traded on USA (OTC), London, Berlin, Frankfurt and Singapore exchanges. The Gazprom Group consists of 88 subsidiaries with 100% equity participation and of 180 subsidiaries with no less than 50% share capital. The major business of Gazprom Group covers exploration, production, transportation, storage, processing and sale of natural gas, gas condensate and oil as well as electric and heat energy generation, and scope of business involves a number of countries in world. For unified management of natural gas resources, Russian Federation Government awarded Company with monopoly on operating Russian gas pipeline system and natural gas export right, providing powerful policy support for development of Company. Ownership structure and corporate governance: As of 30 June 2014, Russian Federation Government has controlling interest of over 50.23% of Company and is ultimate controlling party. In accordance with relevant laws and regulations, Company constantly improves existing corporate governance framework and management system, thus to realize furr normative business operation. Core competitiveness: As world's largest gas producer and one of main local petrochemical product manufacturer and seller, Gazprom Group has abundant hydrocarbon resources. The Gazprom Group occupies a significant position in not only global natural gas exploration, production, processing and sales market, but also oil product markets, domestic electricity and heat market; moreover, it is also equipped with world s largest natural gas transportation system. The Company holds monopoly of Russian pipeline gas exports, was proved to be largest natural gas supplier for whole Europe, which is Company s main market. Debt scale: As of 30 June 2014, Company s debt was 3,867.03bn RR in total, among which 1,838.43bn RR interest bearing debt accounted for 47.54% of total debt, most of interest bearing debt originates from long term bank loans and bond both in local and foreign currency for Company s projects construction. Debt ratio: For each year end from and as of 30 June 2014, Company s assets to liabilities ratio were 29.82%, 29.08%, % and 28.08% respectively; while current ratio reached 1.71, 1.62, 2.06 and 2.19 respectively. 2. Debt Repayment Environment The domestic political environment in Russia is relatively stable, as well as policy continuity. The Russian Federation Government made swift policy adjustmentss to alleviate impact of sanctions imposed by US and EU. Dagong expects tight domestic credit environment currently experienced by Gazprom is likely to gradually improve due to recovery of Russian economy in medium term. The impact of short term deterioration of credit 4

7 Credit Rating Report for Gazprom environment on Gazprom s wealth creation capacity is controllable. Debt Repayment Environment index: 3.09 C CC CCC B BB BBB A AA AA AA 2.1 Political and Legal Environment The Russian political environment is largely stable and policy continuity is intact. The Russian Federation Government is able to make proper policy adjustments to gradually alleviate impact on Russian energy sector caused by sanctions imposed by US and EU. Although US and EU sanctions put pressure on international front, domestic political environment of Russia is relatively stable. The policy continuity has not been impacted. Since Putin s reelection in 2012, Government of Russian Federation continues to consolidate power. Pro Kremliensures that formulation and implementation of policy initiatives will not be hampered by United Russia Party occupies more than half of seats in State Duma 6, which opposition. Meanwhile, Government s crackdown on corruption and stabilization of social order laid down a solid public opinion foundation. In 2014, geopolitical tension between Russia and Ukraine escalated; resulting sanctions 7 squeezed Russia on international front. However, impact on Russian domestic politics is limited. Russia s strong foreign policy stance inspired national sentiment and received support 8 from Russian general public. Overall, domestic political environment remains stable, allowing Government of Russian Federation to introduce policy initiatives. Russia's energy sector enjoys a favorable policy environment; Government's timely adjustment of its strategy for external energy cooperation will help to alleviate adverse effects of Western sanctions. In 2009, Russia adopted Energy Strategy of Russia for Period up to 2030, claiming to establish an innovative and efficient energy industry in Russia and develop leading entities in energy industry so as to transfer Russia from a resource exporting country into an innovation oriented country. Under guidance of national strategy for energy development, Government has promoted new gas pipeline across Black Sea 6 Currently United Russia party occupies 238 seats out of 450 seats, Communist Party of Russia occupies 92 seats, A Just Russia occupies 64 seats, and Liberal Democratic Party of Russia occupies 56 seats. 7 The U.S. and EU imposed a series of sanctions to Russian energy sector. The U.S. sanctions prohibit U.S. person from transacting in, providing financing for, or orwise dealing in new debt of longer than 90 days maturity for a number of Russian energy companies; providing, exporting or reexporting, directly or indirectly, goods, services, or technology in support of exploration or production of oil in Russian Federation. The EU sanction prohibit provision of drilling, well testing, logging and completion services or specialized floating vessels for oil exploration or production; purchasing, selling, providing investmentt services for or assistance in issuance of, or or dealings with transferable securities and money market instruments; and prohibit EU person from making or being part of any arrangement to make new loans or credit with specific maturities. 8 Up till September 2014, Putin s approval rate soared to 86%. 5

8 Credit Rating Report for Gazprom towards Turkey and Norast Asia gas pipeline projects, built up gas giants, enhanced cooperation in natural gas sector with Europe, taken advantage of oil and gas resources to attract foreign capital and technology, and emphasized on importing advanced technologies for continental shelf oil and gas development from Europe and United States in order to modernize its oil and gas industry. This has provided favorable support for development and upgrading of Russia's gas sector. But Western sanctions will slow down Russia's technological cooperation with developed countries in Europe and US in energy sector. Confronting negative effect of European and American economic sanctionss on modernization of energy sector, Russian Government adjusted focus of its external energy cooperation, for example enhanced contacts and cooperation with China in natural gas sector, which would contribute to gradual alleviation of adverse effects of Western sanctions on Gazprom's growth. 2.2 Credit Environment The credit environment is likely to improve in medium term along with recovery of Russian economy, and impact of changes in credit environment on Gazprom s repayment capability is moderate. Recently, credit environment of Russia is tightening, inhibiting corporate financing needs. By end of 2014, capital outflow and sanctions resulted in limitation on offshore financing created liquidity issue in Russian banking sector. Making matter worse, CBR raised key interest rate substantially to 17%, highest since 2008 financial crisis, to counter capital outflow and depreciation of Ruble. The costs of financing for banks increase substantially as a result. Dagong estimate that crude oil price to keep at current low in short term due to oversupply and appreciation of US dollar, which is likely to press Russian economy furr due to its dependence on oil export revenue. Dagong estimates GDP growth of Russia to decrease to 4.5%. The recession and high costss of financing will impact repayment capability of households and private sector, which poses challenges to asset quality of banking sector, resulting in decline of banking system stability and ability of providing credit to real economy as well as deterioration of credit environment for Gazprom. In short term, Russian Federation Government will continue to support banking system through capital injection, sustaining liquidity and capacity to provide credit to real economy. Meanwhile, Russian Government is starting to implement informal capital control, which is likely to stabilize Ruble exchange rate. In medium term, with exchange rate and economy gradually stabilized and capital outflow pressure subsided, CBR may ease monetary policy gradually to improve credit environment in medium term, which would benefit operation of Gazprom. As a large state owned enterprise, Gazprom has a prominent position in national strategy, strong profitability and low debt rate; in particular, its local currency denominated debt is limited; thus impact of unstable factors in domestic credit environment is small on Gazprom's repayment capability. 6

9 Credit Rating Report for Gazprom 3. Wealth Creation Capability With new strategic focus on Asia Pacific, a stronger market demand will provide more development opportunities for Company. The Gazprom Group owns vast resources and has sufficient production capacity. It also enjoys relatively stable prices for its natural gas sales and a leading position among its global peers on profitability. Wealth Creation Capacity Index: 4.47 C CC CCC B BB BBB A AA AA AA 3.1 Market Demand The Gazprom Group is facing broad consumption scope for its major business, and is highly relied by its consumer region. The major gas markets for Company includes Russia, Europe and Former Soviet Union countries. In 2013, se three markets accounted for 27%, 58% and 15% of Company s total gas net revenue respectively, and 51%, 37% and 12% of total gas sales volume respectively. In Russia, share of natural gas in primary energy consumption is among highest globally, with about 55% in Natural gas consumption in Russia was 473.0bcm, 466.1bcm and bcm respectively in last three years, showing stable demand for gas. The Company has legal monopoly power on Russian pipeline gas exports, and is major supplier of gas to European market. In Europe, 30% of total gas consumption and 64% of total gas imports were from Gazprom as of Among European importers, Germany, Turkey, Italy, France, and United Kingdom receive bulk of its exports. The Company s gas saless volumes in Europe fluctuated in recent years due to falling proportion of gas consumption as a result of economic downturn, declining share of natural gas in power generation, as well as wear conditions in recent years. Neverless, sales revenuee has increased gradually. In near future, although policies of promoting renewable energy developments and consumptions will adversely affect growth potential for European natural gas demand, European market is still unable to get rid of dependence on Russian gas due to weak substitute featuree of natural gas and favorable geographical position of Russia. The Company covers 50% of natural gas consumption in FSU countries. Ukraine and Belarus are largest FSU consumers. Unfavorable economic conditions and furr decline of industrial production, as well as increasing share of coal and or energy resources in ir fuel and energy mixes, primarily in Ukraine and Baltic states, led to decrease of natural gas consumptions in FSU countries. The oil indexed pricing would weaken wealth creation capability of Gazprom. From long term perspective, FSU countries will still be heavily dependent on Russian gas and FSU market will still be an active driver for Company s wealth creation capability. 7

10 Credit Rating Report for Gazprom The stability of relationships. market demand will be furr secured by strong long term customer The long history of international cooperation, strong reputation as a reliable supplier and long term contacts secure stable debt repayment sources for Gazprom. The vast majority of Russian gas in Europe is sold on long term contracts (from 20 to 25 years), though some of subsidiaries have been increasingly active in short term sales business. Furr, Gazprom actively cooperates with East Asian countries. In May 2014, Gazprom and CNPC entered into a 30 year Gas Purchase Agreement contract. The terms and conditions of existing contracts ensure a balanced supply and demand in market and in large extent secure stable income sources of Company. Gazprom s new strategic focus on Asia Pacific will create more development opportunities and could help improve its profitability in future. The vast unmet energy demand in Asia Pacific market could be a driving force for Company s development. The Asia Pacific region, which consists mainly of developing countries, accounts for more than 60% of world population. With rapid economic development, increasing consumption level, as well as awareness of using clean energy, re will be huge potential demandd for energy from Asia Pacific, providing more opportunities for Gazprom. Under Western sanctions, Russia has actively cooperated with countries in Asia Pacific region in various fields, especially energy. As a major implementer of national strategy, Gazprom launched a series of investmentss activities. In existing project, Sakhalin II project has started with supply of LNG to Japan, South Korea from Construction of projects that cooperated with China consists of two routes. In May 2014, Gazprom and CNPC entered into a Gas Purchase Agreement which stipulates gas supplies through eastern route. As stated in contract, Russia will supply 38bcm of gas annually over 30 years; construction of route has already started from 3Q 2014, and supplies of gas were planned to begin after The Company s construction projects in Asia Pacific region provide more opportunities for its development and partially relieve political and economic risks caused by high geographic concentration of its sales, thus effectively enhancing its earnings stability. In long term, Gazprom will be expected to achieve more stable incremental income and better secure debt repayment capabilities. 3.2 Market competitiveness The strong market competitiveness of Gazprom from its dominant access to natural resources secures sustainability of its wealth creation capability. Gazprom has access to extensive natural resources in Russia, leading to a unique edge over its competitors. Gazprom controls most of Russia s gas reserves, both in direct ownership and in joint ventures. In 2013, Gazprom s proved gas reserves were 18,921.7bcm, mostly in Urals Federal District, which accounted for 62.95% of total. As of 31 December 2013, Gazprom s natural gas reserves amounted to 16.6% of world s total natural gas reserves and 72.3% of Russia s natural gas reserves. Gazprom also demonstrates very strong sustainability and 8

11 Credit Rating Report for Gazprom growth potential as reflected by its stable natural gas replacement ratio at more than 1.0 for last few years and its recoverable years of gas reserves at around 73. More importantly, most of reserves are located domestically in Russia whichh shields Company from unpredictable international business and political risks in terms of exploitation, providing Company a unique edgee over its competitors. Gazprom s holds a leading position in production of gas both in Russia and World. In 2013, natural gas production accounted to 13.5% of worldwide and 72.9% of Russian production, Urals FD produced 92.79% of Company s natural gas. Western Siberian fields are able to meet demands from Russia, Former Soviet Union (FSU) and Europe. Meanwhile, Gazprom has already set up new gas production centers in east of Russia with sufficient capacity to meet both long term domestic demands in Russia s Eastern regions and international demands in Asia Pacificc countries. The technological advancement and market domination of storage and transportation equipments are conducive to enhance Company s competitiveness and effectively protect its wealth creation capability. While controlling upstream, Gazprom dominates Russia s natural gas transportation system. Transportation system transporting gas from Western Siberian fields and or gas production centers comprises world s largest Unified Gas Supply System (UGSS), covering entire western Russia. Gazprom s UGSS operates about thousand km of trunk gas pipelines, as well as 247 linear compressorr stations, 6 gas processing facilities and 26 Underground Gas Storage Facilities (UGSF). The main export pipelines include Urengoy Uzhgorod, Yamal Europe, Blue Stream (to Turkey) and Nord Stream pipelines, all carrying Russian gas to eastern and western European markets via Ukraine, Belarus, and across Baltic and Black seas. Gazprom has continually upgraded and renovated its pipeline system and facilities in order to maintain its competitive advantages. As a long term financial investment, South Stream project diversifies Company s export routes to Europe for Russian natural gas supplies, with a planned full design capacity of 63.0bcm of gas per annum. However, as a result of Russian Ukraine disputes, South Stream pipeline is planned to be laid through Turkey, avoiding Ukraine s territory altoger. Moreover, to make gas supply and transportation more reliable and efficient, Gazprom carried out overhauls and scheduled preventive maintenance annually, contributing to enhancement of its market competitiveness. Achievements in technological progresss will become new engine for Gazprom s future wealth creation capability. The bulk of investments in technology innovation resulted in remarkable achievements of Company. The costs on R&D from for Gazprom are 7.9bn RR, 7.7bn RR and 6.8bn RR respectively. Investments into innovations include Company s expenditures for future of its business such as increasing reliability and safety, developing new resourcee base, improving competitive and breaking new technological grounds. The key innovative development priorities are deposit exploration and development, especially for gas, gas condensate, oil processing and transportation in extreme ambient conditions of 9

12 Credit Rating Report for Gazprom Far North and Permafrost, Arctic offshore and in areas with severe ice conditions. Gazprom is one of technology leaders in response to such challenges. In 2013, Company successfully tried and tested a first in Russia underwater production system at Kirinskoye field (Sakhalin III project), contributing to accelerated technological development of Russian energy industry. Significant economic benefits are also expected from hydrocarbons extraction from hard to access deposits, liquefaction of natural gas, hydrocarbons processing and GTL. Gazprom possesses strong proprietary R& &D capacities, including eight R&D facilities, and three design institutes, with over eleven thousand people employed. As of 31 December 2013, Company s entities owned more than 2,000 patents to intellectual property rights. In addition, Gazprom also keeps upgrading technical level in exploration, production, transportation, processing and underground storage of gas by pursues a consistent policy through energy saving and implementation of energy efficient technologies, and thus helps to enhance reduction of costs, minimize adverse environmental impacts, improve working efficiency and ensure production safety, providing Company with furr competitive advantage. Highly diversifiedd product portfolio and continuous rising product quality will strongly enhance Gazprom s wealth creation capability in future. From , its sales volume and revenue have shown gradual growth. Gazprom has also maintained leadership in automobile gasoline suppliers and is one of largest diesel fuel suppliers in Russia. Gazprom s refineries produce a wide range of refined oil products, automobile gasoline, diesel fuel, jet fuel, fuel oil and bitumen, etc; higher product diversification will better meet different need of market. In 2013, contribution of diesel fuel accounted for 31% of Gazprom s petroleum products distribution, followed by gasoline and heating oil that accounted for 23% and 18% respectively. The shares of refined products sell inside Russia and far abroad were 56.2% and 36.9% respectively. Domestically in Russia, Company sold 12.3mm tones of motor gasoline and 18.3million tones of diesel fuel in 2013, making it leading automobile gasoline supplier and one of largest diesel fuel suppliers by market shares of 30% and 28% %, respectively. In addition, Gazprom is largest heat power supplier in Russia with bulk of consistent investments funneled to improving production efficiency. In recent years, Gazprom actively expands in electric and heat generation exemplified by its acquisition of OAO MIPC in 2013 which turned Company into largest heat supplier in world. Gazprom consistently made efforts on improving heating supply quality and reliability, by running a number of cost optimization programs, taking actions to improve financial performance and constructing new heating pipelines and power units. From , sales revenue of electric and heat energy grew steadily and respectively accounted for 15% of electric power and 22% of heat energy generated in Russia in Profitability Gazprom has superior profitability among global integrated energy companies. The production capacity added in future is facilitating Company to furr grow its revenue base, 10

13 bringing in stable resources to strengnn its debt repayment capacity. The revenue of Gazprom has shown a stable growth trend; trend is estimated to grow furr, given ample room of growth in both capacity and market demand. From , all segments of Gazprom s operations registered stable revenue growth, with minor volatility amid cycles of international macroeconomy. For 2014, due to plunge of oil prices globally, revenue is expected to decrease moderately. Going forward, Gazprom will continue its expansion into Asian Pacific region, which is likely to bring revenue growth in mid termm future. All segments of Company s operations have slightly different growth dynamics; however, gas business remains core of Gazprom s revenue base. Table1 The revenue, cost and gross margin from FY2011 to FY2013 and 1H2014 (RUB,Billion,%)) Iterms Total Revenue Natural gas Refined products Crude oil and gas condensate Electric and heat energy Gas transportation Cost Grosss margin Credit Rating Report for Gazprom Sales 1H2014 2,874 1, , % of Total Sales FY2013 % of Total 5, ,766 2, ,657 1, ,209 Sources: OAO Gazprom IFRS Consolidated Financial Statements , , Sales FY % of Total Sales 4,637 FY2011 % of Total 2, , Gas business is Company s primary business. From 2011 to 1H 2014, revenue from gas business contributed on average 57.07% of total revenue of Company. In terms of revenue changes due to changes in regional gas consumption pattern, regional consumption pattern is stable, but geographic reach of Gazprom s gas business is expanding, propping revenue growth of Company. Due to geopolitical tension of FSU regions started in 2012, some of FSU regions opt to substitute imported gas with locally produced coal, which resulted in decrease of gas sales in this region, gas revenue in or regions such as Europe are relatively stable, overall revenue growth trend is maintained. In terms of gas price, revenue impact from price level fluctuation is manageable due to fact that Gazprom is able to exert certain degree of pricing power and its pricing mechanism is long term crude oil prices, strong negotiating power in domestic and FSU regions underscore revenue stability of gas business. What s more, current sanction imposed by US and EU is of in nature. Although gas price in Europe is to a certain degree linked to international limited impact on gas revenue, coupled with potential revenue stream from its Asia Pacific operations in future, Company s gas business is likely to sustain its revenue growth trajectory. 11

14 Credit Rating Report for Gazprom Figure1 The natural gas price dynamics for Gazprom ( RUB per mcm) 12,000 10,000 8,000 Russia Far aboard 6,000 4,000 FSU 2, Sources: OAO Gazprom IFRS Consolidated Financial Statements. The Company s refining product business is gaining market share in domestic market, which is ir main market, implying that refining product business will not likely be impacted by international economic and political environment changes. Revenuee from refining business grows quickly, achieving a CAGR of 23.99% from Due to strong domestic demand, in next 1~2 years refining product business is likely to sustain its current strong growth trend. Gazprom s crude oil and gas condensate business contributes only a small portion of Company s total revenue; average revenue contribution from past 3 years is 4.95%.. Due to recent increase in volatility of international crude oil prices, revenue from this segment is declining. It is estimated that given current oil price level, revenue would likely to decrease substantially in dollar terms; however, given commensurate ruble depreciation and relatively small contribution to total revenue, overall impact of crude oil price decline is minimal. Besides, Gazprom s revenue from electricc and heat energy segment is relatively stable for last 3 years, especially significant development on heat business that made Company largest Russian and global heat energy producer, but contribution to Company s revenue is relatively small. Gazprom s operating costs grow commensurately with expansion of revenue base. The operating expenses include oil and gas purchase, taxes or than profit tax, staff cost, etc..; aforementioned three items on average constituted 54.4% of total operating expenses. From , operating expenses of Company grew commensurately with growth of revenue, with a CAGR of 13.8%. The increase in operating expense is primarily driven by increase of gas Mineral Extraction Tax (MET) rate in last 3 years that impacted tax burden of Gazprom. On one hand crude oil MET rates is likely to increase in next 3 years in framework of tax maneuver according to published Government roadmap; on or hand, tax rate on crude oil export envisaged by tax maneuver decreasedd by 40%, and is expected to decrease furr in next 3 years, refined oil product export tariff is likely to decrease in range of 70% 100%. Due to Russian Government s budget reliance on energy export, and because gas and oil MET and export duties are linked respectively to oil and gas price 12

15 Credit Rating Report for Gazprom levels, overall tax burden on Company may rise furr in next 1~2 years. After comprehensive assessment of Company s revenue and expense growth trend, overall profitability of Gazprom is very strong. Compared with global peers in integrated oil and gas industry, Gazprom is best in terms of profit, profit margins and return on assets; in year 2013, net profit margin reached 22.2%, while ROE and ROA reached 12.7% and 9.1% respectively. Going forward, with balanced growth of revenue and expenses, profitability of Company is likely to sustain. Figure2 Profit index of international major oil and gas companies in 2013 ( USD, Million) ) 40,000 35,000 30,000 25,000 20,000 15,000 10,000 5,000 0 (%) Profit Operate margin Profit margin ROA Sources: OAO Gazprom IFRS Consolidated Financial Statements and Bloomberg. 4. Debt Repayment Sources The degree of deviation between available repayment sources and wealth creation capabilities is 1.70, showing that available repayment sources of Company mainly relies on its own wealth creation capabilities, providing strong reliability to ensure debt repayment. Degree of deviation of repayment sources and wealth creation capacity: C CC CCC B BB BBB A AA AA AA 4.1 Profit The strong profit generation of Gazprom secures stability sources to service existing debt. of available repayment In general, large scale of profit from business operations of Gazprom tops industry. By 13

16 Credit Rating Report for Gazprom looking at profit indicators which include net profit, total profit and EBITDA, Company ranked first in top 13 largest peers in industry in 2013, and from cash flow point of view, Company also held no.1 position during same period. Therefore, Gazprom owns very strong ability to generate cash thatt would effectively secure capital expenditure on investment and debt repayment. In next 1~2 years, along with implementing business expansion strategy, EBITDA and CFO of Company will be less affected by Western sanctions and will still maintain relatively high level, providing powerful support for debt repayment. Figure 3 EBITDA of Gazprom from 2010 to 2016 ( RUB, Billion) 2,,500 2,,000 1,,500 1,, Sources: OAO Gazprom IFRS Consolidated Financial Statements and Dagong. 4.2 Assets The stability of Gazprom s quality of assets. available debt repayment sources will benefit from strong The assets of Company are of highh quality and with strong realizable value. As of 31 December 2013, current assets accounted for 21.31% of total assets, and maintained at level of over 20% all year around, of which cash account for a relatively high proportion and restricted cash only accounted a tiny proportion. From aspect of non current assets, PP&E accounted for 84.55% of non current assets and 66.54% of total assets. Those fixed assets are mainly facilities for Company s production, transportation and sales, as owner of Unified Gas Supply System of Russia, Gazprom controls and operates most advanced facilities, consistent improvement in technical level ensuring high realizable value of assets for Company. Overall, Gazprom assets are of relatively high quality, allowing Company to obtain abundant collateralized financing, enhancing stability of debt repayment sources. 14

17 Credit Rating Report for Gazprom Table2 Assets structure(rub,billion,% ) 1H2014 FY2013 FY2012 Value % of % of % of Value Value Total Total Total Current assets Cash and cash equivalents Accounts receivable and prepayments Inventories Non current assets PPE Investments in associated 2, ,864 9, , , ,574 8, , ,659 7, undertakings and ventures Total assets joint , , , Sources: OAO Gazprom IFRS Consolidated Financial Statements. FY2011 % of Value Total 2, , , , Debt Financing A stable cash inflow from debt financing can be ensured, and available debt repayment sources would be enriched by strong domestic financing capacity and gradual improvement of international financing channels. The dominant market position in Russian domestic market enhances Company s domestic financing capability. Due to strategic position in Russian national economy and state controlled background, Gazprom is particularly strong in domestic financing capacity, but will face increasing financing costs as a result of current tight credit environment influenced by CBR key rate hike. Since beginning of 2014, western countries has implemented economic and financial sanctions against Russia, mainly including measures such as requiring European Investment Bank to suspend financing to business in Russia, prohibiting Russian state owned banks from issuing shares or conducting bond financing in EU countries, and strengning restrictions for Russia to step up to EU monetary market. Therefore with increasing financing costs Gazprom is actively seeking to enter Hong Kong and or Asian financial markets to mitigate refinancing risk. The Company s Asia Pacific strategy willl promote Company s diversification of financing channels overseas. With close cooperation with Asia Pacific countries, Gazprom will carry out more projects in Asia Pacific region, and economic interestss for both parties will be linked more closely. Gazprom is more likely to get financial support from Asia Pacific region, especially from project partner countries, to ensure smooth conduction for projects, and to realize win win cooperation for both parties. The Asia Pacific to form diversified financing channels and reduce financing risk for strategy reduces concentration of sales to Europe, meanwhile is conducive Gazprom. 15

18 Credit Rating Report for Gazprom 4.4 External support As a state owned enterprise, Gazprom plays an important role in national economy, implying high probability to obtain support from Government providing a reliable secure for stability of available debt repayment sources. Gazprom plays an important role in both Russia's political and economic life, and Russian Government provides it with strong external support constantly. From a political point of view, Company is able to influence each link of Russia's gas industry policy from formulation to implementation; it is a powerful tool of Russian foreign policy. From standpoint of Russian national strategic development, Gazprom is of significance to protect stability of national development. From an economic point of view, Company produces 8% of Russia s industrial output, ensuring 25% of national budget. Internally it is gas monopoly industry, controls 72.3% of Russia s natural gas reserves and 16.6% of world s gas reserves, and accounts for 90% of total Russia s gas exploitation, has world's largest natural gas transportation system, which accounts for 98% of Russia'ss domestic gas transportation pipelines. Externally it is most critical executor for Russian gas export strategy and almost monopolies natural gas export rights all over Russia. From ownership structure, Russian Federal Government is largest shareholder of Company, as of 30 June 2014, Russian Government has a total of 50.23% holdings of Gazprom. Overall, Russian Government has sufficient power to provide strong external support for Gazprom to ensure stability of available debt repayment sources when appears with debt problems. 5. Debt Repayment Capacity On basis of rated Company s small deviation between its available repayment sourcess and wealth creation capability, and with adjustment through debt management strength index, repayment environment index and wealth creation index, Dagong derives conclusion that Company has a strong repayment capability of local currency denominated debt as welll as a strong foreign currency denominated debt repayment capability, which is inferred after adjusting repayment capability of local currency denominated debt with foreign currency index. 5.1 Local currency Debt Repayment Capability Local currency repayment capacity index: 4.17 C CC CCC B BB BBB A AA AA AA Gazprom represents a relatively reasonable structure of outstanding debt and a rar small debt ratio among its international peers. The sufficiency of its available repayment sources not only secures its outstanding debt could be repaid but also leavee an incremental space for new debt. Comprehensively, Gazprom has a strong repayment capability for its local currency denominated debt. 16

19 Credit Rating Report for Gazprom The Company has a relatively reasonablee term structure of outstanding debt. To be more specific, short term interest bearing debt occupies a relatively low proportion; for instance, it accounted for only 16.03% of total interest bearing debt by end of June Besides, long term interest bearing debt has a relatively balanced repayment structure and thus a comparatively rare concentrated repayment pressure. In recent years, Gazprom has kept a relatively stable interest bearing debt ratio; as of 30 June 2014, interest bearing debt ratio of Company was 47.54%. The Company s various available repayment sources have secured its strong ability for repayment of outstanding debt. In view of Gazprom s assets to liabilities ratio, of which has remained stable in latest three years. At end of June 2014, Company s assets to liabilities ratio was 28.08%, which is far below international average level (50.0% 9 ). From aspect of Company s liquidity, Company has had a higher liquidity than most of its peers in world, as of 30 June 2014, Gazprom garnered a current ratio of 2.19, with a quick ratio of 1.75 and a cash ratio of 0.73, which were all above average 10. From aspect of Company s operating analysis, both data of net income and cash flow from operation indicate a high level of coverage and protection to outstanding debt. From , Company s EBITDA to current ratio weree 1.47, 1.10 and 1.44 times respectively and CFO to interest expense were 18.09, and respectively of its corresponding year. Although Gazprom has some difficulties in external financing, considering its sufficient amount of free cash flows, it is estimated that in next 1~2 years, Company's assets to liabilitiewhich could cover most of ratio would remain better than industry average, with high EBITDA matured debts. In a word, overall outstanding debt repayment capability would remain extremely strong. Table3 Main repayment capability ratios Indicator 1H2014 1H2013 FY2013 FY2012 FY2011 EBITDA/Current liabilities (%) EBITDA/Total liabilities (%) EBITDA/Total interest CFO/ /Total interest EBITDA/Interest expense CFO/ /Interest expense Sources: OAO Gazprom IFRS Consolidated Financial Statements. With its strong capability of wealth creation and comparatively low level of current debt ratio, Gazprom has a wide space for incremental debt and a strong repayment capability for maximum debt. The Company s debt ratio remains below industry average, and its stable and reliable repayment sources could cover a larger outstanding debt, which indicates Gazprom has ability to increasee its debt. Dagong anticipates that gradual implementation of Company s 9 Based on Bloomberg figures. 10 As s of 30 June 2014, average level of current ratio and cash ratio were 1.52 and respectively that extracted from Bloomberg 17

20 Credit Rating Report for Gazprom Asia Pacific Development Strategy would furr increase wealth creation capability of Gazprom, and Company could still remain its relatively low debt ratio. Comprehensively speaking, maximum debt repayment capability of Gazprom is considerably strong enough. 5.2 Foreign currency Debt Repayment Capability Foreign currency repayment capacity index: 4.08 C CC CCC B BB BB BB A AA AAAA The majority of Gazprom s debt is denominated in foreign currency, Company s external financing sources are mainly from United States and European countries and likely to be restrained because of recent western sanctions. However, reasonable distribution of repayment schedule structure of its foreign currency denominated debt allowed Gazprom to manage repayment of its foreign currency debt with flexibility. In terms of currency composition, Company s foreign currency debts are primarily in two currencies: US dollar and Euro. As of 31 December 2013, total amount of its foreign currency debts was $45.07 billion, among which debts in US dollar accounted for nearly 50% while those in Euro accounted for around 30%. The term structure of foreign currency debt is relatively evenly distributed. From , Company s outstanding foreign currency debt is larger than its locall currency debt, with a roughly equal amount of debt mature in each year. The foreign currency debt accounts for 84% of total debt outstanding, but it is relatively small compared to Company s net income. The average term of foreign currency denominate debt repayment is 5.4 year. The Company s available repayment source has a high level of coverage currency debt, indicating strong debt repayment capability. over its foreign Gazprom s foreign currency debt accounts for a large proportion of total outstanding debt. The Company s export business is able to bring sufficient foreign currency revenue, which secures repayment of Gazprom s foreign currency debt. The available sources whichh could be used to repay foreign currency debt are mainly from foreign currency revenue, overseas financing and purchase of foreign currency on market. In short term, Company s cost of currency exchange will increase due to ruble devaluation. To be more specific, in past three years, Gazprom s foreign currency revenue account for more than 50% of total revenue, albeit declining slightly over past 3 years. Going forward, Dagong estimates thatt Company s foreign currency revenue to remain stable. Due to recent Russian Government decision to require Gazprom as well as or four state owned companies to limit ir foreign currency reserves to level at beginning of October 2014, Company s foreign currency reserve might not increase in near future. Dagong forecasts from years of , Company s foreign currency revenue has an averagee of 15.00x multiple to cover its foreign currency debt, current foreign currency reserve is more than adequate to secure repayment of foreign currency debt. In worst case scenario if net foreign currency revenue decreased 18

21 Credit Rating Report for Gazprom to extent that y are not able to cover foreign currency debt due, Gazprom would n repay its debt through currency exchanges, estimated EBITDA after considering 50% Ruble depreciation still has 4.35x multiple to cover outstanding debt. Therefore, Gazprom has a strong foreign currency debt repayment capability, even under current unfavorable macro environment. In long term, due to close link of Russian economy and European economy, recession of Russian economy would brings more harm than good to European economy, Dagong is of view that western sanctions is not likely to persist in medium term. Dagong anticipate that credit environment to recover in medium termm and Ruble exchange rate to rebound, decreasing cost of currency exchange and strengn Gazprom s foreign currency debt repayment capability. Figure 4 Long term debt currency structure of Gazprom 2% 17% 16% 3% 31% 30% 50%51% USD Euro RUB Ors Notes: The inner and outer show data on Dec, and Jun, Sources: OAO Gazprom IFRS Consolidated Financial Statements. 6. Conclusion As a global vertically integrated energy major, Gazprom is engaged in exploration, production, transportation, storage, processing and sale of natural gas, gas condensate and oil as well as electric and heat energy generation, it operates largest gas pipeline system in world. The Company dominates both upstream and downstream activities, has largest resourcee and production base, unique UGSS, significant production and R&D capacities, and also benefits from its legal pipelinee gas export monopoly, geographic position between Europe and Asia, portfolio of long terits reputation as a reliable supplier. Although operations and sales of natural gas will be gas supply contracts, long history of cooperation with foreign partners and adversely effected by geopolitical tension between Russia and EU and continued weak economy in Company s major markets. In addition, Gazprom pursues strategic goal of establishing itself as a leader among global energy companies by diversifying sales markets, ensuring reliable supplies, improving performance, and utilizing R& &D capacities. 19