Research Notes

In our previous desk note “Regional Gas Distributors: Looking Forward to Investment Demand” dated July 16, 2007 we devoted attention to rising interest in gas distribution assets on the part of portfolio and strategic investors. Notwithstanding some progress in this area, stocks of most gas distributors still lack liquidity, which is viewed as a major constraint for their market capitalizations. In similar conditions, we bet on the most undervalued companies in the sector that enjoys relevant liquidity, highlighting also promising concerns in the sector that have just broken onto the capital market.

Improvements in gasification rates and heavier investments in the national gas distribution infrastructure. Russia is witnessing intensive growth in regional gasification projects. Gazprom’s investments in the rollout of regional low- and mid-pressure gas transportation infrastructure are growing along with the gas holding’s investment program. Relevant cash injections equaled slightly over $100 mln in 2004 and the figure will approach $1 bln as of January 1, 2008. Since 2004 the country’s gasification rate has risen from 54% to 62% and taking into account stable growth in investments this trend has a good chance of gaining traction.

Liberalization of the domestic gas market. In line with the current liberalization program, domestic gas prices are to be brought into compliance with global prices by 2011. Given growth rates determined by the Federal Tariff Service, the domestic gas price will be hiked from the current $40 to nearly $100 per 1,000 cu m. Be that as it may, taking into account the current conditions on the global commodities markets, a considerable spike in market gas prices cannot be ruled out, which could be one of the reasons prompting the Cabinet to revise the pace of growth in domestic gas prices upward. Since in recent years gas transportation tariffs have to a large extent correlated with fluctuations in domestic gas prices, there is every reason to expect that gas transportation tariffs will take a sharp leap within the next few years.

Stronger domestic demand for gas. Since 2000 the volume of natural gas sold domestically has increased from 67% to nearly 70%, which can be viewed as a substantial structural change for a stable market. At the same time, the proportion of domestic sales volumes in separate periods is growing against a reduction in gas exports. Given the price environment, this points to a considerable potential of the Russian market. According to our forecasts, this trend will be sustained in coming years on the back of expanding gas distribution networks and a rising number of potential consumers.

In view of steadily growing investment flows into regional gas distribution infrastructure and the intensive rollout of regional gasification programs, regional gas distributors are well positioned to boost their earnings over the next few years. We remain upbeat about the development prospects of the gas distribution segment and consider the current price levels to be quite attractive.

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Vladimir Sergievskiy

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