Fitch Ratings has affirmed Russia-based Joint Stock Oil Company Bashneft's (Bashneft) Long-term foreign and local currency Issuer Default Ratings (IDR) at 'BB' and removed the ratings from Rating Watch Negative (RWN). A Stable Outlook is assigned. A full list of rating actions is provided at the end of this commentary.
The removal of RWN reflects Fitch's view that currently there are no significant risks for Bashneft stemming from the legal action that the Russian authorities launched in mid-2014 against Sistema Joint Stock Financial Corporation (Sistema, BB-/Stable), Bashneft's then majority shareholder. Following a Russian court decision, in December 2014 Sistema's 73.94% stake in Bashneft was transferred to the state and the company was effectively nationalised. In March 2015, the shareholders' meeting elected Bashneft's new Board of Directors that mainly consists of representatives of state and regional authorities. Alexander Korsik, Bashneft's president, has also remained in the Board.
At the same time, there is still some uncertainty over the plans that the Russian authorities might have for Bashneft, in particular its capex, debt and dividend policies, and future strategy. This uncertainty constrains the ratings at the current level. We may consider a positive rating action once the uncertainty has been removed.
Bashneft is a second-tier Russian oil producer that accounts for 3% of country's oil production and 8% of oil refining output, with assets located mainly in the Republic of Bashkiria. Its ratings are constrained by the company's small size, uncertainty over its dividend, capex and financial policies following the nationalisation, concentrated production, and high exposure to downstream. On the positive side we note Bashneft's higher upstream production, eg, outside Bashkiria, solid reserve life and fairly low leverage.
Key rating drivers
Lower Earnings Volatility
The earnings of Russian oil and gas companies, including Bashneft, are less volatile than those of most of their international peers, primarily due to progressive taxation in upstream and reasonable flexibility of the exchange rate. These factors smoothed out Russian majors' EBITDA drop during the 2009 oil prices collapse, and we expect the same factors to aid Russian oil & gas (O&G) companies in 2014-2017, should oil prices remain depressed. A possible revision of taxation aimed at increasing the government's stake in O&G revenues presents a risk, though we view this scenario as unlikely at this stage.
Competitive Reserves and Costs
Bashneft's proved oil reserves of 2.1 billion barrels at end-2014 imply a 17-year reserve life, in line with that of its larger Russian peers. Its 9M14 lifting costs were USD7.6 per barrel of oil (bbl), below that of most international peers but above that of the Russian majors, due to Bashneft's smaller, more mature oilfields.
We expect Bashneft's production costs to edge down in 2015 in US dollar terms following the nearly 45% rouble depreciation since mid-2014 as most of its production costs are denominated in roubles, which should partially mitigate the negative effect of lower oil prices. We expect that company's operations to remain sound in the medium term.
Rising Upstream Production
We positively view the company's strategy to diversify its reserves across Russia and to boost upstream output. In 2014 Bashneft's crude production was 356Mbpd, up 10.8% yoy, compared with the Russian average growth of 1%. Production from Bashkiria, the company's stronghold, contributed around 1/3 of this increase, while the rest came from ramping-up Trebs and Titov (T&T) fields in Russia's north and the recently acquired Burneftegas in western Siberia. These two assets produced on average around 30Mbpd in 2014. We expect the company's upstream production to reach 400Mbpd by 2017.
Downstream Under Pressure
Oil refining in Russia is likely to underperform in 1H15 as domestic prices on refined oil products remain significantly below the export netback (export price minus export duty and transportation costs). This results from a combination of several factors, including the 'tax manoeuvre' undertaken by the Russian government, the rouble depreciation, and reluctance of Russian oil companies to raise oil products prices due to political considerations. We assume that domestic oil product prices will gradually increase and will come close to export netback in 2H15; however, there is some risk that this process may take longer, especially if the state interferes, e.g. through explicit or implicit price controls.
Bashneft is the fourth-largest refiner in Russia; its three Bashkiria-based refineries have 480mbbl/d total primary capacity and a Nelson index of 8.93 (Russian overage: 5.1). In 2014, refining and marketing contributed around a third to the company's EBITDA.
Moderate Dividend Policy
Since 2009, Bashneft has paid high dividends close to 100% of its pre-dividend free cash flow (FCF). We expect the dividend payout to moderate to 25% of net IFRS income, ie, the level recommended by the state to state-owned companies. However, there is still some uncertainty with regard to the dividend policy, especially taking into account that the state is likely to transfer some Bashneft's shares to the Republic of Bashkiria, and Bashneft's re-privatisation cannot be ruled out over the medium term. Higher dividend payments may result in significantly higher leverage than we currently expect.
Leverage Edging Up
We expect Bashneft's net leverage to increase but stay well below Fitch's negative rating action trigger of 2.5x. At end-2014, the company's net debt nearly doubled to RUB143bn (including the long-term prepayment from Vitol) on (i) Burneftegaz's USD1bn acquisition in 2014, (ii) mandatory buy-out of shares under a corporate restructuring (RUB18bn), (iii) consolidation of T&T debt.
Bashneft's debt is predominantly denominated in rouble, therefore, the rouble depreciation did not have a significant impact on leverage. We expect that at end-2014 Bashneft's funds from operations (FFO) adjusted net leverage will be around 1.75x, and will gradually reduce to around 1x by 2018-2019. Bashneft's gross interest coverage may fall below 8x in 2015-2016 but should rise thereafter as total debt will decrease (negative rating action trigger: consistently below 8x).
Positive: Future developments that may result in positive rating action include:
- More certainty with regard to Bashneft's dividend, financial and capex policies
- FFO adjusted net leverage below 2.5x and FFO interest cover equal to or above 8x on a sustained basis
- Upstream production above 375Mbpd
- Stabile refining margins
Negative: Future developments that may result in negative rating action include:
- Failure to maintain crude production at current levels
- Sustained deterioration of credit metrics, ie, FFO adjusted net leverage above 2.5x and FFO interest cover below 8x on a sustained basis, owing to higher capex and dividends
- Consistent underperformance of the refining business
- Oil price deck for Brent: USD55/bbl in 2015; USD65/bbl in 2016 and USD80/bbl thereafter
- RUB/USD: 60 in 2015; 55 in 2016 and 50 thereafter
- Russian progressive taxation cushioning the effect of declining oil prices on Bashneft's EBITDA
- Upstream production rising 5% yoy each in 2015 and 2016
- Dividend pay-out ratio of 25%
Liquidity and debt structure
At 30 September 2014, Bashneft had cash of RUB37bn compared with short-term debt of RUB27bn, most of which has been refinanced since. We believe Bashneft has adequate liquidity to forgo new borrowings until at least end-2016. The company is not subject to US or EU financial sanctions and may technically borrow abroad; however, we assume that the western capital markets remain closed over the medium term.
List of ratings actions
- Joint Stock Oil Company Bashneft
- Long-term foreign and local currency IDRs: affirmed at 'BB', off RWN, Outlook Stable
- Short-term foreign and local currency IDRs: affirmed at 'B', off RWN
- National Long-term Rating: affirmed at 'AA-(rus)', off RWN, Outlook Stable
- Senior unsecured rating: affirmed at 'BB', off RWN
- National senior unsecured rating: affirmed at 'AA-(rus)', off RWN