The Daily Update - Russia’s “Pivot to China” Underway

In what is expected to be Russia’s most ambitious and pricey (USD 55bn) energy project in modern history, we heard this week that state-owned global energy giant Gazprom is 75.5% the way into completing the 3,000km Power of Siberia gas link to China. The project is expected to be completed “on time” with Russia supplying China with natural gas through the East-Route by December 20, 2019.

With uneasy western relations and overhanging sanctions dampening Russia’s reach, Mr. Putin looked to strengthen eastern ties via Sino-Russian energy cooperation, and back in 2014, Gazprom signed a USD 400bn supply deal with China National Petroleum Corp (CNPC) to deliver 38bn cubic metres of gas per annum for 30 years.

This project is key to China’s ambition of cutting pollution by reducing its reliance on coal, and using gas as the main source of fuel for heating homes. Subsequently, China is the world fastest growing consumer (with imports up over 45% in 2017) and was the second largest importer of natural gas (after Japan) last year; even then the north of the country has suffered gas shortages this winter, despite China also increasing domestic production. China is looking to further increase its own LNG production by 8.5% this coming year, hitting record highs. Also, according to sources, China and Russia have discussed the possibility of the Power of Siberia 2 pipeline, to be sourced from the Western Siberian gas fields; although it is only in the initial phase of talks as yet.

We have been a strong supporter of Gazprom’s bonds, even through the energy crash four years ago, when the 8.625% 2034 bond was trading as wide as ~750bps over USTs, and through its subsequent downgrades. Like Fitch we have always believed that the economic fundamentals have supported an investment grade rating, and just this year both S&P and Moody’s have revised their ratings for Gazprom back into IG territory making it eligible of index inclusion. The bond currently trades at a spread of ~280bps over while similar BBB- bonds are priced at 200bps over; we therefore calculate that the bond offers 8% risk-adjusted returns, with an attractive yield of 5.7%, worth adding to at these levels we think.

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