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Moody’s Investors Service has upgraded the senior unsecured issuer and debt ratings of Gazprom from Baa1 to A3, the ratings agency said in a press release.

Also upgraded to A3 were Gazprom’s Loan Participation Notes issued out of Gaz Capital S.A. and Gazstream S.A., the release says.

The outlook on all ratings is stable.

The rating action reflects a number of continuous improvements to the company’s fundamental credit profile. These include strong successive cash flow generation over recent quarters and the prospect of a more diversified and sustainable earnings stream from gradual increases in Russia’s artificially low domestic gas prices and a growing oil business.

Moody’s also believes that recent pricing alignments of Former Soviet Union (FSU) countries closer to Western European export prices will start to positively impact cash flows over time. The rating action also follows further efforts by management to improve efficiency and cut costs, as evidenced by stronger margins and recent cost rises largely in line with inflation, as well as ongoing initiatives to enhance corporate transparency.

“The gradual development of a more diversified earnings base, rather than the high dependence on European exports which constitute a mere third of Gazprom’s gas volumes, provides increasing support to Gazprom’s ratings”, says Philipp Lotter, Senior Credit Officer at Moody’s and lead analyst for Gazprom. “We also take growing comfort from the greater precision with which Gazprom today formulates its near-and long-term strategy, which focuses on much needed reserve development”, adds Lotter.

Moody’s adds that Gazprom is successfully addressing transit risk associated with its Western European exports, which rely primarily on Belarus and Ukraine for final delivery, by means of long-term contracts, acquiring direct ownership in the transit infrastructure or investing in new pipelines such as the Northern Europe Pipeline, which will directly link Russia with Germany by 2010.

However, Moody’s also expresses some concern about Gazprom’s ongoing reliance on Central Asian imports to meet domestic and international gas supply obligations, as well as potential domestic gas shortages which could see Gazprom required to sell greater volumes of gas into the unprofitable domestic market. Accordingly, Moody’s is encouraged by recent statements from Gazprom emphasizing its commitment for much-needed investments in its reserves and pipeline infrastructure following a sustained period of largely flat production.

At the same time, Moody’s states that Gazprom’s strategy includes the prospects of acquisitions domestically and internationally, which could add significant leverage over time, in addition to the company’s ambitious long term capital investment program. Moderate increases in leverage are factored into the rating, and Moody’s adds that Gazprom’s recent acquisitions, including the purchase of oil company Sibneft (now known as Gazprom Neft), have contributed positively to both absolute cash flow generation, and diversification.

Accordingly, the benefits to Gazprom’s business profile of any future acquisition aimed at strengthening the group’s vertical integration or its oil-related activities could be supportive of ratings, as far they do not lead to a step-change in financial policy. Moody’s currently expects Gazprom to maintain retained cash flow to net debt in the 20-40% region, and leverage to be around 30% on average.

The stable outlook anticipates further improvements in Gazprom’s financial and operational performance, which could be exacerbated by further domestic gas price particularly after Presidential elections in 2008. Accordingly, positive pressure could build over time on Gazprom’s fundamental credit quality.

Moody’s regards Gazprom as a government-related issuer (GRI) and thus ratings incorporate significant uplift from its baseline credit assessment of 11-13 for high implied state support. Moody’s thus factors in high government support and medium dependence assumptions into Gazprom’s ratings.

OJSC Gazprom, headquartered in Moscow, Russia, is the world’s largest gas company with proved natural gas reserves of 16 trillion cubic meters (20.7 trillion cubic meters of 2P reserves) under SPE standards, production of 545 billion cubic meters and revenues of USD48.9 billion in 2005. It also owns and operates the largest gas transmission pipeline in the world (ca. 155,000km), and is the leading exporter of gas to Western Europe.

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