OIL AND GAS WEEKLY. Topic of the week. Week ahead. Ideas for this week. Contents: Companies mentioned

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1 APR 15 MAY 15 JUN 15 JUL 15 AUG 15 SEP 15 OCT 15 NOV 15 DEC 15 JAN 16 FEB 16 MAR 16 GAZPROM 37 GAZPROM 28 GAZPROM 34 ROSNEFT 22 SIBNEFT 22 TNK 20 SIBNEFT 23 GAZPROM GAZPROM 21 LUKOIL 22 GAZPROM LUKOIL 20 LUKOIL 23 GAZPROM 20 NOVATEK 21 NOVATEK 22 LUKOIL 19 GAZPROM 19 EDC 20 LUKOIL 18 GAZPROM 18 ROSNEFT 17 LUKOIL 17 TNK 16 TNK 18 TNK 17 NOVATEK 16 GAZPROM 16 NOV TRANSNEFT 18 SIBUR 18 GAZPROM 16 MAY APRIL 8, 2016 Topic of the week SIBUR 2015 IFRS results: good year for petrochemicals In this issue of Oil and Gas Weekly, we review the 2015 financials of Russia s largest petrochemicals producer, SIBUR, which were reported yesterday. In line with our expectations, the company delivered superior profitability last year driven by several factors, including increased spreads to feedstock in the petrochemical segment, the ramp-up of new production facilities, ruble deprecation, and ceasing of trading activities. SIBUR s balanced business model worked well last year, when the oil price fell sharply. In 2015, the reduced EBITDA margin of the energy products segment was compensated by higher profitability of the petrochemical segment (31.4% vs. 14.6% in 2014). The ramp-up of SIBUR s new petrochemical facilities, in particular the world-class Tobolsk- Polymer PP plant, made a large contribution to the stronger EBITDA margin last year. The cornerstone of SIBUR s current capex program is the ZapSib-2 project a new world-class LPG-based cracker in Tobolsk, West Siberia originally estimated at $ bln. SIBUR has secured $4.12 bln in external financing for the project. We estimate that the company will need to spend up to $700 mln per annum from its OCF in to finance ZapSib-2. In our view, in a $50/bbl oil price environment, SIBUR is wellpositioned to cover this capex spending from OCF. SIBUR s net debt climbed to RUB 285 bln ($3.9 bln) as of end 2015, pulling net debt/ebitda to slightly above 2.0x in ruble terms. Currently we estimate the company s further borrowing capacity at roughly $ mln, which in the short term seems sufficient to meet its elevated capex needs. The next peak of debt repayments falls in and SIBUR is likely to tap the debt markets to refinance. The company may place $ mln in eurobonds this year and is considering issuing ruble bonds. Week ahead On April 17, OPEC and non-opec countries will meet in Doha, Qatar, to discuss an oil production freeze in an effort to stabilize oil prices. Ideas for this week Equity. We would open long positions in Gazprom on news of a possible share buyback and in anticipation of 2015 IFRS results. We would open long positions in NOVATEK on the release of strong 1Q16 operating results. Evgenia Dyshlyuk +7 (495) (ext ) Evgenia.Dyshlyuk@gazprombank.ru Evgeniy Khilinskiy +7 (495) (ext ) Evgeniy.Khilinskiy@gazprombank.ru Alexander Nazarov +7 (495) Alexander.Nazarov@gazprombank.ru Contents: Trading ideas summary... 2 Topic of the week... 3 Week in review International markets Equity valuation Fixed Income valuation Equity relative performance Calendar of events Companies mentioned SIBUR NKNC Gazprom Rosneft Gazprom Neft Transneft Lukoil Bashneft Tatneft NOVATEK Debt. We reiterate our idea to BUY RUSSIA42 SELL GAZPRU37. For details, see the following page. Charts of the week SIBUR 18 GAZPRU 18: exceptional performance Russian O&G segment G-spreads, WoW BPS Source: Bloomberg, Gazprombank estimates Source: Bloomberg, Gazprombank estimates 1

2 WEEKLY TRADING IDEAS SUMMARY Equity COMPANY TICKER CURRENT PRICE IDEA Gazprom OGZD LI We would open long positions in Gazprom on news of a possible share buyback and in anticipation of 2015 IFRS results. NOVATEK NVTK LI 87.3 We would open long positions in NOVTEK on the release of strong 1Q16 operating results. Fixed Income IDEAS We reiterate our idea to BUY RUSSIA42 SELL GAZPRU37. The respective spread remained unchanged WoW (96 bps currently vs. a previous 97 bps) and is still below 12M lows for no apparent fundamental reason. We believe that the 6M average level of 130 bps is fair. We are focusing on the GAZPRU37, as the GAZPRU37 GAZPRU34 spread is also currently near 12M lows. 2

3 TOPIC OF THE WEEK SIBUR 2015 IFRS results: good year for petrochemicals In this issue of Oil and Gas Weekly, we review the 2015 IFRS financials of Russia s largest petrochemicals producer, SIBUR, which were reported yesterday. Record high EBITDA margin in In line with our expectations, supported by the strong 2015 results of SIBUR s rival NKNC 1, released earlier, SIBUR delivered superior profitability last year (EBITDA margin of 36%). This was driven by several factors, including increased spreads to feedstock in the petrochemical segment, the ramp-up of new higher-margin production facilities, ruble deprecation, and ceasing of naphtha trading activities via Ust-Luga starting from Another major capex cycle completed. Over the past five years SIBUR completed a capex cycle, expanding capacity across all business segments, which drove the top-line growth (CAGR of 11% in ). While the revenue split between energy products and petrochemicals did not change much, within the petrochemical segment the share of revenues from plastics and OS 2 products and basic polymers (the main focus of the capex program) has increased at the expense of synthetic rubbers and intermediates. Profitability supported by a diversified business model. SIBUR s balanced business model worked well last year, when the oil price declined sharply. In 2015, the reduced EBITDA margin of the energy products segment was compensated by higher profitability of the petrochemical segment (31.4% vs. 14.6% in 2014). The ramp-up of SIBUR s new petrochemical facilities, in particular the world-class Tobolsk-Polymer PP plant, made a large contribution to the stronger EBITDA margin last year. New capex program is much more focused. SIBUR s current capex program is more focused, as compared to its previous capex cycle. The cornerstone is the ZapSib-2 project a new world-class LPG-based cracker in Tobolsk, West Siberia originally estimated at $ bln. SIBUR has secured $4.12 bln in external financing for the project. We estimate that the company will need to spend roughly $700 mln per annum from its OCF in to finance ZapSib-2. OCF is sufficient to finance ZapSib-2. Following the completion of the capex cycle in 2014, SIBUR s FCF returned to positive territory. In 2015, the company generated FCF excluding ZapSib-2 capex of around RUB 67 bln ($1.1 bln). This suggests that in a $50/bbl oil price environment, SIBUR is well-positioned to cover the required ZapSib-2 capex (~$700 mln per annum) from OCF. Increased leverage, but there is still room for borrowing. SIBUR s net debt climbed to RUB 285 bln ($3.9 bln) as of end 2015, lifting net debt/ebitda to slightly above 2.0x in ruble terms. Given that the company s internal financial policy caps net leverage at 2.5x, currently we estimate the company s further borrowing capacity at roughly $ mln, which in the short term seems sufficient to meet its elevated capex needs. Tapping debt markets to refinance before SIBUR s next peak of debt repayments falls in , when the company s $1 bln eurobonds come due. At that time, ZapSib-2 will not be generating any cash flows yet (the project is scheduled for completion in 2020) and SIBUR will likely tap the debt markets to refinance before According to the company s management, SIBUR may place $ mln in eurobonds already this year and is considering issuing ruble bonds. 1 Nizhnekamskneftekhim 2 Organic synthesis products 3

4 2015 results: record-high EBITDA margin In 2015, SIBUR s revenues increased 5.2% YoY to RUB 380 bln ($6.26 bln) (Table 1) on increased sales volumes and a weaker ruble. The higher sales volumes were attributable to capacity additions completed in , at the end of the company s capex cycle, and their ramp-up during 2015 (investment projects are discussed in a section below). Given SIBUR s high share of exports (mainly in energy products and synthetic rubbers) 44% of total revenues in 2015 and the fact that domestically prices for energy and petrochemical products (basic polymers, plastics and OS products, intermediates) are determined to a large extent by export/import parity (netback), the company was wellpositioned to benefit from ruble depreciation last year on the top-line and EBITDA levels. EBITDA was up by 32% YoY to RUB 136 bln ($2.23 bln) in 2015, with the EBITDA margin reaching a record-high level of 36% (vs. 28% in 2014). The main factors driving SIBUR s profitability last year were as follows: increased spreads to feedstock in the petrochemical segment on lower oil prices (prices for petrochemical products were more resilient than those for energy products/feedstock, which correlate closely with the oil price); the ramp-up of new, higher-margin petrochemical facilities, including the world-class PP plant Tobolsk-Polymer; ruble deprecation against hard currencies (on the EBITDA level a large share of ruble-based costs); ceasing of low-margin naphtha trading activities via Ust-Luga sea terminal starting from Net income to shareholders was down 75% YoY to RUB 6.25 bln ($182 mln) in 2015, adversely affected by a net FX loss of RUB 63 bln primarily as a result of debt revaluation on RUB deprecation (~70% of SIBUR s total debt was denominated in foreign currencies, mainly USD, as of end 2015), higher interest expense (RUB 11.4 bln), a higher effective income tax rate and other factors. Table 1. SIBUR core IFRS financials, RUB mln YOY Avg. Brent oil price, $/bbl % CAGR Avg. RUB/USD rate % Russia CPI 6.1% 6.6% 6.5% 11.4% 12.9% RUB mln Revenues 248, , , , , % 11.2% Feedstock costs 49,309 62,989 67,152 78,052 83, % 14.2% % of revenues 20% 23% 25% 22% 22% EBITDA 86,669 82,291 78, , , % 11.8% EBITDA margin 35% 30% 29% 28% 36% Net income to shareholders 62,829 60,126 45,598 25,004 6, % -43.8% USD mln Revenues 8,461 8,727 8,471 9,503 6, % -7.3% Feedstock costs 1,678 2,026 2,108 2,072 1, % -4.6% EBITDA 2,949 2,647 2,476 2,693 2, % -6.8% Net income to shareholders 2,138 1,934 1,432 1, % -46.0% Source: company data, Bloomberg, Konsultant Plus, Gazprombank estimates 4

5 Another capex cycle completed: expanding capacity across all business segments Over the past five years, SIBUR s revenues have increased by almost 70% (Table 2), growing at CAGR of 11%, as the company completed another capex cycle (Table 3). Organically and via the acquisition of a 49% interest in OOO Yugragazpererabotka, SIBUR expanded its gas-processing capacity, increasing the APG processing volume from around 13 bcm in 2011 to 21 bcm in This resulted in higher production of energy products raw NGL (feedstock for petrochemicals) and natural gas. SIBUR expanded gas fractionation capacity at its core production site in Tobolsk, West Siberia, adding a second GFU, and built a 1,100 km raw NGL pipeline connecting NOVATEK s Purovsk Gas Condensate Plant with Tobolsk. Tobolsk s gas fractionation capacity has increased from 3.8 to 6.6 mln tpa of raw NGL, yielding higher volumes of LPG and naphtha (energy products). To accommodate higher exports of LPG and naphtha to price-attractive North European markets, SIBUR built a sea terminal at Ust-Luga, Leningrad region, with turnover capacity of 1.5 mln tpa of LPG and 2.5 mln tpa of light oils. Currently, Ust-Luga is Russia s only LPG terminal on the Baltic sea. SIBUR also built a 2 mln tpa propane purification facility to bring the quality of LPG in line with European requirements. In the petrochemical segment, over the past five years SIBUR has completed a number of investment projects boosting production of: Basic polymers: construction of the new world-class PP plant Tobolsk-Polymer; Plastics and OS products: acquisition of Biaxplen group and expansion of BOPP-films capacity at Tomsk and Novokuybyshevsk; acquisition of Acrylate and development of acrylates production in Nizhny Novgorod; construction of a new EPS production facility in Perm; expansion of PET capacity in Blagoveshchensk (Polief); construction of a new PVC and caustic soda production facility in Nizhny Novgorod (under the JV with SolVin); Intermediates: upgrade of the ethylene cracker of SIBUR-Neftekhim (to support new PVC production) and expansion of EO capacity in Nizhny Novgorod; Synthetic rubbers: construction of a new SBS (thermoplastic elastomers) production facility in Voronezh and expansion of IIR (specialty rubbers) capacity in Togliatti. SIBUR has been also divesting non-core businesses/assets and decommissioning outdated production facilities. The largest divestments were the sale of the company s mineral fertilizers and tires business in , Plastic (styrene, EPS and ABS plastics production facility in Tula region) in 2013, and the Ust-Luga sea terminal in SIBUR also attempted to sell its fleet of LPG rail cars in 2013, but the deal did not go through. In 2013, SIBUR decommissioned Caprolactam, an outdated chlorine and caustic soda production facility near Dzerzhinsk, Nizhny Novgorod, and transformed its production site into Oka Polymer industrial park, which was sold later. In 2014, SIBUR divested PVC cable compounds production operated by SIBUR-Neftekhim. 5

6 Table 2. SIBUR revenue structure CHANGE (2015 VS. 2011) RUB mln % RUB mln % RUB mln % Energy products segment 112,337 45% 186,497 49% 74,160 66% Petrochemical segment 136,323 55% 193,355 51% 57,032 42% Plastics and OS products 24,742 10% 63,748 17% 39, % Basic polymers 21,782 9% 50,892 13% 29, % Synthetic rubbers 50,971 20% 35,079 9% -15,892-31% Intermediates and other 24,407 10% 26,083 7% 1,676 7% Other revenues 14,421 6% 17,553 5% 3,132 22% Total revenues 248, % 379, % 129,516 53% Source: company data, Gazprombank estimates Table 3. SIBUR external sales volumes, kt ENERGY PRODUCTS SEGMENT CHANGE GROWTH DRIVER New GPP Yuzhno-Priobskiy (900 MMcm/year) under JV with Gazprom Neft Natural gas, bcm Acquisition of 49% stake in Yugragazpererabotka operating three GPPs (total capacity % bcmpa) Modernization and expansion of Yuzhno-Balykskiy, Nizhnevartovskiy and Vyngapurovskiy GPPs LPG* 2,569 3,791 48% New raw NGL pipeline connecting NOVATEK s Purovsk Gas Condensate Plant with Tobolsk Second GFU in Tobolsk (+2.8 mln tpa of raw NGL) Naphtha* 978 1,226 New LPG (1.5 mln tpa) and light oils (2.5 mln tpa) sea terminal at Ust-Luga, Leningrad region 25% New propane purification facility in Tobolsk (2 mln tpa) MTBE and other fuel additives PETROCHEMICAL SEGMENT % Plastics and OS products New PVC (330 ktpa) and caustic soda (225 ktpa) production facility in Kstovo, Nizhny Novgorod, under the JV with SolVin Expansion of BOPP-films capacity in Novokuybyshevsk (+30.5 ktpa) and Tomsk (+38 ktpa) Expansion of PET capacity in Blagoveshchensk (+70 ktpa) 75% New EPS production facility in Perm (100 ktpa) Divestment of Plastic, producer of styrene (-60 ktpa), EPS (-11 ktpa) and ABS plastics (-23 ktpa) in Tula region Acquisition of 100% in Acrylate, Russia s sole producer of acrylic acid and its esters in Dzerzhinsk, Nizhny Novgorod (54 ktpa) New PP plant Tobolsk-Polymer (500 ktpa) Basic polymers % Acquisition of 25% (effective stake) in PP producer Poliom (total capacity 210 ktpa) New SBS production facility in Voronezh (50 ktpa) Synthetic rubbers % Expansion of IIR capacity in Togliatti (+12 ktpa) Upgrade of cracker of SIBUR-Neftekhim in Kstovo, Nizhny Novgorod (+60 ktpa) Intermediates and other % Expansion of EO capacity in Dzerzhinsk, Nizhny Novgorod (+36 ktpa) * Excluding volumes for resale SIBUR s revenue split between energy products and petrochemicals has not changed over the past five years: the top line is still roughly evenly split between the two segments (Table 3). Yet, within the petrochemical segment, the sales structure has changed: the share of plastics and OS products and basic polymers (the main focus of the capex program) has increased at the expense of synthetic rubbers and intermediates. Profitability supported by diversified business model and contribution of new, highermargin petrochemical production facilities SIBUR s balanced business model worked well, supporting the company s EBITDA margin in 2013, when synthetic rubber markets were hit, and in 2015, when the oil price declined sharply (see Table 4). Source: company data, Gazprombank estimates 6

7 In 2015, the reduced EBITDA margin of the energy products segment (37.1% vs. 41.8% in 2014) (prices for energy products, with the exception of natural gas, correlate closely with the oil price) was compensated by the higher margin of the petrochemical segment (31.4% vs. 14.6% in 2014) on increased spreads to feedstock (energy products). The ramp-up of SIBUR s new, higher-margin petrochemical facilities, in particular, the largescale Tobolsk-Polymer PP plant, contributed to stronger profitability of the segment in 2014 and To compare, SIBUR s rival NKNC, which produces only petrochemical products (synthetic rubbers and basic polymers), delivered a lower EBITDA margin over the past two years, in spite of the positive effect from the recently introduced negative excise tax adjustment for naphtha (the main feedstock for NKNC). Table 4. EBITDA margin SIBUR vs. NKNC Brent price, $/bbl SIBUR aggregate EBITDA margin 34.9% 30.3% 29.2% Energy products segment 45.6% 44.5% 45.2% 28.5% (32.2%)* 34.9% (41.8%)* 35.7% 37.1% Petrochemical segment 18.1% 11.9% 5.9% 14.6% 31.4% NKNC aggregate EBITDA margin 19.2% 17.6% 10.5% 11.8% 24.0% * adjusted for naphtha trading activities at Ust-Luga Source: company data, Gazprombank estimates New capex program is much more focused, with ZapSib-2 being the cornerstone As compared to SIBUR s completed capex cycle, which envisaged capacity expansions across all business segments, the company s current capex program is much more focused. Its cornerstone is the ZapSib-2 project, originally estimated at $ bln, which envisages the construction of a world-class 1.5 mln tpa LPG-based cracker in Tobolsk, West Siberia, started in The new petrochemical complex will produce PE (1.5 mln tpa) and PP (500 ktpa) for the domestic market and exports. The other projects of SIBUR s current capex program are: (i) expansion of Vyngapurovskiy GPP from 2.8 to 4.2 bcmpa to accommodate higher APG supplies from Russneft s fields; (ii) further expansion of gas fractionation capacity in Tobolsk from 6.6 to 8.0 mln tpa of raw NGL; and (iii) completion of expansion of PP and LDPE capacity at the existing facility in Tomsk (started in 2012). At $50/bbl oil, operating cash flow is sufficient to cover ZapSib-2 capex For ZapSib-2, SIBUR has secured $4.12 bln in external financing (see Table 5), of which $2.37 bln is ECA-backed loans and $1.75 bln is financing from Russia s National Wealth Fund (NWF) within the quota of the Russian Direct Investment Fund (RDIF). We estimate that given the residual project budget of $7.2 bln as of end 2015, SIBUR will need to spend roughly $700 mln per annum from its operating cash flow in to finance ZapSib-2. Table 5. SIBUR ZapSib-2 project financing sources SOURCE MATURITY AVAILABLE FINANCING, $ MLN* Hermes ECA-backed committed credit line 15 years 1,903 Coface ECA-backed term loan 15 years 468 RESIDUAL BUDGET FOR , $ MLN 1,850 Russia s National Wealth Fund (NWF) 15 years 1,750 1,750 SIBUR operating cash flow 5,379 3,600 Total ZapSib-2 capex 9,500 7,200 * based on the current EUR/USD rate of 1.14 Source: company data, Gazprombank estimates 7

8 Following completion of the capex cycle in 2014, SIBUR s FCF returned to positive territory (see Table 6). In 2015, the company generated FCF excluding ZapSib-2 capex of around RUB 67 bln ($1.1 bln). This suggests that in a $50/bbl oil price environment (average Brent of $52.4/bbl in 2015) SIBUR is well-positioned to cover the required capex spending (~$700 mln per annum) from OCF. SIBUR has yet to make an investment decision on another capital-intensive greenfield project in the Far East under the JV with Gazprom Amur petrochemical complex integrated with Amur GPP, which is currently being built by Gazprom and will feed on gas from the Power of Siberia pipeline. The Amur petrochemical complex would process ethane from the GPP into PE for export to China and other Asian countries. The capacity of the new plant, as well as its capex and timeline, could be very similar to that of ZapSib-2. The Amur project is currently at the FEED stage and the investment decision will be made no earlier than 2H18. SIBUR s OCF may not be sufficient to cover both projects ZapSib-2 and Amur petrochemical complex. Yet, the Amur project s structure has yet to be determined: as a JV the project may not require financial guarantees or loan provisions by SIBUR. Further, SIBUR may attract strategic investors to the Amur project, in particular its new shareholder Sinopec and/or other Chinese companies. Table 6. SIBUR operating and free cash flows RUB mln YOY OCF 54,181 62,661 72,741 91, , % Capex -55,553-74,274-70,010-67,707-80, % incl. ZapSib-2 project ,891-2,838-21,135-43,168 Interest paid -3,509-3,496-3,718-5,710-14, % FCF -4,881-15, ,635 23, % FCF (excl. ZapSib-2) -4,673-11,218 1,851 38,770 66, % USD mln OCF 1,844 2,015 2,284 2,351 1, % Capex -1,890-2,389-2,198-1,776-1, % incl. ZapSib-2 project Interest paid % FCF % FCF (excl. ZapSib-2) , % Leverage has increased, but there is still room for borrowing Source: company data, Gazprombank estimates Mainly on the back of the purchase of a 49% stake in Yugragazpererabotka and the launch of the ZapSib-2 project in 2014 (SIBUR s FCF was strongly positive in 2014), the company s net debt increased by around 60% YoY to RUB 285 bln ($3.9 bln) as of end 2015, lifting net debt/ebitda to slightly above 2.0x (see Table 7). Provided that the company s financial policy caps net leverage at 2.5x (a level that we also deem sustainable), currently we estimate SIBUR s further borrowing capacity at roughly $ mln, which in the short term seems sufficient to meet its elevated capex needs. 8

9 Table 7. SIBUR debt and leverage metrics YOY RUB mln Short-term debt 31,194 54,936 42,743 56,240 47, % Long-term debt 51,716 41,058 57, , , % Total debt 82,910 95, , , , % Cash and cash equivalents 14,971 13,570 7,948 27, , % Net debt 67,939 82,424 92, , , % Net debt/ebitda USD mln Short-term debt 969 1,809 1,306 1, % Long-term debt 1,606 1,352 1,764 2,667 5, % Total debt 2,575 3,161 3,070 3,667 6, % Cash and cash equivalents , % Net debt 2,110 2,714 2,827 3,175 3, % Net debt/ebitda Source: company data, Gazprombank estimates Debt reshuffled: extended maturity, higher share of RUB-denominated debt In Q16, SIBUR reshuffled its debt, extending its maturity (Graph 1) and increasing the share of RUB-denominated debt (Table 8). The company arranged for ruble loans with Russian and international banks and placed RUB 10 bln in local bonds. SIBUR s next peak of debt repayments falls in , when the company s $1 bln eurobonds come due (see Graph 1). At that time, ZapSib-2 will not be generating any cash flows yet (the project is scheduled for completion in 2020) and thus SIBUR will likely tap the debt markets to refinance before According to the company s management, SIBUR may place $ mln in eurobonds already this year and is considering issuing ruble bonds. Graph 1. SIBUR debt maturity schedule, RUB bln AFTER 2019 AS OF MARCH 1, 2015 AS OF MARCH 31, 2016 Source: company data, Gazprombank estimates 9

10 Table 8. SIBUR debt structure by currency RUB 39,910 17,573 11,270 39, ,096 EUR 2,630 2,171 3,950 8,112 19,470 USD 40,370 76,250 85, , ,583 Total debt 82,910 95, , , ,149 RUB 48% 18% 11% 19% 29% EUR 3% 2% 4% 4% 4% USD 49% 79% 85% 77% 67% Source: company data, Gazprombank estimates Terminology APG associated petroleum gas (produced in the process of oil production) EO ethylene oxide (used as an intermediate for production of monoethylene glycol (MEG), may be sold as an end-product) EPS expandable polystyrene (used in many applications, including thermal insulation board in buildings, packaging, cushioning of valuable goods, food packaging) GFU gas fractionation unit (processes raw NGL into LPG and naphtha) GPP gas processing plant (processes APG into dry (natural) gas and raw NGL) IIR butyl rubber (a copolymer of isobutylene with isoprene, used in the inner linings of automobile tires, pharmaceutical closures, and other applications) LDPE low-density polyethylene (used for packaging like foils, trays and plastic bags both for food and non-food purposes) LPG liquefied petroleum gas (propane, butane, isobutene, pentane, isopentane) PP polypropylene (used in a wide variety of applications including packaging and labeling, plastic parts and containers of various types, automotive components) PET polyethylene terephthalate (used for plastic bottles and other applications) PVC polyvinyl chloride (used in construction, packaging, electrical/electronic, healthcare, and other applications) SBS thermoplastic elastomers (used in road constructions and other applications) 10

11 WEEK IN REVIEW Oil news The Brent price rose about 4% over the past week to $40.3/bbl on an unexpected decrease of US inventories and in anticipation of the meeting between OPEC and non- OPEC oil-producing countries in Doha next week. KEY CORPORATE NEWS Gazprom might buy back 2.7% of its shares from VEB. Positive News. Gazprom might buy back its shares from Vnesheconombank (VEB), which would allow the latter to resolve its financial issues, Bloomberg reported citing its own sources. VEB acquired a 2.7% stake in Gazprom in from E.ON and this asset is one of the most liquid in the bank s portfolio. At the same time, since the shares were purchased by VEB in a different market environment and their current price is lower, VEB could report a loss on its balance sheet as a result of the sale. Earlier, Economy Minister Alexey Ulyukaev claimed that the sale would not resolve VEB s key financial issues, while the bank s BoD Chairman Sergey Gorkov said that should a decision to sell Gazprom ADRs owned by VEB be made, the lender would not sell the stake on the open market. Based on yesterday s closing price ($ per ADR) Gazprom s stake is valued at $1.4 bln, or around 7% of the overall market value of the company s free float (38%). TICKER GAZP RX GAZP RX Target price RUB RUB Closing price RUB RUB Recommendation OVERWEIGHT OVERWEIG Upside 40% 36% Ratings BB+/Ba1/BBB- BB+/Ba1/BB Source: Bloomberg Effect on company. Given the considerable undervaluation of Gazprom shares, a buyback could be a good solution for the Group, in our view. As VEB purchased the stake at a different price (Gazprom shares traded as high as RUB 244 per share in vs. RUB 144 at yesterday s close), the bank might ask for a premium to the current price. Effect on shares. As investors were possibly concerned about the sale of a 2.7% stake in Gazprom on the open market, we believe the news regarding the buyback (possibly with a premium to the market price) should support the company s share price performance. NOVATEK releases 1Q16 operating results. Moderately positive News. NOVATEK released operating results for 1Q16. Effect on company. Gas production amounted to 17.2 bcm, down 3% QoQ but up 7% YoY. Production of liquid hydrocarbons increased 25% QoQ and 61% YoY to 3.2 mln tonnes. Oil product sales volumes reached 1.88 mln tonnes, up 14% QoQ and 2% YoY. The ongoing growth in liquids production was driven by the launch of the Yarudeiskoye field. Most of the increase was contributed by highly profitable oil, which suggests tax benefits and thus could have an even greater positive effect on NOVATEK s financials. TICKER NVTK LI GAZP RX Target price $110 RUB Closing price $86.9 RUB Recommendation OVERWEIGHT OVERWEIG Upside 27% 36% Ratings BB+/Ba1/BBB- BB+/Ba1/BB Source: Bloomberg Aside from the record production and sales figures, we note that NOVATEK continued to sell down its reserves the company s commercial gas reserves decreased by 0.9 bcm, while liquid hydrocarbon reserves fell by 260 kt. Effect on shares and bonds. The news is moderately positive for NOVATEK shares and bonds and could support the company s financial results for 1Q16. To recap, the company will likely release its IFRS report for 1Q16 in late April (the first to do so in the sector). We will take a closer look at the macroeconomic conditions for Russian O&G companies in 1Q16 and provide a calendar of quarterly reports in one of our upcoming issues of Oil & Gas Weekly. 11

12 Transneft releases 2015 IFRS results; stable EBITDA margin, higher leverage. Neutral News. Transneft published IFRS results for Overall revenues increased 5.3% YoY to RUB 816 bln. Revenues from oil and oil product transportation services grew a respective 11.8% and 18.9% to RUB 559 bln and RUB 57 bln due to changes in tariffs, transportation volumes and cargo traffic. The EBITDA margin remained stable compared with 2014, standing at 45% (RUB 568 bln). Among the company s cost items, export duties decreased considerably. We also note a RUB 19.7 bln increase in provisions for impaired accounts receivable (other than trading). Net income jumped by nearly 2.5x in 2015 to RUB 143 bln amid a lower net financial expense, a smaller loss from associates and JVs, and other factors. TICKER TRNFP RX GAZP RX I Target price RUB 76,310 RUB Closing price RUB 183,200 RUB Recommendation UNDERWEIGHT OVERWEIG Upside -58% 40% Ratings BB+/Ba1/ - -/Ba1/BBB- Source: Bloomberg Transneft managed to generate positive FCF of RUB 5.3 bln in Leverage increased at year end, with net debt climbing 22.5% YoY to RUB 686 bln, while net debt/ebitda stood at 1.9х in ruble terms (vs. 1.6х as of end 2014). Effect on shares. We expect the market to react in neutral fashion to the results, as only Transneft preferred shares (prices for which are driven by dividend yields) are traded. Transneft currently calculates its dividends based on RAS financials and we expect the 2015 dividend yield on preferred shares to be below 1%.. Rosneft in talks on gas exports to China via Gazprom s Power of Siberia pipeline News. Rosneft is in talks with China s Beijing Gas Group regarding gas exports via the Power of Siberia pipeline currently being built by Gazprom, RBC reports. In particular, the parties are discussing the possibility to supply gas produced at Rosneft s fields located in Eastern Siberia Srednebotuobinskoye, Verkhnechonskoye or Yurubcheno- Tokhomskoye. It is supposed that the gas price will not be set below the price contained in Gazprom s gas export contract with CNPC. TICKER ROSN RX GAZP RX Target price RUB RUB Closing price RUB RUB Recommendation NEUTRAL OVERWEIG Upside 2% 36% Ratings BB+/Ba1/- BB+/Ba1/BB Source: Bloomberg In 1H16, the government should discuss the feasibility of allowing independent gas producers access to the Power of Siberia gas pipeline, while retaining the single export channel (i.e. via Gazprom), according to the protocol issued after the meeting of the Presidential Commission on the fuel and energy sector held in October The document refers to sales of natural gas and associated petroleum gas (APG) produced at greenfields located in Eastern Siberia and the country s Far East. Previously, Rosneft s President said that the company is ready to supply up to 30 bcm of gas per annum via the Power of Siberia pipeline. By 2030, the company plans to produce 45 bcm of gas per annum at its Eastern Siberian fields. For comparison, under Gazprom s existing contract with China, annual gas exports via the Power of Siberia pipeline stand at 30 bcmpa. Effect on company. In our view, receiving access to pipeline gas exports is important for Rosneft. Weak domestic gas prices anticipated in the foreseeable future may challenge implementation of Rosneft s ambitious strategy, which envisages growing gas production to 100 bcm by 2020 (in bcm). However, Gazprom does not support providing access to pipeline gas exports to independent producers. Further, the company is in talks with China regarding a second contract on exports of gas from West Siberian fields that envisages construction of another gas pipeline Power of Siberia-2 with capacity of 38 bcmpa. We also note that in order to extract dry (natural gas) from APG, Rosneft would have to invest significantly in construction of processing capacities in Eastern Siberia and the Far East. Effect on shares. From the standpoint of Gazprom shares, we believe the market may react negatively to this news. Given persisting excessive gas supply and weak pricing on 12

13 the domestic market, competition from Rosneft, in our view, will increase. Meanwhile, on export markets, Gazprom will face stronger competition from US gas producers and LNG projects. 4% increase in domestic gas prices proposed for 2017, followed by liberalization. Mixed impact News. The Federal Antimonopoly Service (FAS) has proposed to raise gas wholesale prices for industrial consumers by 4% starting July 1, 2017, according to media reports citing a letter from FAS. After 2017, gas prices will be liberalized and set according to price indicators based on the outcome of trading, the letter says. Effect on companies. To remind, preliminary agreement was reached to increase domestic gas prices by 2% in On average, the proposed tariff hike is in line with our long-term outlook, which sees gas prices growing 2-4% p.a. until That said, the proposed increase does not interfere with our financial forecasts for Russian gas companies. However, the suggested liberalization is relatively innovative. Currently, the amount of gas sold under long-term contracts linked to regulated prices (in case the contract is not linked, the regulated price serves as a benchmark) still accounts for a large share of Russia s gas consumption breakdown. On the one hand, liberalization could be positive for the gas market in all respects, as prices would be seasonally sensitive and react to the supply/demand balance, including the weather impact. On the other hand, to make a liberalization decision, significant changes must be made to the basic principles of the Russian market, as Gazprom still has restrictions on minimum gas sales prices. We believe that liberalization of the domestic gas market could be tied to universal reform of the entire gas market, including issues on exports, guaranteed suppliers and the participation of independent producers in construction of the gas network. Effect on shares and bonds. Until specific decisions are made, we see no significant impact on the share and bond price performance of Russian gas companies. However, we note that talks regarding the Russian gas market alongside changes to the tax regime and dividend policies of state companies will be among the major investment themes for the next several years. March O&G production: another record in oil as exports grow, gas output flat despite higher exports News. Average daily oil output in Russia totaled mln bpd in March (+0.2% MoM, +1.9% YoY), according to preliminary data from CDU TEK. Gas output stood at 54.0 bcm, down 2.8% YoY. Effect on companies. Russian oil production reached another record of mln bpd. After a slight decline in February, growth resumed, although the country might need to cut back in order to comply with a potential formal agreement to freeze oil production. However, we continue to expect an organic contraction in output starting from 3Q16. On a YoY basis, the growth figure returned to 1.9% in March following an increase of 1.5% in February. The growth in March stemmed mainly from small producers, as most majors even slightly decreased their production volumes. We note an accelerated decline in Rosneft s production volumes, with daily average output sliding 0.7% MoM, while on an annual basis it fell 1.6%. The pace of Lukoil s decline also accelerated, to 3.6% YoY in March. On the other side of the spectrum, the leaders in terms of production growth included Gazprom Neft (+5% YoY) and Tatneft (+4%). 13

14 Oil exports continued to trend upward, by 6% YoY in March and 5.2% YoY in 1Q16. Russia continues to boost its export volumes. Gas production volumes dropped 2.8% YoY, with the decline rate accelerating, as the warm weather in Russia had a negative impact on output. That said, according to a statement on Saturday by Gazprom CEO Alexey Miller, Gazprom boosted its gas exports to EU countries by 29% YoY. Effect on shares and bonds. We do not expect to see any impact on shares or bonds of companies in the sector, while noting another record in oil production and export volumes, which could exert pressure on oil prices. Lukoil to consider final dividends on April 26, not interested in noncontrolling stake in Bashneft. Moderately positive News. Lukoil held a conference call following the publication of 2015 IFRS financials. Effect on company. The key takeaways are as follows: On April 26, Lukoil s BoD will consider final dividends for 2015 and approve a new dividend policy. The management did not provide the exact amount of dividends, but confirmed that the company has almost no short-term debt, while boasting solid FCF and cash on is balance sheet. To remind, we conservatively estimate a dividend of RUB 100 per share, while noting significant upside risk. TICKER LKOH RX GAZP RX Target price RUB 2,936 RUB Closing price RUB 2,722 RUB Recommendation NEUTRAL OVERWEIG Upside 2% 36% Ratings BBB-/Ba1/BBB- BB+/Ba1/BB Source: Bloomberg Lukoil is not interested in a non-controlling stake in Bashneft. Moreover, the company sees no point in talking about a considerable premium to the market price following Bashneft s share price appreciation in recent months. To recap, in our report on privatization we mentioned the risk that the privation of Bashneft might be delayed. The company will maintain ruble capex at the 2015 level (~RUB 600 bln), while the dollar-denominated figure will decrease by about 25% vs. our expectation of 20%. Effect on shares. Expectations of considerable final dividends alongside the strong 2015 numbers supported the company s share price performance. Refusal to take part in the privatization of Bashneft or its delay would allow Lukoil to pay out significant dividends and maintain a low debt burden. We have a moderately positive view on Lukoil, as the company remains our only long-term OVERWEIGHT among first-tier names in the Russian oil universe. Effect on bonds. The company continued to show the best (except for SurgutNG and Tatneft) net leverage and interest coverage (EBIT/Interest) ratios in the sector in 2015, totaling 0.7х and 10.7х, respectively. Debt coverage by free cash flow remained exceptionally strong at 34%. Lukoil s liquidity position is flawless, as the company must repay only RUB 60 bln in debt in 2016, while its cash as of year end amounted to RUB 257 bln. Moreover, with flat capex in 2016, the company will likely continue to generate free cash flow even after dividend payments. In our view, the results provide a solid justification for the Lukoil curve to remain below those of other Russian issuers (~100 bps above the sovereign curve and ~20 bps below the Gazprom curve). Currently, the LUKOIL23-RUSSIA23 (~120 bps, 12M average of 140 bps) and LUKOIL23-GAZPRU (around -10 bps, 12M average of 7 bps) spreads are justified, in our view. 14

15 Lukoil releases 2015 IFRS results: strong FCF and balance sheet News. Lukoil reported IFRS results for This marked the company s first IFRS report (after having switched from US GAAP) and its first to be denominated in rubles (previously USD). Effect on company. Revenues were up 4%, broadly in line with the ruble price of oil in 2015, while EBITDA decreased 4% YoY to RUB 798 bln. The latter was slightly worse than peers (e.g. Tatneft reported 25% YoY growth in RUB-denominated EBITDA), but that was due to write-offs Lukoil wrote off RUB 161 bln, mainly in upstream (RUB 125 bln) and Africa (RUB 67 bln). Adjusted EBITDA increased 6% YoY. Hedging also helped Lukoil s net hedging gain totaled RUB 83 bln vs. a gain of RUB 72 bln in TICKER LKOH RX GAZP RX Target price RUB 2,936 RUB Closing price RUB 2,722 RUB Recommendation NEUTRAL OVERWEIG Upside 2% 36% Ratings BBB-/Ba1/BBB- BB+/Ba1/BB Source: Bloomberg FCF was very impressive at RUB 248 bln (nearly $4 bln) for the full year, including RUB 76 bln ($1.1 bln) in 4Q15 alone very strong results. Moreover, asset sales generated an additional RUB 79 bln ($1.1 bln). In fact, Lukoil seems to be in a position to increase final dividends YoY. Thanks to the impressive FCF, leverage decreased, with net debt/ebitda at just 0.78x vs. our expectation of above 0.9x. Short-term debt amounted to just RUB 60 bln, while cash on hand totaled RUB 258 bln. In fact, Lukoil could now buy a 50% stake in Bashneft at the market price (RUB 188 bln) using only its cash pile, while still having enough cash left to cover its short-term debt. Rosneft releases 2015 IFRS results: better than expected EBITDA and FCF News. Rosneft released 4Q15 and 2015 IFRS results there were stronger than expected on the EBITDA and FCF levels. Effect on company. Revenues of RUB 1,196 bln ($18.1 bln), down 7.7% QoQ, were in line with our and market expectations. EBITDA of RUB 250 bln ($3.8 bln), down 8.8% QoQ, was substantially higher than our forecast (RUB 210 bln) and the market consensus (RUB 223 bln). The EBITDA margin remained unchanged from the 3Q15 level at 21%, while we expected deterioration in margins. The main factor that supported profitability was lower other than income taxes (MET and export duties). TICKER ROSN RX GAZP RX Target price RUB RUB Closing price RUB RUB Recommendation NEUTRAL OVERWEIG Upside 2% 36% Ratings BB+/Ba1/- BB+/Ba1/BB Source: Bloomberg Net income to shareholders of RUB 53 bln (~$800 mln), down 52.7% QoQ, was in line with market expectations. The bottom line was adversely affected by a net loss from hedging, a higher effective income tax rate, and other factors. Another surprise was lower than forecast capex in 4Q15: cash capex amounted to RUB 186 bln ($2.8 bln), up by around 33% QoQ. This brings total cash capex for the full year to RUB 595 bln ($9.5 bln) vs. RUB bln expected. As a result of higher than expected EBITDA and moderate capex, FCF came in above our forecast, at a level of RUB 206 bln ($3.1 bln), up 32.1% QoQ. Net debt of RUB 2.05 trln ($28.1 bln) as of end 2015 was in line with our forecast. Net leverage (net debt/ebitda) as of end 2015 remained unchanged from 9M15, standing at 1.8х, while total leverage decreased by 0.2х to 2.9х. We note, however, that if we use the principles common to rating agencies and classify prepayments under longterm contracts on oil supplies as debt, the company s net leverage would reach 3.4х (vs. 3.7x for 9M15 and 3.6х for 2014). The share of FX debt in Rosneft s debt portfolio structure stands at 89%, while that of export revenues in 2015 amounted to 75%. We also note the company s strong liquidity position. In 2016, Rosneft must repay $14.3 bln in debt, which can be more than covered by the company s current cash of $19.2 bln (RUB 1.3 trln on accounts and short-term deposits). In addition, more than $1.7 bln (RUB 112 bln) has been held on the company s deposits for more than one year. 15

16 Effect on bonds. The strengthening of the credit portfolio and liquidity position is positive for the company s bonds, although upside potential is limited, in our view. The ROSNRM22-GAZPRU22 spread currently stands at 12 bps, while Gazprom s net leverage is far lower (1.1х). We still regard a premium of around 25 bps as justified. The ROSNRM22 s spread to the sovereign RUSSIA22 currently stands at 149 bps, the lowest level YTD. INTERNATIONAL MARKETS BHI: US rig count records 30th loss of past 32 weeks The overall US drilling rig count declined by double digits during the week ended April 1 for the 11th time in 13 weeks to begin the year. The latest data from Baker Hughes show the count shed 14 units to settle at a total of 450, down 1,470 units since the drilling dive commenced following the week ended December 5, Posting losses in 30 of the past 32 weeks, the rig count has shown no signs of relenting from its downward momentum. Since first hitting a low in recorded data on March 11, the count has dropped an additional 30 units. The US oil-directed rig count dropped 10 units this week to settle at 362, down 1,247 units since its peak in BHI data on October 10, Gas-directed rigs lost four units to 88, continuing to hit lows not seen in decades. The loss of rigs continues to reflect shrinking capital expenditures by beleaguered exploration and production firms, which have worked during the industry contraction to improve operational efficiencies and cut costs to stay afloat. OPEC lowers crude oil production in February According to secondary sources, total OPEC crude oil production in February averaged mln bpd, a decrease of 175 kbpd over the previous month. Crude oil output decreased mostly from Iraq, Nigeria and UAE, while production increased in Iran, Saudi Arabia and Kuwait. India, Saudi Arabia seek energy cooperation Leaders of Saudi Arabia and India say they want to extend their countries oil-trading relationship into joint investment in exploration and petrochemicals. Energy was part of a joint statement on business and strategic cooperation issued April 3 after a two-day official visit by Indian Prime Minister Narendra Modi to Riyadh at the invitation of Saudi King Salman bin Abdulaziz Al Saud. Said Arabia is the largest supplier of crude oil to India, where oil demand grew 5.7% last year and is expected by the IEA to increase 6.3% this year. According to some observers, India might replace China as the world s center of oildemand growth. India s oil consumption in January averaged about 4.25 mln bpd, up 12% YoY, according to the IEA. The country produces about 870 kbpd of crude. Salman and Modi agreed to transform the buyer-seller relationship in the energy sector to one of deeper partnership focusing on investment and joint ventures in petrochemical complexes and cooperation in joint exploration in India, Saudi Arabia, and in third countries, according to the statement. Kuwait says oil producers can reach output freeze without Iran OPEC and other major oil producing countries can reach an agreement for a production freeze, even if Iran does not join the action meant to help shore up prices, according to Kuwait s OPEC governor. 16

17 Oil-producing countries have no option but to reach an agreement to freeze production when they meet on April 17 in Doha, Qatar, because prices are too low, Nawal al-fezaia said in a telephone interview. The freeze, which may be at February levels, may also help set a floor for oil prices, she said. Oil producers have no option but to freeze their production as oil prices are low and hurting everyone, she said. All early signs before the meeting point to this conclusion. OPEC and other producers are meeting in Doha to finalize the agreement to freeze production in an effort to curb the global glut. Their unity came under immense strain last week as Saudi Arabia s deputy crown prince said the kingdom s commitment depends on regional rival Iran. While Iran may attend the talks, it has refused any limits on crude supply as it restores oil exports after international sanctions were lifted in January. Rising production from Iran will not hinder the agreement, as the country will find it difficult to sell its crude in an oversupplied market, Kuwait s al-fezaia said. The oil market is expected to return to balance in the second half of this year, she said. Oil prices may end the year at $45-60/bbl, she said. Brent for June settlement declined $0.06 to $37.63/bbl on the London-based ICE Futures Europe exchange. India's March Iran oil imports top 500 kbpd India's Iran oil imports topped 500 kbpd in March, the highest level in at least five years, as private refiner Reliance Industries resumed purchases after a multi-year lay-off, preliminary tanker data obtained by Reuters shows. Indian refiners together imported kbpd oil from Iran last month, a jump of about 135% from February, the data showed. In March of last year, the refiners halted imports from Iran to keep shipments within the parameters of the temporary nuclear deal then in force. The higher imports by India signals Tehran's success in beginning to regain market share after the lifting of Western sanctions targeting its nuclear program. Iran has said it will continue increasing its oil production and exports until it reaches the market position it held before the imposition of sanctions. In the fiscal year ended on March 31, Indian refiners shipped in 14.4% more oil from Iran at about kbpd, the data showed. The increase was the largest annual growth since the 2007/08 fiscal year, according to Reuters data. Essar Oil was the biggest importer of Iranian oil in March at about kbpd, followed by about 130 kbpd by Mangalore Refinery and Petrochemicals Ltd and about 90.6 kbpd by Reliance, its first shipments in about six years. Reliance had halted Iranian oil imports in 2010 because it was worried that the threat of US sanctions on companies doing business with the Islamic republic would complicate its efforts to boost market share for its fuels in the US. Last month Reliance imported Forozan grade and South Pars condensate from Iran, the data showed. Indian Oil Corp., the country's biggest refiner and not a regular buyer of Iranian oil, shipped in 2 mln bbl or about 67 kbpd from Tehran last month. Iran s green oil output growth insignificant Despite a huge rise in Iran s oil exports, the pace of output growth seems to be much less than that of exports. In the meantime, the main part of oil output is expected to come from old fields rather than new ones. According to the latest data released by the IEA and Reuters surveys, Iran increased oil exports to about 1.55 mln bpd in March 2016 from the 2015 average export level of 1.1 mln bpd. 17