Ed Crooks Gazprom counts the cost of the Ukraine dispute in its results, but reports some good news too

Gazprom’s profits were battered by plunging gas sales to the European Union and Ukraine in the first three months of the year, it has reported in its latest results under international accounting standards.

A 62 per cent drop in profits to Rbs110bn (about $3.5bn, at today’s exchange rate), reflects steep falls in gas export volumes, which were down 31 per cent to the EU, and 61 per cent to the former Soviet Union countries, including Ukraine. The economic downturn, which has hit demand for gas, particularly from industrial users, in Europe and around the world, was part of the reason; supply disruptions caused by the interruption of flows to Ukraine during the pricing dispute in January were another.

However, there were also some more positive signs in the figures.

Gazprom’s problems as a result of plunging energy prices and the squeeze on its finances caused by the credit crunch are well-known. It has been cutting its investment plans and scaling back its forecasts of future production.

The company’s debts are continuing to rise. Borrowings were up 17 per cent by the end of March from the end of 2008 to Rbs1,191bn (about $38bn at today’s exchange rate), mostly because of the fall in the value of the ruble, which pushed up the ruble value of Gazprom’s foreign currency debts. Since then, it has made significant further expenditures, including $4.1bn buying a 20 per cent stake in its oil subsidiary Gazprom Neft from Eni of Italy, and $1.67bn buying 55 per cent of London-listed Sibir Energy.

On the more encouraging side, though, Oswald Clint of Sanford Bernstein highlights Gazprom’s success in cost reduction:

A welcome reduction in 1Q costs (all reported in Rubles) was reported by Gazprom, which bodes well if the trend is sustainable. While costs of Central Asian gas purchases have increased as Gazprom now pays European parity prices, the company managed to reduce material costs by 47% q-o-q and the ‘Other’ costs line by significantly more

The lesson he draws is that while Gazprom is unlikely to reattain its 2008 production level of about 550bn cubic meters until “later in the next decade”, it is taking significant steps to improve its cash flow.

Capital expenditures have been cut 15% in 2009, the 2008 proposed dividend was cut 86%, and capex hungry projects in the Yamal peninsula have been delayed. Combined, we now expect much improved balance sheet flexibility, and expect the company to generate positive free cashflow this year, which provides plenty of scope to re-grow the dividend. With added tailwinds of favorable government moves to boost domestic pricing tariffs by 15% in 2010, 2011 and 2012, the company is also likely to start generating profit for the first time from
292Bcm of gas sales (50% of total) sold in the domestic market.

He concludes:

With reduced capex, rising productionsince late June and strong intentions from Europe to continue those imports, we expect upward revisions to Gazprom’s 2009 and 2010 EPS estimates.