Morgan Stanley Asks: Is The Russian Oil Sector Under Pressure?

In a report published on Friday, Morgan Stanley analysts mentioned that pressure seems to be mounting on Russia's oil & gas sector. There were a number of developments in 4Q14 that are a cause for concern, the analysts said, while citing "faster-than-expected cost growth, the first major gas field write-off, pressure on low complexity refining and slow de-leveraging." Although the depreciation of the Rouble is good news for Russia's oil & gas sector, the impact of this is likely to be much lower than expected – "the share of Rouble costs could bec.70-75%, not 90-95%, 4Q14 results (and our own analysis) suggest," the analysts said, while adding that "it could take a few more quarters to confirm this trend." This change in assumption could impact EBITDA by less than 3-5%, while "the stretched FCFs of 2015 in USD could be impacted more significantly, by up to 32%, the analysts added. "Gazprom Neft (Equal Weight rated, with $18 PT) may find itself more exposed on the cost side, due to its higher share of advanced technology and greenfield development, and Rosneft's downstream spend could also come under pressure due to its higher share of USD costs," the report mentioned. While stating that pressure in the gas segment has now reached the independents, the analysts cited Lukoil LUKOY (Overweight rated, with $55 PT) as the first independent gas producer in Russia to write off and freeze a major gas project, Tsentralno-Astrakhankoye. "Even though the domestic market is oversupplied and underpriced (in USD), we expect no impact in the short term on production plans. Longer-term projects, such as Novatek's NOVKY (Equal Weight rated, with $95 PT) Gydan peninsula and Rosneft's Kynso-Chasel and Kharampur, look at risk though - we estimate that even if all goes ahead as planned, share of gas in Rosneft's EBITDA in 2018e will be only 4% vs 10% achievable at 2014 exchange rates," the analysts commented. The risks faced by low complexity refineries are likely to grow, in view of lower crude pricing and the tax maneuver. "Modernisation costs are mainly USD denominated, which, with the oil price low and debt markets frozen, makes them burdensome," the analysts wrote, while citing Rosneft RNFTF (Overweight rated, with $5 PT) as the one with the maximum exposure, since it has the lowest complexity downstream assets among its peers and higher modernisation costs. "We believe that to avoid shelving key upstream projects, Russian oil companies will tap state funding/state banks as much as possible before looking to de-lever, the 2014 results (so far) suggest. Once again, Rosneft stands out– we estimate it requires c.$16bn in prepayments and/or refinancing in 2015-16 to avoid exhausting its cash pile," Morgan Stanley added. The analysts have an Overweight rating on Surgut prefs SGTPY (RUB 63 PT) and Bashneft (RUB 1,600 PT), an Equal Weight rating on Tatneft OAOFY ($37 PT) and Surgut SGTZY ($10 PT) and an Underweight rating on Gazprom OGZPY ($5 PT).