The Russian corporate sector has encountered some of the most serious challenges in decades. These challenges stem fr om continuously strengthening external shocks, and not internal factors. Although GDP growth was low over the past five years, key sectors demonstrated stable financial and operational metrics, and there was no mass deterioration of their credit quality.
After a significant decline in 2020 triggered by the pandemic, the corporate sector showed signs of recovery to the pre-pandemic level and moderate growth of operational indicators in 2021. The sector’s credit risk continued to be stable, and there were no tangible signs of it deteriorating.
Since the end of February 2022, the number of external negative shocks has sharply increased, which mainly influences the following indicators.
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Sharp growth of the interest rate set by the Bank of Russia impacted the cost of debt, both public and bank debt, which had a negative impact on levels of interest payment coverage for all categories of borrowers, and forced them to cut volumes of planned capital expenditures, which would have been financed using borrowed funds.
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The exit fr om the market of the majority of foreign producers, suppliers of equipment and components, as well as participants of joint ventures made it impossible to continue carrying out modernization projects in a number of industries and led to a transition to the production of less technologically advanced products. In cases wh ere it was possible to find a replacement for retired equipment and components, there was a significant lengthening of supply chains and an increase in the cost of transportation. However, companies had supplies of some categories of equipment and components, which will allow many of them to maintain their operating performance at current levels until the end of 2022. Due to this, ACRA does not expect a sharp decline in revenues and operating cash flow, or a significant fall in profitability of production in the corporate sector at least until the end of 2022. This should contain the process of deterioration of the credit quality of borrowers in terms of the growth of their debt burden.
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The serious impact of financial sanctions related to the closure of Eurobond and bank finance markets for Russian borrowers is expressed in the sharp decline of liquidity sources, especially for major Russian companies that were integrated into the international financial system. In addition, some countries have already or will soon enter a technical default on their international financial obligations due to the impossibility of making payments either due to blocked accounts or being prohibited fr om transferring funds via western correspondent banks. So far, the question of how the holders of Eurobonds will behave and whether defaults on them will be announced remains open. ACRA does not expect a wave of defaults in the short term, but if the situation does not change or worsens in the second half of the year, the probability of defaults may increase by the end of the year.
In ACRA’s opinion, the extent of the impact of negative economic factors on individual industries of the Russian corporate sector will differ depending on the integration of a particular industry into global markets and the overall resilience of a business to negative external shocks, both in terms of changes in the operating environment and overall worsening financial conditions for doing business.
The Russian corporate sector, represented by the major players, generally has resilience to maintain its credit quality until the end of 2022. The speed of its deterioration will depend on the gradual exhaustion of the accumulated margin of safety, as well as on the volume and pace of implementation of sanctions that have already been deployed, which can have a transformational impact on the credit quality of the sector in 2023 and beyond.
We will look in detail at the impact of structural shifts in the economy on the most significant sectors for the Russian economy.
Oil and gas sector
Lower demand for gas and reorientation of consumers to LNG as a result of a sharp rise in prices and the emergence of plans to gradually phase out Russian energy sources in Europe, as well as the refusal of some European countries to pay for gas supplies in rubles, will lead to a decrease in pipeline gas exports to Europe by about 40 bln cubic meters this year. At the same time, countries that refused to pay for gas in rubles accounted for 30.4 bln cubic meters of pipeline exports of Russian gas in 2021. There is also the risk of a complete stoppage of transit through the Ukrainian gas transit system — in May, the pumping of gas through the Sokhranivka gas measuring station was suspended, and this has already reduced the possibility of transit via Ukraine by a third.
A complete halt to gas transit via Ukraine carries the risk of an additional reduction in supplies by 15 bln cubic meters in 2022. Further decline of gas exports to Europe in 2023–2024 can be expected if additional sanctions are deployed that lim it (and in the future prohibit) the consumption of Russian gas in Europe. Starting from 2025–2027, Europe will be able to continue decreasing its consumption of Russian gas due to new facilities for producing LNG coming online in Qatar and the US.
As gas deliveries to Europe decline, exports to China will grow. In 2025, pipeline exports of gas to China via the Strength of Siberia pipeline will grow by 30 bln cubic meters compared to the 2021 indicator. However, it should be noted that in the event of a significant decline of consumption of Russian gas in Europe, it will not be possible to fully redirect these volumes to other consumers. Consequently, the gas industry will have to cut production and mothball a number of operating wells.
Figure 1. Export of pipeline gas from Russia, bln cubic meters
Sources: Federal Customs Service, ACRA
In 2022, pipeline exports may cumulatively decline by around 20% year-on-year, while a two- or three-fold increase in gas export prices would allow for a sharp increase in gas export revenues. The reorientation of gas supplies from the European to the Asian market will require additional investments (in LNG and/or pipelines) in the amount of about USD 100 bln by 2030.
At the same time, the EU’s plans to abandon Russian gas will keep gas prices at levels that considerably exceed average historical indicators for the past ten years. This will allow sufficient financial resources to be accumulated to invest in reorienting exports to Asian markets, with revenues from gas exports to exceed USD 100 bln in 2022, according to forecasts.
ACRA assumes that if gas supplies decline but prices remain high, the credit quality of the sector’s companies will be stable until the end of 2022, and a decline of key credit metrics is unlikely. If the general situation does not change or additional sanctions limiting the consumption of Russian gas are deployed more actively, then a faster decline of the credit quality of the sector’s companies can be expected as early as 2023. Financial metrics may be partly supported by a reduction in investments and capital expenditures that were previously planned to maintain or increase gas production volumes.
The sixth package of EU sanctions adopted on June 3, 2022, which introduced a total embargo on crude oil supplies from Russia by the end of 2022, has so far been agreed only in respect to oil transported by tankers rather than oil delivered through pipelines. However, it is highly likely a full-fledged embargo will still be introduced, and therefore, in its estimates of Russia’s oil production and exports, ACRA takes into account the EU’s complete rejection of Russian oil imports by the end of 2022.
From January to April, the total volume of oil production in Russia grew by 5.2% year-on-year and amounted to 176.7 mln tons. At the same time, the production volume decreased significantly only in April: by 4% year-on-year and by 8.8% compared to March 2022. At the end of May, according to preliminary data, we can expect some recovery in average daily production — by about 2–3% compared to April. In March and April, a gradual reorientation of oil supplies from the European market to the countries of the Asia-Pacific region began, yet no quick abandonment of Russian oil by Europe has taken place. Thanks to this, the rate of decline in production and exports is contained, which gives Russian oil producers the time they need to reorient supplies.
Today, the volume of Russian oil supplies to Europe exceeds 100 mln tons per year. Three European countries (Hungary, the Czech Republic, and Slovakia) that receive oil by pipeline consume less than 15 mln tons per year. Accordingly, the introduction of the embargo will push down oil supplies to the EU by 85 mln tons per year and will also affect the supply of petroleum products. The main consequence of these restrictions will be oil production cuts.
The reorientation of oil supplies to Asia will not fully replace declining deliveries to Europe. For example, the growth of oil supplies to China is limited due to the limited capacity of the oil transport system, which is now fully loaded, while deliveries to India are possible only by sea, which is associated with higher logistics costs and requires additional price discounts.
According to the optimistic scenario, if the decline in oil supplies to Europe is partially replaced by supplies to Asia, and the average daily production in the period from May to December 2022 remains at the April level, then the volume of oil production in 2022 will decrease by about 20 mln tons (3.8%) compared to 524 mln tons produced in 2021.
In the pessimistic scenario, which at the moment seems more likely, if Europe rejects Russian oil, in the second half of the year the decline in production will accelerate significantly and by the end of 2022 could reach 50 to 80 mln tons (9.5–15%) year-on-year. At the same time, this scenario also assumes higher oil prices in the global market, which will largely offset the losses of Russian oil producers caused by production cuts. Thus, from January to April 2022, the average price of Urals oil was USD 84.68/bbl compared to USD 60.47/bbl in 2021. Therefore, even if oil prices remain at the level reached in the first four months until the end of the year, this will offset the expected decline in production (in 2021, the average price of Urals oil was USD 72.88/bbl).
In H2 2022, the credit quality of oil companies will begin to deteriorate, and if the current situation persists, this deterioration may accelerate in 2023. Some support for the credit metrics of the industry may be provided by both a reduction in capital expenditures for the development of new fields and an increase in production. In addition, high oil prices should support profitability and operating cash flow, while the availability of previously accumulated liquidity should help oil companies maintain their financial stability in the short term.
Metallurgy
According to the World Steel Association, in 3M 2022, steel production in Russia shrunk by 1.2% year-on-year, which seems to be a good result given the deeper global plunge in steel production (by 6.8% year-on-year for the same period). However, the slow recovery of the global economy after the pandemic and the growing effect of sanctions on Russian steel companies may lead to a more significant reduction in steel production in Russia in 2022.
ACRA is of the opinion that if the pessimistic scenario materializes, steel production in Russia could fall by 3% year-on-year, or by about 74 mln tons. This fall could be partly offset by stimulating the domestic demand and reducing imports, including those from Ukraine. Since the European market is now closed, Russian companies are forced to review the logistics of export deliveries and reorient their exports to other markets, including the Middle East, Egypt and Asia. For example, in April, Russian exporters increased the supply of semi-finished steel products to China to 0.4 mln tons, which is five times higher than the volume supplied in all of 2021. This trend is likely to continue in the future, given the lockdown introduced in some Chinese regions. At the same time, it should be noted that products manufactured by Russian steel companies are sold to China with significant discounts.
The industry’s credit burden is not a cause for concern, even if we assume a decrease in sales volumes. In this regard, it is highly likely that the credit ratings of metal companies will remain at their current levels. High prices in the world market allow manufacturers to compensate for declining output, while in the domestic market, the sales margins of Russian steel companies are likely to decrease. The government requires industry companies to abandon linking domestic prices to export prices and to base their pricing policies on the “costs plus some margin” principle (especially in the case of product deliveries for major state-run infrastructure projects).
Transportation
In the rail freight transportation segment, there may be a downward trend in the medium term, taking into account the refusal of European consumers to buy coal and oil products (coal accounts for about 30% of all cargo transported through the rail network of Russian Railways). The total load on the Russian Railways network in January–April 2022 amounted to 410.3 mln tons, which is -1.1% year-on-year.
The reorientation of cargo flows from Europe to Asia can partially compensate for the drop in traffic, however, at the moment, the railway infrastructure capacity in the eastern direction is fully used, and in order to increase traffic, it is necessary to expand the capacity of the Baikal-Amur and Trans-Siberian Railways, as well as increase the transshipment capacity in Russia’s eastern ports.
To redirect the export of petroleum products such as liquefied hydrocarbons (mainly exported to Europe) to Asian countries, it is necessary to build terminals on the east coast.
The air travel market is facing its second major challenge in the past three years. At the end of 2021, passenger traffic approached pre-pandemic levels after the 2020 crisis year for the industry, mainly due to domestic routes. It was expected that in 2022, international destinations could also begin to recover, however, the current situation is highly likely to lead to significant changes in the industry.
First, before the pandemic, international and domestic air traffic was almost equal, but now it is obvious that in the medium term, the share of domestic flights will be about 75–80%. A reduction in the higher-margin segment against the backdrop of increased inflation, rising fuel costs, and a drop in household incomes can put significant pressure on the already low profitability over the next few years. This determines the sector’s strong need for government support.
Second, the aviation market must adapt its fleet to the new reality, since the supply of western-made aircraft and spare parts has stopped. A portion of the foreign-made fleet remaining in Russia will continue to operate, but before these resources are exhausted, it is necessary to significantly boost domestic manufacturing of aircraft, along with refinement and creation of competitive solutions in civil aviation, since the current manufacturing volumes are insufficient to replace foreign aircraft.
Difficulties in the aviation market may lead to passengers preferring rail transport, which can be supportive to this segment wh ere the growth has noticeably lagged behind the air transport segment over the past few years. ACRA closely monitors the operational and financial performance of its clients in the transport industry. Since many of them belong to the infrastructure segment rather than carriers, their financial strength and, therefore, their credit ratings are more resilient.
Figure 2. Passenger traffic, bln passenger-km
Source: Rosaviatsia
