Russian Oil and Gas Basic industry overview

Transcription

1 P/E 15 JUNE 18, 214 INDUSTRY UPDATE Analysts: Alexander Nazarov Russian Oil and Gas Basic industry overview Russian oil and gas industry handbook. In this report we provide a basic description of the Russian oil and gas industry, including profiles of major companies, and discuss the sector s role in the Russian and global economy as well as the main trends. Russia is the world s largest hydrocarbon producer, producing 15% of total hydrocarbons. Russia produces 12.8% of global oil and 17.6% of global gas, making the country the world s top oil and gas producer on a combined basis. In 213, Russia produced 1.5 mln bpd of oil, ranking second in terms of global production after Saudi Arabia. In 213, Russia also produced 684 bcm of gas, making it the world s second-largest gas producer after the US. Oil and gas industry the most important for Russia s economy. Russia s significant weight in the global economy has historically been underpinned by the country s strong oil and gas sector. As of 213, the sector accounted for 28% of Russia s GDP, 67% of the country s exports and 56% of total revenues of the federal budget. Eastern focus, strengthening ties with China. Asian markets have become a strategic focus of export diversification, with the fastest progress achieved in relations with China. Russian-Chinese cooperation boomed in 213, including largescale export contracts (Rosneft s contract with CNPC, preliminary agreements with Sinopec), JVs, and Chinese companies buying stakes in Russian projects (Sinopec s purchase of a 2% stake in NOVATEK s Yamal-LNG). In May 214, Gazprom signed a $4 bln, 3-year gas export contract to China for annual deliveries of 38 bcm of gas, which may boost its non-cis gas exports by almost 25% starting from 219, and announced plans to renew negotiations on a further increase of gas exports to China using the Western route. Oil and gas accounts for 5% of the Russian equity market and 22% of the bond market. The oil and gas sector accounts for 5% (oil 33%, gas 17%) of the Russian equity market s capitalization, with weekly turnover in oil and gas equities averaging $ bln per day (~5% is outside Russia, 38% on Moscow Exchange, 11% OTC). In the Eurobond corporate universe, oil and gas issues comprise 31% of the total amount outstanding, with a bigger input only from the financial sector (44%). Among local non-government bonds, 11% of the amount outstanding is attributed to oil and gas issues. Largest Russian oil and gas companies low leverage, cheap valuation, high dividend yields. Russian oil and gas companies trade with significant discounts to international DM and EM peers, have low leverage, stable or even growing outlooks, and offer good dividend yields. We highlight excellent investment opportunities with good returns in both equity and fixed income instruments. Our top picks include Lukoil among the blue chips, and dividend names such as the preferred shares of SurgutNG, Bashneft and Tatneft. Ivan Khromushin Ivan.Khromushin@gazprombank.ru Alexey Dorokhov Alexey.Dorokhov@gazprombank.ru Ekaterina Zinovyeva Ekaterina.Zinovyeva@gazprombank.ru Yury Tulinov, CFA Yury.Tulinov@gazprombank.ru Erik DePoy Erik.DePoy@gazprombank.ru Russian oil and gas production mln bpd bcm E 215E Oil (LHS) Gas (RHS) Source: CDU TEK, Gazprombank estimates Russia s share in global hydrocarbons production, 213 Russia 8.1 bln boe 15% Others 44.6 bln boe 85% Russian oil and gas sector valuation* 14х 12х 1х 8х 6х 4х Tatneft Gazprom neft Lukoil EM Bashneft Rosneft DM Source: CDU TEK, BP Novatek 2х Gazprom 1х 3х 5х 7х 9х EV/EBITDA 15 * hereafter as of June 16, 214 Source: Bloomberg, Gazprombank estimates Research Department 1 Copyright Gazprombank (Open Joint-Stock Company)

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3 JUNE 18, 214 CONTENTS Russian economy and oil and gas sector... 3 Macroeconomics...3 Sino-Russian cooperation...3 Oil and gas prices... 5 Oil prices...5 Gas prices...6 Russian oil and gas sector main facts... 8 Industry overview...8 Russian oil and gas: main players... 1 Industry trends Regulations Unconventional oil and gas Cooperation with China Asia-Pacific and China: the most promising oil markets Rosneft: the most Asia-oriented Russian oil major Gazprom Eastern gas program Lukoil Gazprom Neft Corporate profiles Gazprom NOVATEK Rosneft Lukoil Gazprom Neft Bashneft Surgutneftegas Tatneft SIBUR Oil and gas sector on financial markets Equity markets Appendix

4 JUNE 18, 214 RUSSIAN ECONOMY AND OIL AND GAS SECTOR Macroeconomics At present, Russia enjoys steady positions among the world s largest economies. According to the IMF and WTO, as of 213 Russia ranked eighth globally in terms of nominal GDP ($2.1 trln), sixth in nominal GDP based on PPP valuation ($2.6 trln) and thirteenth in external trade turnover ($868 bln). Russia s significant weight in the global economy has historically been underpinned by the country s strong oil and gas sector. According to GPB estimates, as of 213 the sector contributed 28% to Russia s GDP, 67% to the country s exports and 56% to total revenues of the federal budget. Unsurprisingly, Russia s key macro gauges exhibit high sensitivity to the level of oil prices. For example, according to GPB estimates, for 214 a decrease of the yearaverage Urals price from $11/bbl to $1/bbl would prompt a.3-.7 pps deceleration of the country s real GDP growth, a pps decrease in the volume of investment and a pps deterioration of the federal budget surplus (as a percentage of GDP). That said, we do not see significant downside risks for our average Brent oil price forecast for this year ($18/bbl). It is also important to note that given the relative stabilization of both selling prices and production volumes, the oil and gas sector has not been the driving force of the Russian economy in recent years. As such, over 213 the contribution of minerals extraction to Russia s real GDP growth (+1.3%) totaled just.1 pps. Sino-Russian cooperation Asian markets have become a strategic focus of export diversification for many Russian companies, with the fastest progress achieved in relations with China. Imports from China have also been flourishing on the back of increasing private sector consumption. In general, over the past five years Russia s trade turnover with China has expanded by 2.3x times, demonstrating a spectacular 5Y CAGR of 18%. In 213, China contributed 1% of Russia s consolidated imports and exports, lagging behind the EU s figure of 48%. However, this figure has potential for further growth according to Russian and Chinese government officials, trade turnover between the two countries could reach $1 bln in 215 (vs. $89 bln in 213) and may double over the next five years, to $2 bln in 22. One should not be misled by the stagnation of Sino-Russian trade volumes in 213 totaling $89.2 bln (vs. $88.2 bln in 212), as this was primarily caused by plunging volumes of Russian exports to China (-1.2% YoY). This is likely to reverse in view of the recent hydrocarbon deals agreed between the two countries. Direct investment flows also provide evidence of strengthening economic ties between the two countries. Direct investment by Chinese companies in Russia has more than doubled since 29, to $374 mln in 9M13. Russia s direct investment in China has been relatively small of late (in our view, mainly due to China s limitations on capital flows from abroad), but we highlight a tripling of the figure YoY in 212 to $63 mln. On the corporate level, Sino-Russian cooperation boomed in 213, including large-scale export contracts, upstream and downstream JVs (Rosneft s contract with CNPC, preliminary agreements with Sinopec) and purchases of stakes in Russian projects by Chinese companies (Sinopec s purchase of a 2% stake in NOVATEK s Yamal-LNG). In May 214, Gazprom signed a $4 bln 3-year gas export contract to China for deliveries of up to 38 bcm per year, which could boost its non-cis gas exports by almost 25% starting from 219. Aside from oil and gas, this cooperation has extended to the utilities sector, including the construction of Tianwan NPP by Rosatom for the Jiangsu Nuclear Power Corporation, and potential electricity exports from the Russian Far East to China by Inter RAO. 3

5 JUNE 18, 214 Oil & gas sector is the key element of Russia s economy but not its key driver of late 8% 7% 6% 67% SHARE OF OIL & GAS SECTOR (213) 56% 25% 2% 15% 1.% 5.% 5% 4% 3% 2% 1% % 28% EXPORTS BUDGET REVENUES GDP 1% 5% % -5%.% -5.% % SHARE OF MINERALS EXTRACTION IN RUSSIAN REAL GDP GROWTH, % (LHS) RUSSIA REAL GDP GROWTH, % YOY Source: State Statistics Service, Finance Ministry, Gazprombank estimates Source: CBR Sino-Russian trade turnover is expanding $ bln as are mutual direct investment flows $ bln EXPORT TO CHINA IMPORT FROM CHINA DIRECT INVESTMENTS TO CHINA DIRECT INVESTMENTS FROM CHINA Source: Economy Ministry Source: CBR 4

6 JUNE 18, 214 OIL AND GAS PRICES Oil prices Alongside its position as the most vital commodity for the world economy, oil also remains one of the most liquid financial assets and its price is highly sensitive to major trends on global financial markets. We expect the Fed, ECB and central banks of other key OECD countries to remain accommodative in their monetary policy, which should provide additional support to nominal oil prices. We see the Brent price averaging $18/bbl in 214 and remaining above $1/bbl in the medium term, gradually rising to $121/bbl by 22 with 2% CAGR (mid-cycle Brent price of $11/bbl in real terms), driven by ongoing demand growth (especially in Asia and non-oecd countries in other regions), a natural decline in oil production from existing fields, and quite limited additional supply, with the rates of US shale oil production being one of the key risks on the supply side in the short term. Brent price and GPB forecast, $/bbl 13 Global oil demand , mln bpd mln bbl/d E 218E 221E E 215E Source: Bloomberg, Gazprombank estimates Source: IEA, EIA, OPEC, BP, Gazprombank estimates Despite the considerably improved production outlook in non-opec countries, particularly due to the expansion of shale oil projects, OPEC countries will play a key role in the development of the global oil market in the long term. We expect demand for non-opec crude, which would balance OPEC s strength on the oil market, to remain high, leading to higher costs of each incremental barrel required to meet rising oil demand. Capital and production costs of new projects on the higher end of the supply curve are already approaching $1/bbl, thereby providing long-term support to oil price levels. 5

7 RUSSIA INDONESIA MEXICO AZERBAIJAN NORWAY IRAQ ALGERIA SAUDI ARABIA OMAN NIGERIA KUWAIT QATAR VENEZUELA JUNE 18, 214 Oil prices set to balance budgets of major oil and gas exporters 12 $/bbl mln boe 6, 5, 4, 3, 2, , 5-1, OIL PRICE BALANCING THE BUDGET HYDROCARBON EXPORTS Source: BP, EIA, Gazprombank estimates Long-term oil price performance, $/bbl 16 $/bbl US crude oil inventories, mln bbl mln bbls Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec BRENT BRENT YEAR AVERAGE RANGE Source: Bloomberg Source: US Department of Energy Gas prices Russia Regulated gas tariffs for Russian industrial customers will be kept flat in 214 and prices for residential consumers are set to rise at a 3% discount to inflation rates. Still, due to the base effect, the effective rates of regulated tariff increases would be 7.5% for industrial consumers and 8.1% on average. The regulated prices will set the stage for the average realization prices of independent gas producers on the domestic market. We expect the average Gazprom realization price to Russia for 214 to exceed $15/mcm, with prices in different regions varying depending mainly on the distance from key producing regions. The prices for final consumers are further increased by VAT (18%), the cost of gas transportation by distribution networks and the commissions of supply companies, adding $25-35/mcm to wholesale prices. The average level of prices for final customers is $13-14/mcm. Europe Oil-linked prices in Europe. Gazprom sells gas to European countries on the base of long-term contracts extending until , with gas prices predominantly linked to the basket of oil products with a lag of 6-9 months. The contracts envisage the mechanism 6

8 JUNE 18, 214 of price renegotiations in case of substantial changes of the situation on the gas market. Over the past 2-3 years, Gazprom has substantially adjusted the terms of long-term contracts for the key market of Western Europe, where the level of competition with LNG is especially strong, introducing up to 15% of spot market indexation in its longterm contracts. We expect the average Gazprom realization price in Europe in 214 to be in the range of $37-38/mcm. We expect gas prices on the markets of East European countries to show substantial 15-2% premiums to West European markets due to limited availability of spot gas. We think that the oil link will retain its leading positions in volume terms in Europe at least over the next 3-5 years. Heightened political tension gave rise to various speculations regarding the prospects for Gazprom s gas transit to Europe through Ukraine, as well as potential disruption of the company s gas export sales to Ukraine. Transit risk is indeed one of the largest risk factors for Gazprom. Still, we note that the role of gas exports through Ukraine has diminished substantially following the launch of Nord Stream at full capacity and currently the share of transit through Ukraine is below 5% of gas exports to Europe vs. over 8% in Moreover, almost half of current export flow through Ukraine can be redistributed to other routes, leaving ca. 3% in the risk zone. The impact could be further softened by Gazprom s underground gas storage capacity in Europe. The launch of the South Stream pipeline in may completely eliminate the issue of transit risks for Gazprom. Spot NBP prices (Europe). Due to the outflow of LNG deliveries from European markets to premium Asian markets, we expect strong performance by European spot prices, including NBP. We expect average NBP prices in 214 to total $31-35/mcm, being relatively close to Gazprom prices or exceeding them in the winter season. The inflow of additional gas from new LNG projects at end 215 through 217 may exert temporary pressure on European spot prices, although we expect the new gas to be mostly absorbed by Asian countries. European authorities may increase their efforts to raise the share of hub-based pricing of imported gas in Europe by strengthening regulations and promoting hub-based gas trading. Gas prices, $/mcm JAN 13 APR 13 JUL 13 OCT 13 JAN 14 APR 14 HENRY HUB JAPAN LNG NBP GAZPROM Source: Bloomberg, Gazprom 7

9 JUNE 18, 214 LNG. Prices for LNG deliveries to Asian countries declined almost 5% YoY to an average of $589/mcm in 213, but were still more than 5% above average European spot prices NBP (NBPGDAHD Index) averaged $38/mcm and the price of longterm Gazprom contracts ($378/mcm). Prices for LNG deliveries to Europe averaged $379/mcm in 213, i.e. matching the level of spot prices. Events during 213 showed that LNG prices are very sensitive to changes in the gas market environment. Prices for LNG delivery to the US East Coast increased eightfold, from $143/mcm in November 213 to $1,16/mcm in February 214 due to high gas demand during the unseasonably cold winter. Over 7% of LNG trade takes place on the basis of long-term contracts. The prices of such contracts are mainly linked to oil prices, an oil product basket (Asia), main regional benchmarks (NBP in Europe and Henry Hub in the US), or the combination of oil-link and spot benchmarks. Gas and LNG prices in 213 $/mcm LNG global netback* dynamics $/mcm JAPAN LNG EUROPE LNG NBP HENRY HUB GAZPROM AV. EUROPE May-1 Apr-11 Mar-12 Feb-13 Jan-14 ANNUAL NETBACK AVERAGE NETBACK Source: Bloomberg * LNG price minus shipping cost Source: Bloomberg RUSSIAN OIL AND GAS SECTOR MAIN FACTS Industry overview Russia produces 12.8% of global oil and 17.6% of global gas, making the country the world s top oil and gas producer on a combined basis. In 213, Russia produced 1.5 mln bpd of oil, ranking second in terms of global production after Saudi Arabia. In 213, Russia also produced 684 bcm of gas, making it the world s second-largest gas producer after the US. In 214, according to our base case, Russian oil and gas production should be almost flat YoY at 1.5 mln bpd of oil and condensate and ca bcm of gas amid a stable oil price the Brent price should average $18/bbl. In terms of reserves, Russia ranks fourth globally in terms of oil and gas reserves with a 1% share. Russia holds reserves of 87.2 bln bbl of crude oil, ranking eighth in the world. Russia also holds 33 tcm of gas reserves, ranking second in terms of reserves globally after Iran. We note that these reserves do not include tight oil and gas reserves Russia is also one of the world s largest holders of tight and other nonconventional hydrocarbon resources. Russian oil and gas companies also have a number of large-scale upstream and downstream projects throughout the world. 8

10 JUNE 18, 214 Russian hydrocarbon reserves share, bln boe Russia 294 bln boe 1% Russian hydrocarbon production share, bln boe Russia 8.1 bln boe 15% Others 2,552 bln boe 9% Others 44.6 bln boe 85% Source: EIA Source: EIA Russian oil and gas production mln bpd E 215E OIL (LHS) GAS (RHS) bcm Top holders of shale oil and gas technically recoverable resources China 244 US 184 Argentina 179 Algeria 14 Russia 13 Canada 118 Mexico 117 Australia 11 South Africa 74 Brazil 52 bln boe OIL GAS Source: CDU TEK, Gazprombank estimates Source: EIA 9

11 JUNE 18, 214 Russian oil and gas: main players Russia s oil and gas sector is rather concentrated. The two largest gas companies (Gazprom and NOVATEK) accounted for 77% of the country s total gas production in 213, while the six largest oil companies (Rosneft, Lukoil, Surgutneftegas, Gazprom Neft, Tatneft and Bashneft) accounted for 79% of the country s total oil production. Gas is mainly transported through the trunk pipeline system operated by Gazprom. Oil and oil products are transported mainly via the trunk pipeline system operated by the state-controlled operator Transneft directly to Russian or international customers or to export sea ports, and partially by railroad. Russian oil companies are continually increasing refining volumes and refining quality (in terms of light products yield) and have mostly completed the quality program ensuring compliance with Euro-5 environmental standards. Gasoline production is projected to reach 39.5 mln tonnes in 215, up 3.4% compared to 212, and is expected to amount to 14.2% of refining volumes. Russia s top oil producers, 213, mln bpd Russia s top gas producers, 213, bcm GAZPROM.3 BASHNEFT.3 OTHERS 1.8 ROSNEFT 3.9 NOVATEK 53 OTHERS 7 ROSNEFT LUKOIL SURGUTNG 12 GAZPROM NEFT 13 TATNEFT.5 GAZPROM NEFT.6 SURGUTNG 1.2 LUKOIL 1.7 GAZPROM 476 Source: CDU TEK Source: EIA Russian refining volumes, 213, mln tonnes mln tonnes Russian gasoline production, 213, mln tonnes mln tonnes E 215E E 215E Source: CDU TEK, Gazprombank estimates Source: CDU TEK, Gazprombank estimates 1

12 JUNE 18, 214 Industry trends Russian exports EU accounts for the lion s share of hydrocarbon exports from Russia so far 32% of oil and 25% of gas produced RUSSIA REST OF THE WORLD Oil exports Gas exports.6 mln bpd 59 bcm PRODUCTION CONSUMPTION Oil 1.5 mln bpd 5.8 mln bpd Gas 684 bcm 436 bcm OIL AND GAS EUROPE Oil exports Gas exports 3.4 mln bpd 173 bcm Oil exports CHINA.4 mln bpd Gas exports.6 bcm OTHER ASIA Oil exports Gas exports.3 mln bpd 14 bcm Source: Gazprombank Capex of major Russian oil and gas companies: inflation of capex observed but there are no sharp spikes $ bln E 215E GAZPROM ROSNEFT LUKOIL OTHERS Dividend payments of major Russian oil and gas companies we expect a gradual increase of dividend payments $ bln E 215E 16 GAZPROM ROSNEFT LUKOIL OTHERS

13 JUNE 18, 214 Free cash flow of major Russian oil and gas companies steady FCF generation despite capex inflation $ bln E 215E GAZPROM ROSNEFT* LUKOIL OTHERS Discretionary free cash flow of major Russian oil and gas companies small decrease expected on the back of increased dividends $ bln E 215E GAZPROM ROSNEFT* LUKOIL OTHERS * including long-term prepayments on oil supply agreements * including long-term prepayments on oil supply agreements Chinese imports: Russia s share is not large, but will grow in the near future RUSSIA Oil imports.4 mln bpd Gas imports.6 bcm CHINA ASIA AND MIDDLE EAST Oil imports 3.1 mln bpd Gas imports 35 bcm REST OF THE WORLD Oil imports 2.1 mln bpd Gas imports 6 bcm Source: Gazprombank 12

14 BASHNEFT PREF BASHNEFT COM SURGUTNG PREF NIZHNEKAMSKNEFTEKHIM PREF TATNEFT PREF ROSNEFT GAZPROM NIZHNEKAMSKNEFTEKHIM COM TATNEFT COM GAZPROM NEFT EURASIA DRILLING LUKOIL SURGUTNG COM NOVATEK TRANSNEFT JUNE 18, 214 Decent dividend yields. The oil and gas sector is one of the best dividend payers in Russia and a decent payer compared to international majors. We expect an average dividend yield of 6.% for the Russian oil sector for 213. Large caps to yield 5-6%. The largest Russian oil and gas companies will provide decent dividend yields for 213, including 5.% at Gazprom, 5.1% at Rosneft and 5.9% at Lukoil. Second tier to provide even larger dividends. The Russian oil and gas sector contains unique dividend plays, including mainly preferred shares. The prefs of three Russian oil companies in particular (Bashneft, Surgutneftegas and Tatneft) may bring yields of 7-11% for 213. Russian oil and gas company final dividend yields 12% 11.4% 1% 8% 8.5% 8.3% 6.6% 6.6% 6% 4% 2% 5.1% 5.% 4.5% 3.8% 3.5% 2.9% 2.8% 2.2% 1.1% 1.% % 13

15 JUNE 18, 214 Regulations As we mentioned above, Russian oil and gas plays a crucial role for Russia s economy and budget income. That said, the lion s share of revenues of Russian oil companies is subject to taxation. In addition to income tax (2%), the fiscal regime for Russian oil companies consists of two major parts aside from corporate income tax: the mineral extraction tax (MET) and export duty if crude is exported. The MET represents a royalty payable by the producer on the volume of extracted resources, and differs between oil and gas production. For oil, the calculation of the duty involves some adjustments for the oil price and changes in the ruble exchange rate against the dollar. The base MET rate for gas and gas condensate starting July 1, 214 will be calculated as 15% of the weighted-average selling price of gas and gas condensate on domestic and export markets. In order to stimulate development of Arctic and East Siberia hydrocarbon resources, certain tax breaks were adopted for production in these areas depending on the complexity of developments in the region (with developments in the Arctic offshore, for example, receiving the greatest relief). A special tax regime is also applied to tight oil producers in order to intensify the development of abundant shale resources of the Bazhenov formation. An export duty applies to oil, gas and oil products exported from Russia. The oil export duty is calculated according to a special formula based on the average official Mediterranean and Rotterdam price in the previous month and then applied from the start of the following month. Overall, the MET and export duty takes about 7% of oil companies export revenue per barrel. The export duty for gas is 3% of the sale price. Thus far there have been no special oil or gas tax breaks for supplies to China, except for the gas (MET break may be granted) tax breaks in Russia are mainly linked not to sales destination, but to production region origination, with a few minor exceptions. Domestic oil product sales are also subject to excise taxes, which account for about 2% of product prices depending on quality (Euro 4-5 to Euro 1-3) Russia s two main oil taxes, $/bbl $/bbl NETBACK E 215E MET Export duty Urals price Source: Gazprombank estimates 14

16 USA CHINA CANADA AUSTRALIA INDIA RUSSIA ARGENTINA MEXICO INDONESIA ALGERIA EC JUNE 18, 214 There are no official regulatory restrictions or pricing regulations on oil and oil product exports and pricing, both externally and domestic. In gas, the export of natural gas is a monopoly right for Gazprom (excluding LNG), while domestic gas prices for Gazprom are regulated both for industrial and residential users. Although gas prices are not regulated for other Russian gas producers, the regulated gas price is a benchmark, so the actual prices do not differ much from regulated prices. However, independent gas producers provide certain discounts on their gas sales to industrial customers on the domestic market, which is actively used in competition with Gazprom. Unconventional oil and gas The so-called shale revolution altered the very core of the US gas market, spilled over to many other sectors in the US economy and seriously affected key regional gas markets globally. However, we believe that its effect (decreasing US gas imports, fall in US gas prices, declining global coal prices) has already taken its toll, while shale gas production growth in the US has sharply decelerated and is unlikely to be followed by a similar boom elsewhere in the foreseeable future. That said, we note the possibility of the start of commercial production in China and Argentina. Moreover, the shale revolution has had a rather limited direct impact on Russian companies. In Europe, for example, Gazprom faces competition not with shale gas, but mainly pipeline gas, LNG and coal. However, the indirect influence of the shale revolution has been felt via the oil price. Unconventional gas production by 235 and its share in total gas production bcm % 7% 6% 5% 4% 3% 2% 1% % TIGHT GAS COALBED METHANE SHALE GAS SHARE OF UNCONVENTIONAL GAS IN TOTAL PRODUCTION Source: IEA Russia is one of the largest holders of tight oil resources in the world, mostly concentrated in the Bazhenov shale formation in Western Siberia. We consider tight oil resources as an important source of potential support for Russian total oil production for and beyond, as crude output from conventional fields in Russia may start to decline YoY. However, further development of tight oil resources largely depends on the government s position in terms of the tax support regime for tight oil producers balanced by its appetite for tax revenues to the budget. We think that further easing is required to make shale oil production economically viable for oil companies. 15

17 JUNE 18, 214 Russian major shale oil resources BAZHENOV FORMATION TIGHT OIL PRODUCTION IN RUSSIA E 24E 14.8 m bpd 36m bpd 1,1 m bpd Source: IHS CERA, IEA, Gazprombank 16

18 JUNE 18, 214 COOPERATION WITH CHINA Starting from 29, Russian oil majors have increasingly looked at Asia as a strategic market and consider it the most important vector for diversification. The launch of the ESPO pipeline and Rosneft s large-scale long-term crude export contracts to China made the expansion of Russian oils to Asia a reality and laid the foundation for a further substantial increase of hydrocarbon exports to the region as well as broader cooperation in the energy sphere. Asia-Pacific and China: the most promising oil markets Asian markets are expected to remain the key centers for long-term oil demand growth in the world. Oil demand in the Asia-Pacific region is expected to grow at double the average rate of world oil consumption. According to IEA forecasts, China will likely account for 6% of total oil demand growth in Asia to 23. Thus, the Chinese market is currently one of the most attractive options for diversification of exports of Russian oil and gas. Currently most of China s oil imports come from the Middle East (over 5%). Alongside China s further deregulation of its oil and gas market, this could create further opportunities for other exporters. Most Russian oil and gas companies consider Asia and specifically China as a strategic export market, and are designing and undertaking large-scale projects aimed at export diversification to Asia. The long-term trend of export diversification to Asia is organically matched by the rising share of oil production in East Siberia and intensive oil demand growth in Asia (specifically China). Russian crude supplies to Asia may reach 65 mln tonnes by 22 and up to 8 mln tonnes by 235, with a proportional reduction of exports to Western markets. Substantial capex needs arising from the development of Eastern projects may be partially counterbalanced by fiscal stimulus provided by the government as well as potential funding from Asian partners. Russian oil and gas majors primarily have healthy borrowing capacity and apply the same profitability criteria to the Eastern projects as to the rest of the upstream project portfolio. Given its vast resource base in East Siberia and the Far East of Russia as well as long-term crude export agreements with Chinese companies, Rosneft is the clear leader in this process. Gazprom becomes the key player in the gas area with the conclusion of a gas export contract with China. Among other Russian oil and gas companies, Surgutneftegas, Lukoil, SIBUR, Gazprom Neft and NOVATEK will also play a significant role in exports to Asian markets. Developments over the past several weeks may improve the ties of Russian oil companies to Asian partners, including an increase in the number and volume of joint projects, and accelerated realization of key projects of Russian oil and gas companies aimed at Asian markets. Diversification of crude exports to Asian markets gives Russian oil companies a longterm fundamental base to increase their value through the development of greenfields in Eastern Siberia and the Far East, and to secure access to new export markets. Rosneft: the most Asia-oriented Russian oil major Rosneft is the most Asia-oriented Russian oil major and has the largest portfolio of joint projects with Chinese NOCs. Large-scale agreements with CNPC and Sinopec clearly show Rosneft s commitment to rebalance the company s export structure and increase the role of Asian markets in its global strategy. 17

19 JUNE 18, 214 Oil supply. Rosneft is the leader among Russian oil companies by volume of crude exports to China. In 213, Rosneft exported 15 mln tonnes to China (.3 mln bpd) and another 8.6 mln tonnes to Asian markets through Kozmino seaport. We expect Rosneft s oil exports to Asian markets to ramp up quickly; in 214 the company may send mln tonnes of oil to China by pipeline and increase the total amount of exports to Asia to more than 3 mln tonnes (over 34% of its non-cis exports). The total volume of Rosneft s crude oil deliveries to China (including direct deliveries by ESPO and Kozmino, exports through Kazakhstan and additional deliveries to Tanjin refinery starting from 22) may rise to 6 mln tonnes (1.2 mln bpd) by 22, and the share of exports to Asia in Rosneft s revenues may total up to 25%. Gazprom Eastern gas program In Eastern Russia, Gazprom owns an abundant resource base that is set to be used for gasification of Eastern Siberia and the Far East as well as potential gas deliveries to foreign markets, primarily in Asia. Gas deliveries to China. In May 214, Gazprom signed a $4 bln contract with CNPC for annual delivery of 38 bcm of gas to China. The contract became the ever-largest contract between Russia and China, organically complementing a previously signed long-term oil delivery contract between Rosneft and CNPC. As a result of the contract, Gazprom may take ca. 15% of the Chinese gas market by 22 and increase the volume of its non-cis gas exports by almost 25%. The implied price of the contract is ca. $36-38/mcm, on our calculations. The agreement envisages the prepayment of $25 bln. Russia also offered to cancel the gas MET for gas fields participating in the project, while the Chinese party agreed to reduce the taxation of gas imported from Russia. Key elements of the project will include the Power of Siberia pipeline, development of the Chayanda and Kovykta gas fields, and construction of gas refining and helium plants. There is also a probability of some participation by independent gas producers in the project during one of its stages. According to Gazprom, the total volume of investments in the project on Russian territory will exceed $55 bln. We expect Gazprom s capex to increase from $44 bln in 213 to $46-5 bln per year in Gazprom has also announced plans to renew negotiations in the near future on further increase of gas exports to China using the Western route. Lukoil With the launch of West Qurna-2 in 214, Lukoil aims to become an important player on the Chinese oil market. The company is already delivering around 3 kt of oil via ESPO to China and Southeast Asia per month. At end March 214, Lukoil launched its largest upstream project the West Qurna-2 field in Iraq and produced 12 kbpd at the field, while the end 214 target stands at 4 kbpd and is set to reach peak production of around 1.2 mln bpd in 217. Lukoil considers Asian countries and China as key markets for its share in the project s production (up to 2 kbpd) and we do not exclude that the lion s share of the Iraqi part of the field s output will also go directly to Asian markets. Gazprom Neft Gazprom Neft holds licenses for the development of several greenfields in Eastern Siberia, including the Kuyumbinskoye and Chonskiy fields, which are expected to be launched by Gazprom Neft s production from these fields may reach 9.5 mln tpa by 22, which will most likely be delivered to Asian markets, including China, via the ESPO pipeline. Another potential oil field whose resources may be used for export to Asian markets is Messoyakha located in northeast Siberia. Proved 2P reserves are 48.3 mln tonnes with peak production of 3.5 mln tpa by 226. Gazprom Neft is currently in the stage of constructing infrastructure at the field. 18

20 JUNE 18, 214 CORPORATE PROFILES Gazprom Gazprom is the largest public natural gas and hydrocarbons producer in the world. The company holds 123 bln boe of proved reserves and produces 9.5 mln bpd, accounting for 7% of Russian and 15% of world gas production. Gas has the dominant share in Gazprom s reserves and production, with 91% and 87% shares, respectively. Gazprom s key producing assets are located in Yamalo-Nenets Autonomous District in the North of West Siberia. The high quality of Gazprom s upstream assets makes it the best company among global oil and gas majors by lifting costs and upstream capex per barrel. Gazprom has an exclusive right to export Russian gas via its pipeline, and owns and operates the world s largest trunk gas pipeline network that connects its fields with Russian and European markets, accounting for 57% of gas revenues and 32% of total revenues. Gazprom has a well-developed oil and condensate business and is the largest electricity producer in Russia. Liquids production accounts for 3% of Gazprom s revenues. Gazprom s oil subsidiary, Gazprom Neft, is the fourth-largest oil company in Russia. Company-specific drivers Positive export outlook, gas exports to Europe (57% of gas revenues, 32% of total revenues) to stay close to the record levels of 213, gas prices to remain broadly flat, declining 2.5% YoY in Europe in 214. Dividend growth. A switch to 25% IFRS dividends payouts is possible in and could lead to an increase in dividend distribution. Gazprom s DPS may reach $.34 in E, up more than 6% from the current level. Long-term gas supply contract with China for 38 bcm p.a., or almost 25% of 213 exports to Europe, including a $25 bln prepayment, providing market diversification and boosting non-cis gas exports by almost 25% starting from 219. Switch to gas MET formula on July 1 adds long-term predictability to gas taxation and links the tax burden to average realized prices vs. fixed tax rates used previously. Strong credit profile with one of the lowest degrees of leverage among EM/CIS/Asian peers and significant borrowing headroom under internal indebtedness and rating agencies limits (min. $48 bln as of end 213). Company-specific risks Capex risk. Simultaneous implementation of several large-scale projects Yamal peninsula development, gas pipelines to Europe (Bovanenkovo-Ukhta, South Stream, Southern corridor) and the Eastern gas program may drive Group capex to over $45-5 bln in , pressuring FCF and requiring additional borrowings. Funding needs, however, could partially be covered by long-term prepayments totaling $25 bln agreed under the gas delivery contract to China. Regulation. Risk of sanctions, lifting of re-export limitations, leveling of realization prices in European countries, change in regulatory treatment of key pipeline projects. Taxation changes. Risks of cancellation of part of export duty tax breaks (up to 3-4% of EBITDA), risk of further potential revision of gas MET formula parameters over the next 2-3 years. Transit risk. Gazprom transports through Ukraine ca. 5% of its gas exports to Europe. Further non-payment for gas by Ukraine and intensification of discussion of gas supply and transit issues may lead to a temporary interruption of transit. Gazprom may reduce the share of Ukrainian transit to ca. 35% of European exports. The launch of South Stream may almost fully eliminate this risk by 216. Gazprom shareholder structure Government 5% Source: Company, Gazprombank estimates Gazprom key metrics GAZPROM Ticker, LSE Ticker MICEX BBB-/Baa1/BBB OGZD LI GAZP RX Current price $4.2 Target price $6.1 Upside potential 46% Recommendation MCap EV OVERWEIGHT 214E $99 bln $143 bln 215E P/E 3.x 3.1x EV/EBITDA 2.4x 2.5x Source: Bloomberg, Gazprombank estimates Gazprom share price performance 12% 11% 1% 9% Treasury stock 3% 8% JAN-14 MAR-14 MAY-14 Others 47% Source: Bloomberg Gazprom eurobond spreads to UST GAZPROM MICEX bps GAZPRU 37 GAZPRU GAZPRU /3 8/1 1/3 1/28 4/28 Source: Bloomberg 19

21 JUNE 18, 214 Gazprom s key gas assets GAS PIPELINES GAS FIELDS LNG GAS PIPELINES UNDER CONSTRUCTION BOVANENKOVO YNAO, YAMAL Yamal Europe SHTOKMAN Bovanenkovo Ukhta YAMBURGSKOYE Ukhta ZAPOLYARNOE URENGOISKOYE Novy Urengoy RUSSIA Nord Stream Saint-Petersburg CHAYANDINSKOYE TO EUROPE Torzhok Smolensk Gryazovets Moscow Izhevsk Urengoi Pomary Uzhgorod KOVIKTINSKOYE SAKHALIN II, III KAMCHATKA South Stream TO EUROPE TO EUROPE Elets Krasnodar ASTRAKHANSKOYE Balagansk Power of Siberia Blagoveshchensk TO CHINA Khabarovsk SAKHALIN II KIRINSKY BLOCK TO EUROPE TO TURKEY Blue Stream VLADIVOSTOK-LNG PROJECT Source: company data, Gazprombank Gazprom IFRS financials, $ mln E 215E 216E Revenues 153, ,989 17, ,29 185,822 EBITDA 54,495 65,177 59,655 56,875 57,965 EBITDA margin 35.5% 39.5% 35.% 32.1% 31.2% Free cash flow 3,117 1,144 9,6 5,4 3,94 Financial debt 49,46 55,56 53,29 58,881 66,792 Net debt/ebitda.6x.5x.6x.7x.8x Gas production, bcm Cash flow dynamics Debt maturity profile as of end (5) (1) $ BLN E 215E 216E DIVIDENDS OPERATING CF $ BLN 5 (5) (1) CAPEX (INCL % CAPITALIZED) DISCRETIONARY CF (RHS) $ BLN AND LATER LOCAL BONDS LOANS EUROBONDS

22 JUNE 18, 214 NOVATEK NOVATEK is Russia s second-largest gas company with 213 gas production of approximately 62 bcm of gas and 4.8 mln tonnes of liquid hydrocarbons, mainly gas condensate. NOVATEK s principal operating areas are concentrated in the Yamal- Nenets Autonomous District (YNAO) in Western Siberia. YNAO is the most significant gas producing region in Russia, accounting for approximately 9% of Russia s natural gas production and approximately 17% of global gas production. NOVATEK in 213 accounted for 8% of Russian gas production and 18% of the Russian domestic endcustomer gas market. NOVATEK also operates the Purovsky gas condensate stabilization plant and Ust-Luga stable gas condensate fractionation complex. NOVATEK owns 6% of Yamal LNG (2% owned by Total, 2% by CNPC), which is an LNG project with annual capacity of 16.5 mln tonnes and scheduled to start production in 217. Company-specific drivers Unique combination of growth and FCF. NOVATEK may provide a unique combination of double-digit growth in production of hydrocarbons and significant free cash flow (FCF) generation. Usually oil companies provide growth in FCF, which is especially attractive for a liquid stock with MCap of about $3 bln. Yamal-LNG Russia s largest LNG plant. Yamal-LNG will be the largest Russian and the northernmost LNG plant in the world with one of the cheapest upstream bases among global LNG plant projects. The LNG plant, which will start output in 217, will be a transformative project for NOVATEK the company may transform from a Russian gas domestic player (currently approximately 6-7% of NOVATEK s revenues come from domestic gas sales) into an international diversified oil and gas major. Notably, 75% of LNG is contracted already. Pro-active M&A player. NOVATEK uses its FCF to expand its business both organically and through M&A. In alone, NOVATEK purchased stakes in attractive greenfields, Nortgas and SeverEnergia, which will account for at least 3% of the company s consolidated production by 217. As we mentioned above, NOVATEK generates enough free cash flow to look for more M&A in the future. LNG supplies to China and project financing with the help of China. During the visit of President Putin to China in May 214, NOVATEK signed a contract to supply 3 mln tpa of LNG to CNPC. On the same day, China Development Bank Corporation, Vnesheconombank, Gazprombank and Yamal-LNG signed a memorandum on project financing for the Yamal-LNG project. Company-specific risks Regulatory risks in taxation and gas tariffs. Although starting in 214, gas tariffs will grow at a slower rate than inflation and the new gas MET formula will be introduced, Russian oil and gas taxation may change to the detriment of oil and gas companies. Lower than expected growth. NOVATEK is the most expensive company in the Russian oil and gas universe on multiples, but the premium is justified by growth. Lower than expected growth may create uncertainty regarding the company s prospects, while the premium valuation may seem unjustified to investors. Inflation of Yamal-LNG capex. Upward revision of Yamal-LNG capex may lead investors to revisit the attractiveness of the project. NOVATEK shareholder structure Total SA 15% Source: Company, Gazprombank estimates NOVATEK key metrics NOVATEK Ticker, LSE Ticker MICEX BBB-/Baa3/BBB- NVTK LI NVTK RX Current price, ADR $122 Target price, ADR $185 Upside potential 52% Recommendation MCap EV OVERWEIGHT 214E $35 bln $39 bln 215E P/E 1.9x 9.5x EV/EBITDA 8.7x 8.x Source: Bloomberg, Gazprombank estimates NOVATEK share price performance 11% 1% 9% 8% Gazprom 1% G. Timchenko 23% Others 27% V. Mikhelson 25% 7% Jan-14 Mar-14 May-14 Source: Bloomberg NOVATEK eurobond spreads to UST bps NOVATEK MICEX NVTKRM 22 NVTKRM /3 8/1 1/3 1/28 4/28 Source: Bloomberg 21

23 JUNE 18, 214 NOVATEK s key assets GAS AND GAS CONDENSATE PRODUCTION REFINING LNG YAMAL-LNG CORE UPSTREAM UST LUGA PUROVSK RUSSIA Source: company data, Gazprombank NOVATEK IFRS financials, $ mln E 215E 216E Revenues 6,79 9,37 11,438 12,747 14,65 EBITDA 3,123 3,819 4,542 4,955 5,668 EBITDA margin 46.% 4.8% 39.7% 38.9% 38.7% Free cash flow 1, ,944 2,565 3,46 Financial debt 4,362 5,6 3,52 2,296 1,752 Net debt/ EBITDA, x 1.2x 1.3x.7x.3x.4x Hydrocarbons production, mln boe Cash flow dynamics 6 $ BLN $ BLN 4 2 (2) (4) E 215E 216E OPERATING CF CAPEX DIVIDENDS DISCRETIONARY CF (1) (2) Debt maturity profile as of 1Q $ BLN Y 1-2Y 2-3Y 3-4Y 4-5Y AFTER 5Y LOCAL BONDS LOANS EUROBONDS 22

24 JUNE 18, 214 Rosneft Rosneft is the largest listed crude oil producer and reserves holder in the world and the second-largest listed company globally by hydrocarbon reserves and production volumes after Gazprom. Most of Rosneft's activity is located in Russia with its main resource base being Western Siberia, while Eastern Siberia is the second-largest producing region. With oil production of 4.2 mln bpd, Rosneft's share in global oil output reaches 4.5%. Rosneft hydrocarbon reserves (33 bln boe) and production (5.1 mln boepd) exceed those of ExxonMobil by 31% and 22%, respectively. Rosneft has the largest greenfield portfolio among Russian oil companies. In addition, Rosneft also has over 318 bln boe of risked resources on the Russian sea shelf. Rosneft is the most Asia-oriented Russian oil major and by far the largest oil exporter to China and Asia-Pacific countries. Agreements with CNPC and the export contract memorandum with Sinopec envisage an increase of oil exports to China from a current.3 to mln bpd. In Nakhodka, Rosneft is designing Russia s largest refining and petrochemicals complex (.6 mln bpd), aimed at Asia-Pacific markets. Rosneft is also the third-largest gas producer in Russia, with its share of gas reaching 26% in reserves and 17% in production. Rosneft aims to more than double gas production by 22 and is seeking opportunities for LNG and pipeline gas exports from its East Siberian and Sakhalin assets to China and Asian markets. Rosneft is the largest refiner in Russia, with the strongest positions among Russian oils in East Siberia and the Far East. Rosneft s refining throughput reaches 2. mln bpd. The company operates the largest retail network of over 2,7 retail stations. Company-specific drivers High operational efficiency. Lowest lifting costs, F&D costs and upstream capex per barrel among Russian and global oil majors. Attractive medium-term growth prospects. Liquid production CAGR by 22 over 1% and hydrocarbon output CAGR of ca. 2%, which are above the broadly flat national levels. Extension of tax breaks for East Siberian projects, offshore projects, tax breaks for tight oil. Tax breaks are designed to raise greenfield IRR to 16.3%. Solid level of dividend commitments at 25% of net income under IFRS. Advance payments by CNPC and Sinopec for long-term crude supply contracts totaling an estimated $95 bln available for withdrawal by Credit portfolio optimization. Gradual refinancing of ST debt raised for the TNK- BP acquisition: $1.6 bln of the $24.6 bln in 2Y lines has already been repaid, reducing the refinancing overhang in from $37 bln to a current $31 bln. Company-specific risks Capex risk. A number of capital intensive projects create risks of further capex growth and a lack of clear project prioritization. Further acquisitions. Market perception of the company s further acquisitions would depend on strategic fit, price parameters and impact on leverage. Weaker upstream performance. Due to a combination of geologic factors and efforts to optimize capex budgets, Rosneft may moderately reduce production targets. Potential share overhang. The planned privatization of up to a 19.5% stake in Rosneft s equity for may create a share overhang. Substantial increase in interest rates. The majority of Rosneft s debt has floating rates and is based on LIBOR, which is currently close to historic long-term lows of around.25%. Growth in rates could lead to an increase in debt service expenses. Rosneft shareholder structure Government 69.5% Source: company, Gazprombank estimates Rosneft key equity metrics ROSNEFT Ticker, LSE Ticker MICEX BBB-/Baa1/- ROSN LI ROSN RX Current price $7.3 Target price $8.8 Upside potential 2% Recommendation MCap EV 214E NEUTRAL $77 bln $143 bln 215E P/E 5.6x 5.3x EV/EBITDA 4.5x 4.x Source: Bloomberg, Gazprombank estimates Rosneft share price performance 11% 1% 9% Others 11% 8% JAN-14 MAR-14 MAY-14 BP 19.8% Source: Bloomberg Rosneft eurobond spreads to UST ROSNEFT bps ROSNRM 22 ROSNRM 17 TMENRU 2 MICEX 15 5/3 8/1 1/3 1/28 4/28 Source: Bloomberg 23

25 JUNE 18, 214 Rosneft s key assets OIL PRODUCTION ASSETS GAS PROJECTS REFINERY GAS PROJECTS SEVERNAYA NEFT YUGANSKNEFTEGAZ YANOS (5%) SAMOTLOR SAMARA ORENBURGNEFT RYAZAN VANKOR CLUSTER PURNEFTEGAZ UVAT NIZHNEVARTOVSK ACHINSK TOMSKNEFT RUSSIA YURUBCHENO- TOKHOMSKOYE VERKHNECHONSKOYE TAAS-YURIAKH ANGARSK SAKHALIN-1, 3, 5 SARATOV CAUCASUS KOMSOMOLSK TUAPSE Source: company data, Gazprombank Rosneft IFRS financials, $ mln E 215E 216E Revenues 98,68 147,14 161, ,48 177,293 EBITDA 19,891 29,384 31,569 35,245 38,47 EBITDA margin 2.2% 2.% 19.5% 21.1% 21.5% Free cash flow (incl. LT prepayments) ,542 23,48 23,524 16,625 Financial debt 32,628 72,474 51,296 33,452 26,131 Net debt/ebitda 1.1x 2.2x 1.4x.8x.4x Oil production, mln bbl 893 1,398 1,523 1,525 1,557 Cash flow dynamics 6 $ BLN $ BLN (2) (7) (4) (14) E 215E 216E OPERATING CF CAPEX DIVIDENDS DISCRETIONARY CF (RHS) Source: company, Gazprombank estimates Debt maturity profile as of 1Q $ bln Source: Company, Gazprombank estimates 8 8 2Q14-4Q AND LATER LOCAL BONDS EUROBONDS LOANS 25 Source: company, Gazprombank estimates 24

26 JUNE 18, 214 Lukoil Lukoil is the largest holder of oil reserves among privately owned listed oil and gas companies and one of the largest integrated oil companies in the world. In Russia, Lukoil is the second-largest oil company, producing 16% of the country s oil output, and is the largest private player in the oil industry. Most of Lukoil s activity is located in Russia, with its main resource base being Western Siberia. As of end 213, Lukoil held 13.4 bln bbl of oil reserves under SEC standards and produced 2.2 mln boepd of hydrocarbons, of which liquids production reached a total of 1.9 mln bpd. Lukoil also actively participates in international projects in CIS countries and Iraq and has substantial refining and retail assets in Europe. We expect Lukoil to market over.2 mln bpd of crude from its Iraqi projects in Chinese and other Asian markets from 215. Lukoil is Russia s second-biggest company in terms of refining volumes and operates the second-largest (after Rosneft) retail network in Russia numbering 2,4 stations. Lukoil key managers Vagit Alekperov and Leonid Fedun are the company s largest shareholders, which reduces potential conflicts of interest with minority shareholders. In 29, Lukoil approved a new strategy aimed at improving FCF generation and providing higher returns to shareholders, and has increased dividends by over 1% since 29. Company-specific drivers Production turnaround. After oil production dropped 7.9% in (-2.8% CAGR), Lukoil achieved remarkable success in production stabilization by implementing modern field development and drilling technologies, including a dramatic increase of horizontal drilling. Lukoil showed 1.2% oil production growth in 213 and is expected to reach over 4% liquids CAGR in Growth centers: West Qurna-2 (Iraq), Imilorskoye field in West Siberia, Caspian, Timan-Pechora and Urals fields. Consistent increase in dividends with 15% targeted dividend CAGR until 221 and expected dividend yield of 5.7% for 213. Possible start of share buyback at end 214 early 215. Start of capex reimbursement for West Qurna-2. The launch of the West Qurna-2 field in Iraq in 1Q14 will add over $5 bln per year to Lukoil s EBITDA in , as the company would receive fast capex reimbursement through a high share in project revenues in the initial years of production. Strong credit profile. Lukoil s leverage at.5x net debt/ebitda is among the lowest in the Russian oil and gas universe. Has solid borrowing headroom of $9-1 bln under internal leverage limitations (.2x debt/capitalization), which is stricter than current standalone credit rating requirements. Tax breaks for offshore fields, hard-to-recover oil. Lukoil is one of the key beneficiaries from the tax breaks for offshore fields and hard-to-recover oil. Company-specific risks Capex overruns. The implementation of complex upstream and refinery modernization projects may lead to further upward revision of capex budgets and pressure on operating cash flow. Acceleration of production decline at brownfields. Acceleration of production decline rates at West Siberian brownfields may have a negative impact on the production trend and operating cash flow. Suboptimal capital allocation. Inefficient acquisitions. Substantial increase of exposure to Iraq. Substantial increase in spending on risky exploration projects outside of Russia. Lukoil shareholders structure L. Fedun 1% Lukoil key equity metrics LUKOIL Ticker, LSE Ticker MICEX BBB-/Baa2/BBB LKOD LI LKOH RX Current price $62. Target price $87.7 Upside potential 41% Recommendation MCap EV OVERWEIGHT 214E $53 bln $62 bln 215E P/E 3.9x 3.5x EV/EBITDA 2.8x 2.5x Source: Bloomberg, Gazprombank estimates Lukoil share price performance 11% 1% 9% Treasury stock 11% Others 58% V. Alekperov 21% 8% JAN-14 MAR-14 MAY-14 Source: Bloomberg Lukoil eurobond spreads to UST LUKOIL bps LUKOIL 23 LUKOIL 17 LUKOIL 2 MICEX 15 5/3 8/1 1/3 1/28 4/28 Source: Bloomberg 25

27 JUNE 18, 214 Lukoil s key assets REFINERY CRUDE OIL AND GAS RESERVES BOLSHEKHETSKAYA TIMAN-PECHORA UKHTA URAY AND KOGALYM WESTERN SIBERIA RUSSIA NIZHNY NOVGOROD URALS PERM VOLGA VOLGOGRAD KAZAKHSTAN NORTHERN CASPIAN AZERBAIJAN UZBEKISTAN IRAQ WEST QURNA 2 Source: company data, Gazprombank Lukoil US GAAP financials, $ mln E 215E 216E Revenues 139, , , , ,884 EBITDA 18,872 18,564 22,68 24,788 27,334 EBITDA margin 13.6% 13.1% 15.9% 16.9% 17.3% Free cash flow 7,35 1,492 1,3 3,866 4,86 Financial debt 6,621 1,821 11,176 1,625 1,53 Net debt/ebitda.2x.5x.5x.4x.3x Oil production, mln bbl Cash flow dynamics Debt maturity profile as of (2) (4) $ BLN $ BLN (2) E 215E 216E OPERATING CF CAPEX DIVIDENDS DISCRETIONARY CF (RHS) $ bln AND LATER CONVERTIBLES EUROBONDS BANK LOANS

28 JUNE 18, 214 Gazprom Neft Gazprom Neft is Russia s fourth-largest oil company. The company s key upstream assets are located in West Siberia, which is the main Russian oil production province. Gazprom Neft holds 1 bln boe of proved reserves, with hydrocarbon production reaching 1.3 mln boepd and oil accounting for over 8% of total production volume. Gazprom Neft has shown very impressive growth over the past six years, raising oil production by 16% and hydrocarbons production by over 4%. Such growth is set to continue, as the company has one of the largest greenfield portfolios among Russian oils. Gazprom Neft aims to further increase hydrocarbons production by 54% by 22, and may reach the best rates of production growth CAGR among Russian oil majors until 22 of 6.3%. Being a listed oil subsidiary of Gazprom, Gazprom Neft benefits from the program to transfer several oil and condensate fields from the parent company, including the first oil field in the Russian Arctic shelf (Prirazlomnoye), as well as from synergies in field development, downstream and logistics. Gazprom Neft is one of the most active players in the Russian downstream market, operating the country s third-largest retail network. Since 27, the company has boosted its refining by more than 6% and has nearly tripled its retail sales. Company-specific drivers Assignment of several large oil and gas condensate fields from Gazprom (Prirazlomnoye, Dolginskoye, Orenburg, Novoport), expected to provide up to 16 mln tonnes of incremental production by 22 (3% of the expected oil production increase). Effective greenfield development in the northern part of West Siberia and in East Siberia, boosted by tax breaks. The government has made key decisions on major tax breaks for greenfields (MET and in some cases export duty breaks), aiming to provide at least 16.3% IRR. Active development of the downstream business aimed at further increasing the domestic market share in premium segments (retail sales of high-octane gasoline, diesel, sales of jet fuel, bunker fuel, lubricants). Attractive dividend profile. The company s dividend policy envisages the payment to shareholders of 25% of IFRS net income as well as the repayment of semi-annual interim dividends. Healthy credit and liquidity profile. As of 1Q14, net debt/ebitda stood at.6x and is expected to remain well below moderate the internal limit of 1.5x in the foreseeable future. Additional flexibility is provided by the $5.6 bln cash cushion, covering most of the company s capex financing needs in 214. Company-specific risks Capex. We expect capex to rise from $6.6 bln in 213 to $1 bln in 214 and $8 bln in 215 against the backdrop of continuing greenfield development. A substantial part of Gazprom Neft s greenfield projects is accounted using the equity method and is not consolidated on the company s balance sheet. The development of complex projects in new frontier regions poses a natural risk of capex overruns. M&A. The company remains active on the M&A market, which incurs price risks as well as risks of suboptimal capital allocation. Potential acquisition targets include E&P and retail assets in Russia as well as refineries in Europe and Asian markets, including Vietnam. In additional, payment for the Prirazlomnoye field may exceed $3. bln. Gazprom Neft shareholder structure Gazprom 96% Gazprom Neft key equity metrics GAZPROM NEFT Ticker, LSE Ticker MICEX BBB-/Baa2/BBB GAZ LI SIBN RX Current price $4.4 MCap EV 214E $21 bln $29 bln 215E P/E 4.x 4.x EV/EBITDA 3.1x 2.8x Source: Bloomberg, Gazprombank estimates Gazprom Neft share price performance 11% 1% 9% 8% JAN-14 MAR-14 MAY-14 Others 4% Source: Bloomberg Gazprom Neft eurobond spreads to UST GAZPROM NEFT MICEX bps GAZPRU 37 GAZPRU GAZPRU /3 8/1 1/3 1/28 4/28 Source: Bloomberg 27

29 JUNE 18, 214 Gazprom Neft s key assets OIL PRODUCTION ASSETS GAS AND GAS CONDENSATE PRODUCTION REFINERY MESSOYAKHA PRIRAZLOMNOYE OIL FIELD NOYABRSKNEFTEGAZ MOSCOW YANOS (5%) CLUSTER OF ORENBURG OIL FIELDS GAZPROM NEFT - KHANTOS OMSK TOMSKNEFT RUSSIA KUYUMBA Source: company data, Gazprombank Gazprom Neft IFRS financials, $ mln E 215E 216E Revenues 48,827 47,267 52,887 57,361 64,258 EBITDA 8,436 9,592 9,47 1,261 12,582 EBITDA margin 17.3% 2.3% 17.8% 17.9% 19.6% Free cash flow 2,349 2, ,868 3,933 Financial debt 7,659 9,59 1,152 11,31 1,694 Net debt/ebitda.6x.7x 1.x 1.x.8x Gas/oil production, bcm Cash flow dynamics Debt maturity profile as of 1Q14 15 $ BLN $ BLN 3 5. $ BLN (5) (1) 1. (1) (2) E 215E 216E OPERATING CF CAPEX DIVIDENDS DISCRETIONARY CF (RHS). LESS 1Y 1-2Y 2-5Y 5Y AND MORE LOCAL BONDS LOANS EUROBONDS 28

30 JUNE 18, 214 Bashneft Bashneft is Russia s sixth-largest oil producer. The company holds over 2 bln bbl of proved oil reserves and produced.3 mln bpd of oil in 213. Bashneft is an outstanding example of corporate transformation and value creation by building, smartly managing and developing an efficient integrated oil company on the base of a group of scattered assets. Bashneft managed to revive its mature oil fields, having raised production by over 3% since 29. Bashneft produces crude mainly at brownfields in Urals region. The company aims to further increase production volumes and diversify its upstream asset base to Timan- Pechora and West Siberia. The share of crude production in new regions may reach 2% by 218, we estimate. The company owns three refineries in Bashkortostan, which are the best in Russia in terms of complexity. As Bashneft s refining currently exceed production by 33%, the company aims to further extend the production base and increase production via development of the existing base and new acquisitions to balance production and refining volumes. Bashneft is the leader among Russian oil companies in terms of dividend payouts, consistently returning to shareholders all cash except that for required to cover operating and capital expenditures and a reserve required for the company s development and acquisitions. Like other Russian oil and gas prefs, Bashneft preferred shares are equity-like instruments. According to Bashneft charter, dividends on Bashneft prefs cannot be lower vs. the DPS on common shares. Bashneft is considering an SPO on international markets in Company-specific drivers Production ramp-up at Trebs and Titov fields, started in 4Q13. By 218, Trebs and Titov fields, jointly developed with Lukoil, may account for up to 2% of Bashneft s total production volumes. Possible extension of tax breaks for Trebs and Titov and other company projects in Timan-Pechora. High dividends. Highest dividends among key Russian oil and gas companies. Potential conversion of preferred shares into commons in the future. Possible credit rating upgrade from Fitch to BB+, given that company has managed to refinance a major part of its short-term debt. Company-specific risks Tax maneuver. Accelerated implementation substantially reduces refining margins, which is sensitive for Bashneft a company with over 13% refining cover. Lowering production targets from Trebs and Titov fields. Due to previous experience of Russian oil companies in Timan-Pechora, when the companies had to substantially reduce production guidance and reserve estimates of greenfields in the region in the early stage of development, the market will remain sensitive to production guidance. Start of oil production decline in Bashkortostan. Due to the late stage of Bashkir field development and remarkable production growth achieved in recent years, crude production in Bashkortostan may start to decline over the next 2-3 years. M&A. In the current situation of limited availability of available-for-sale assets in Russia, further M&A may bear price risk and have a negative impact on leverage. Reducing debt capacity. Debt-financed acquisition of Burneftegas, regulatory share buyback and high dividends for 213 required additional borrowings +53% of the debt increase was already seen in 1Q14, raising Debt/EBITDA from.9x to an est. 1.4x vs. the internal limit of 2.x. Bashneft shareholder structure AFK Sistema 74% Bashneft key equity metrics BASHNEFT ORD Ticker, MICEX -/Ba2/BB BANE RX Current price $71.3 Target price $74.9 Upside potential 5% Recommendation BASHNEFT PREF Ticker, MICEX NEUTRAL -/Ba2/BB BANEP RX Current price $53.3 Target price $6. Upside potential 13% Recommendation MCap EV OVERWEIGHT 214E $12 bln $15 bln Others 2% 215E P/E 6.8x 6.8x EV/EBITDA 4.3x 4.6x Bashneft share price performance 14% 13% 12% 11% 1% 9% Treasury stock 6% 8% JAN-14 MAR-14 MAY-14 BASHNEFT MICEX BASHNEFT PREF Source: Bloomberg 29

31 JUNE 18, 214 Bashneft s key assets OIL PRODUCTION REFINERY TREBS AND TITOV FIELDS RUSSIA OIL FIELDS IN BASHKORTOSTAN BURNEFTEGAS Ufa UFA REFINERY NOVOIL UFANEFTEKHIM Source: Company s data, Gazprombank Bashneft financials, $ mln E 215E 216E Revenues 17,139 17,73 17,424 18,16 18,673 EBITDA 3,176 3,188 3,44 3,192 3,384 EBITDA margin 18.5% 18.% 19.5% 17.7% 18.1% Free cash flow 1,299 1,642 1,593 1,273 1,35 Financial debt 3,629 2,775 4,663 4,77 4,411 Net debt/ebitda Oil production, mln bbl Cash flow dynamics Debt maturity profile as of June 1, (1) (2) (3) $ BLN E 215E 216E OPERATING CF DIVIDENDS $ BLN (1) (2) (3) CAPEX DISCRETIONARY CF (RHS) $ BLN AND LATER

32 JUNE 18, 214 Surgutneftegas Surgutneftegas is Russia s third-largest oil company in terms of both crude output and market cap. The company s 213 crude production totaled about 61.5 mln tonnes. Surgutneftegas also produced 12. bcm of gas last year, making it the country s fourthlargest gas producer. Brownfields account for 91% of production, with only one field Fedorovskoye accounting for more than 1% of total company output. Moreover, brownfield production is declining we estimate by 1.5% in 211 and about % per year going forward. In , the decline in brownfields is compensated by production from Eastern Siberia (mainly Talakan field). Surgutneftegas is a unique company in terms of balance sheet structure it is one of the few large companies in the world with a cash pile on its balance sheet that is similar in size to the company s market cap, e.g. the EV of Surgutneftegas is close to zero, implying the lowest EV/EBITDA multiples in the industry. Surgutneftegas preferred shares are a decent dividend play. According to the company s charter, dividends on preferred shares should be equal to about 7% of RAS net income, as preferred dividends move in line with RAS net income dynamics. Surgutneftegas preferred shares provide shareholders with a dividend yield of 8-11%. At the same time, the company s charter does not contain a benchmark for the dividend payout on ordinary shares, which yield only about 1-2%. As a result, the company s preferred shares, which have historically traded with a 35-45% discount to commons, began to trade with a premium in May. Company-specific drivers Tax maneuver. Surgutneftegas has one of the largest shares of crude oil export sales in revenues among Russian O&G majors and one of the lowest refining yields. Although not finalized yet, the tax maneuver will likely decrease refining margins and increase upstream margins, which will support Surgutneftegas profits. High dividends on preferred shares. As we noted, Surgutneftegas preferred shares are among the highest-yielding stocks in the Russian oil and gas universe. Common shares, although bringing lower yields, reflect the growth in preferred shares. Defensive play against ruble depreciation. Surgutneftegas holds a large cash pile, mainly denominated in USD and EUR. As a result of ruble depreciation, Surgutneftegas books a FX gain that is included in RAS net income for dividend calculation purposes. We roughly estimate that holders of Surgutneftegas preferred shares receive an additional RUB.3 in dividends (boosting the yield by around 1 pp) for every 1 RUB in depreciation against the dollar. Company-specific risks Decrease of production at core fields. Like most Russian oil majors, Surgutneftegas faces a decrease in output from its brownfields. Although the company has new projects, it may face an overall production decline in the future. Non-transparent shareholder structure. We estimate that about 66% of Surgutneftegas common shares are owned by non-commercial entities, none of which hold a share of more than 5%. The absence of a clear beneficiary and the risks of an unfriendly merger (with no offer to minorities) are probably among the main reasons for the almost zero EV/EBITDA multiples. Cash pile usage. For years, the cash pile has never been used by Surgutneftegas, leading to speculation that it does not exist. Surgutneftegas has not used its cash for expansion, mergers or buybacks and has thus been criticized by the market. The fact that the cash pile is not being used by the company is probably the reason why the market does not really account for it when valuing Surgutneftegas. Surgutneftegas shareholder structure Non-commercial organizations 66%% Surgutneftegas key equity metrics SURGUTNG ORD -/-/- Ticker, MICEX SNGS RX Current price $.79 Target price $.93 Upside potential 17% Recommendation NEUTRAL SURGUTNG PREF -/-/- Ticker, MICEX SNGSP RX Current price $.82 Target price $.82 Upside potential 1% Recommendation MCap EV OVERWEIGHT 214E $34 bln $3 bln 215E P/E 8.9x 9.3x EV/EBITDA.3x.3x Surgutneftegas share price performance 12% 11% 1% 9% 8% JAN-14 MAR-14 MAY-14 SURGUTNG SURGUTNG PREF MICEX Management 4% Others 3% Source: Bloomberg 31

33 JUNE 18, 214 Surgutneftegas key assets OIL PRODUCTION REFINERY RUSSIA KINEF CRUDE REFINING SURGUT (KEY PRODUCTION REGION) TALAKANSKOYE Source: Company s data, Gazprombank Surgutneftegas financials, $ mln E 215E 216E Revenues 42,78 41,363 42,9 42,88 43,518 EBITDA 8,839 8,219 8,463 8,534 8,68 EBITDA margin 21.% 19.9% 2.1% 19.9% 19.9% Free cash flow 3,515 2,537 1,394 2,383 2,55 Financial debt 2,91 2,284 1,917 1,917 1,917 Net debt/ebitda Oil production, mln bbl Cash flow dynamics Cash pile dynamics as of $ BLN $ BLN $ BLN (2) 2 (4) (1) 15 (6) (8) (2) 1 (1) (3) E 215E 216E OPERATING CF CAPEX DIVIDENDS DISCRETIONARY CF 29* * According to RAS 32

34 JUNE 18, 214 Tatneft Tatneft is Russia s fifth-largest oil producer with annual production of more than 25 mln tonnes. Tatneft s fields have a unique geographical profile most of the company s reserves are located in a single geographical zone with the shortest route both to export and refining capacities. The company s crude oil production has been stable for the past 1 years and can probably remain so for another 1 years. We also note that Tatneft has the longest reserves life among Russian oil majors. The company also operates the 8 mln tonne p.a. TANECO refinery, which starting from 214 began to be reflected in Tatneft s margins. In 1Q14, TANECO started a hydrocracker that has been a game changer for Tatneft s downstream. Before 1Q14 the downstream generated insignificant margins due to low refining quality. Revenues in the refining segment in FY13 accounted for about 4% of the company s total revenue structure and 15% of pre-tax income, up from about 9% in 212. As of 1Q14, the share of this segment in pre-tax income amounted already to 23%. Thanks to the unique geographical location of Tatneft s fields (close to main export destinations), the company has the lowest transportation expenses per bbl among Russian oil majors. On the back of a lack of development capex, Tatneft has the lowest upstream capex per bbl among Russian oil companies. The company is an excellent FCF generator, with FCF totaling almost $3 bln in 213 and another $1 bln in 1Q14. The situation may change when the company starts the construction of the second stage of TANECO refinery, which may cost $4.5 bln. The company is also a decent dividend payer. Tatneft has historically paid out 3% of RAS net income, which implies a 4-5% dividend yield for common shares and 7-8% for prefs. Company-specific drivers Hydrocracker at TANECO improved margins. In 1Q14, after the start of the hydrocracker, Tatneft showed the highest EBITDA margin in the company s history. Moreover, 1Q14 did not fully reflect the operations of the new TANECO unit and the full effect will be seen only in the coming quarters. Bitumen oil project. This is a separate mega-project of high viscous (bitumen) oil production that could require up to RUB 1 bln in investment. The company expects to reach production of 2 mln tonnes of bitumen oil within the next 3-4 years. Taking into account the special tax regime, production of bitumen oil is profitable at current oil prices. The bitumen oil project gives Tatneft something that the company s investment history has not seen for quite a long time growth. Dividends. As mentioned above, Tatneft is a stable dividend payer, providing investors with a defensive play. Company-specific risks TANECO second stage. Tatneft is about to decide on whether to expand TANECO refinery to 14 mln tonnes p.a., which would push FCF into negative territory for several years. Moreover, the project may have a negative NPV as a result of changes in taxation that decrease refining margins. Mature upstream. Tatneft operates one of the world s oldest oil fields Romashkinskoye, which still accounts for more than 5% of the company s crude oil production. Although the recovery ratio is unique and Tatneft has an excellent track record of operating its mature brownfields, there is still a risk of declining output in the future. Tatneft shareholder structure Tatarstan 61% Tatneft key equity metrics TATNEFT ORD -/-/- Ticker, LSE Current price (ADR) ATAD LI $37.9 Target price $37.2 Upside potential -2% Recommendation NEUTRAL TATNEFT PREF -/-/- Ticker, MICEX TATNP RX Current price $3.6 Target price $3. Upside potential -16% Recommendation MCap EV 214E NEUTRAL $14 bln $16 bln 215E P/E 6.7x 6.5x EV/EBITDA 4.5x 4.3x Tatneft share price performance 11% 1% 9% TAIF 5% Others 3% Treasury stock 2.5% Management 2% 8% JAN-14 MAR-14 MAY-14 TATNEFT MICEX TATNEFT PREF Source: Bloomberg 33

35 JUNE 18, 214 Tatneft s key assets OIL PRODUCTION REFINERY RUSSIA TANECO REFINERY & KEY UPSTREAM Source: company data, Gazprombank Tatneft financials, $ mln E 215E 216E Revenues 14,293 14,299 13,863 13,662 15,96 EBITDA 3,844 3,888 4,45 3,846 3,99 EBITDA margin 26.9% 27.2% 29.2% 28.2% 24.6% Free cash flow 1,282 1,927 1,793 1,648 1,897 Financial debt 2,38 1, Net debt/ebitda.5x.2x -.1x -.3x -.5x Oil production, mln bbl Cash flow dynamics 6 $ BLN $ BLN 3 Net debt dynamics $ BLN (2) (4) (1) (2) E 215E 216E OPERATING CF CAPEX DIVIDENDS DISCRETIONARY CF