Russian Region Yamal-Nenets Autonomous Okrug Rating Affirmed At 'BBB-'; Outlook Remains Stable

OVERVIEW
  • We expect the Russian region Yamal-Nenets Autonomous Okrug (YANAO) will maintain strong liquidity and very low debt.
  • We view the realization of liquefied natural gas projects as positive for the okrug's medium-term growth prospects, but we think it could also increases the region's dependence on hydrocarbons.
  • We are affirming our 'BBB-' long-term rating on YANAO.
  • The outlook is stable.
 
RATING ACTION
On Dec. 7, 2018, S&P Global Ratings affirmed its 'BBB-' long-term issuer 
credit rating on Yamal-Nenets Autonomous Okrug (YANAO). The outlook is stable.

 
OUTLOOK
The stable outlook reflects our expectation that YANAO will maintain its 
current debt level and liquidity position while keeping potential future 
deficits under control. 

Downside scenario
Any negative rating action on Russia would be followed by a similar action on 
YANAO. Alternatively, we could take a negative rating action if changes in the 
okrug's approach to expenditure management resulted in a materially higher 
deficit after capital accounts and larger debt accumulation than we currently 
expect. Downward pressure on the rating could also build if YANAO's liquidity 
situation dilutes.

Upside scenario
Any positive rating action is contingent on a positive rating action on 
Russia. In addition, we could revise up our assessment of YANAO's stand-alone 
credit profile (SACP) if we concluded that YANAO's economy, and consequently 
the okrug's revenue sources, were diversifying away from oil and gas. A 
consistent improvement in the okrug's long-term capital and financial planning 
or its political and managerial strength could also improve the okrug's SACP. 

 
RATIONALE
The rating on YANAO is based on the region's very sound financial situation, 
as highlighted by high operating balances, the very low tax-supported debt 
burden and contingent liabilities, and high debt service coverage. 
Furthermore, we believe the region will lean on cash to finance its capital 
program, thereby maintaining a very limited debt burden in the medium term. At 
the same time we take into account Russia's volatile and unbalanced 
institutional framework, as well as the okrug's high dependence on 
hydrocarbons and consequent low diversification of its tax revenues. 
 
 
Very wealthy but concentrated economy, within a volatile and unbalanced 
institutional framework 
 
Like other Russian regions, YANAO's financial position relies highly on the 
federal government's decisions under Russia's institutional setup, which 
remains unpredictable, with frequent changes to tax mechanisms affecting 
regions. The presidential decrees of May 2018 will likely result in higher 
operating and capital expenditures for most Russian local and regional 
governments (LRGs) through 2024. These will focus mainly on healthcare, 
education, and infrastructure. 

YANAO's economy is dominated by gas production, which underpins its very high 
wealth levels, but also leads to high economic and tax-base concentration and 
volatility. Recently the region has seen an important increase in industrial 
production in line with the realization of liquefied natural gas and other 
large industrial projects. We anticipate that, in the medium term, economic 
growth in the region will be supported by progressive implementation of a 
number of industrial projects carried out by Russian oil and gas companies. At 
the same time, we also think that these projects will likely contribute to 
further concentration of the region's tax base. YANAO holds about 70% of 
Russia's total proven gas reserves, and the world's largest gas producer, 
Gazprom, remains the main investor, employer, and taxpayer in the region. We 
expect that oil and gas production will continue to make up more than 50% of 
the okrug's gross regional product and about 40% of its budgeted revenues in 
2018-2020. 

Decisions regarding regional revenues and expenditures are centralized at the 
federal level, leaving little budgetary flexibility to the okrug's 
authorities. The majority of YANAO's tax revenues are controlled by federal 
legislation, which makes it especially difficult for the okrug to address 
potential revenue volatility. Like most Russian LRGs, YANAO's modifiable 
revenues (mainly transport tax and nontax revenues) are low and don't provide 
much flexibility. We forecast they will account for less than 10% of the 
okrug's operating revenues on average over the next three years. However, we 
believe YANAO has more leeway on the spending side than peers, due to its 
relatively large self-financed capital program, which we think it could reduce 
at least by one-half if necessary.

In September 2018, Dmitry Artyukhov was elected as new governor of the region. 
We believe that relations with the central government will remain smooth. We 
note YANAO's improved expenditure management over the past couple of years, 
with the implementation of tighter control of spending growth. We also think 
the okrug's debt and liquidity management have strengthened significantly 
during that time. Management has diversified the okrug's funding base by 
issuing longer-term bonds, constructing a smoother debt repayment schedule, 
keeping high cash reserves, and holding medium-term revolving bank lines. At 
the same time, similar to most Russian LRGs, the okrug lacks reliable 
long-term financial planning and doesn't have sufficient mechanisms to 
counterbalance the volatility that stems from the concentrated nature of its 
economy and tax base in an international comparison. 
 
 
Strong operating balance results in low debt and an important cash cushion
 
In the past couple of years, the robust performance of the corporate profit 
tax (CPT; which represents about 30% of the okrug's tax revenues) has strongly 
supported the okrug's revenues, owing to the stronger operating results of the 
main taxpayers. We expect CPT growth to be negatively affected by the increase 
in the value-added tax to 20% from 18% and the potential increase in the 
mineral extraction tax. However, the okrug's revenues will benefit from the 
broadening of the tax base following the commissioning of new industrial 
facilities in the coming years. At the same time, we anticipate that the 
implementation of large capital projects will likely lead to modest deficits 
after capital accounts in YANAO over the next three years. The okrug's 
financial indicators will also remain subject to volatility. Large 
fluctuations in YANAO's tax revenues stem from its dependence on a single 
taxpayer and from frequent changes in federal tax legislation. 

YANAO's tax-supported debt will remain below 30% of consolidated operating 
revenues through year-end 2020, in our view. The okrug's debt burden includes 
the guarantee the LRG provides to its government-related entities (GREs), 
mainly to the okrug-owned construction company handling the program for 
resettlement from dilapidated housing. In addition to the okrug's direct debt, 
we include in our assessment of YANAO's debt burden the debt of Yamalgossnab 
GUP, the company that ensures wholesale distribution of petroleum and 
petroleum products to the remote polar areas of the okrug, which has been 
loss-making for the past number of years.

YANAO's GRE sector is relatively small compared with those of other Russian 
peers. We think its GREs and municipalities are unlikely to require 
significant extraordinary financial support through year-end 2020. We estimate 
the maximum loss under a stress scenario at less than 2% of the okrug's 
consolidated operating revenues.

We expect that the okrug's cash reserves will exceed its very low debt service 
by severalfold in the next 12 months. The okrug's average cash, including cash 
of its budgetary units, will likely exceed Russian ruble 40 billion ($570 
million) in the same period. At the same time, we incorporate the okrug's 
limited access to external liquidity in our overall assessment of its 
liquidity. This is because of the weaknesses of the domestic capital market, 
and applies to all Russian LRGs. We also note that YANAO's debt service will 
likely remain below 5% of operating revenues on average in the near term.