Stress testing Russian Oil & Gas Big 4


$30/bbl oil price creates challenges for the Russian economy and the Big 4 oil and gas firms

Russian government income is weakening as the oil price falls, both in USD and RUB, adding budgetary pressure. This has led to the imposition of additional taxes on the oil and gas sector for 2016, and further declines raise the risk that taxes could be extended. These moves negatively affect the cashflows of Russia’s Big 4, leaving companies facing difficult choices between investment, dividends and debt.

Oil/RUB combination matters for the Big 4. Our Emerging Markets team conducted in their report an oil price sensitivity under various oil/RUB pairings down to $30/bbl. The oil/RUB effect varies according to the different operating profiles of the Big 4. Lukoil, Novatek and Gazprom remain free cash flow positive in 2016 in a $30/bbl oil scenario, while Rosneft dips into the red given its ambitious investment programme. Some cash flow is left for dividends, but coverage would vary depending on the oil/RUB combination. For all of the Big 4 a stronger exchange rate would impose greater strain on cashflows – both opex and capex have significant RUB components. Thus, RUB continuing to lag on the way down is a worrying sign.

Liquidity supportive, net leverage moving higher. Liquidity is a crucial driver of credit quality amid lower oil. Positively, the Big 4 have good cash balances and/or actions already taken to address short-term debt. FX liquidity in Russia is also supported by healthy current account trends. However, sector net leverage will move higher and less cash flow will be available for debt reduction, leading to greater reliance on refinancing. A less optimal oil/RUB combination can erode liquidity buffers over time.

Equity recommendations: In assessing opportunities among the Big 4 the team looks for balance sheet strength, resilient cashflow generation and attractive dividend yield. On this basis they find Lukoil (OW) comes out on top. In their report they continue to rate Gazprom and Novatek EW, and similarly still regard Rosneft (UW) as least attractive.

Credit recommendations: Lukoil (OW) retains the most resilient credit profile and is their top pick. Gazprom also keeps resilient cash flow and access to FX borrowing; they stay OW. Novatek’s cash flows are strong in all scenarios, but stays MW given Yamal LNG financing needs. They keep Rosneft UW; the recent liquidity boost is priced in.