In the Mood for Crude

Lev Snykov
Senior Analyst, Oil & Gas
VTB Capital

Our commodities team, lead by Wiktor Bielski, revised our Brent price forecast from $65 to $85/bbl for 2010, from $80 to $100/bbl for 2011 and to $110/bbl for 2012. Our new long-term forecast (beyond 2015) is $90/bbl, based on the expected marginal cost of Canadian oil sands (now the world’s second largest oil reserves). Good prospects of oil prices in 2010 and 2011 resulted in an upgrade of forecasts of oil companies’ share prices. In particular, the higher oil assumptions resulted in a 37 percent upgrade of sector earnings in 2010 and a 42 percent upgrade in 2011. The largest upgrades are seen in Rosneft (because of the tax break in Vankor) and Gazprom Neft (due to its solid downstream exposure and the consolidation of Sibir Energy).

We remain bullish on the sector, as we have been so far this year. While short-term risks for oil stocks have increased after the recent oil market rally and bearing in mind seasonality and OPEC’s spare capacity, any correction would in our view extend the buying opportunity with regards to Russian oils. Although Russian names are up 56 percent to 149 percent in the year to date, on average they have still underperformed global majors since the beginning of the crisis and are trading at an average 37 percent discount to global peers. They suggest visibly more growth potential in our view.

Also, we expect strong 3Q09 results to be reported across the oil sector later this year. The continued recovery in oil prices coupled with a rebound in domestic demand resulted in a major quarter-on-quarter (QOQ) boost in downstream profitability in the third quarter. As a result, we estimate that Russian downstream operations generated on average $7.5/bbl in EBITDA in 3Q09 (compared with $3.5/bbl in 2Q09). Mainly helped by refining, we estimate that integrated oils increased their EBITDA profitability 25 percent QOQ to $30/bbl in 3Q09.

Out of the oil majors, we continue to see the largest fundamental upside in LUKoil’s stock, although in the short term Rosneft might see a bit more support due to the newsflow on tax breaks. We are reiterating our “Buy” rating on both names, with LUKoil’s 12-month target price of $130 implying 144 percent upside potential from current levels and Rosneft’s 12-month target price of $12 suggesting 64 percent upside potential.

We continue to view a rebound in the gas sector as an imminent continuation of the oil market recovery, which has not so far been reflected in valuations (bearing in mind Gazprom’s relatively weak performance in 9mo09).

Gazprom therefore remains our top pick in the gas sector. The company has no plans to waive the take-or-pay penalties, which its European customers are likely to face this year. While the penalty is applied to 75 percent of the volume differential, it is duty-free, hence even marginally accretive for Gazprom. Meanwhile, given the strong oil price dynamics in 3Q09, European gas prices are set to rise in 4Q09 (from 3Q09 lows) and are likely to average around $290/mcm this year. This is somewhat above the company’s previous guidance.