Wood Mackenzie: Russian majors at US$60/bbl

Russian major oil and gas companies are uniquely positioned to take advantage of the current macro-economic environment and favorable fundamentals, and to withstand any prolonged period of oil price weakness, according to the latest analysis from Wood Mackenzie.

Dr. Valentina Kretzschmar, a research director for Wood Mackenzie's Corporate Upstream research service, said, "Russian majors' upstream cash flow break evens are among the lowest in the world at less than US$60/bbl. Costs are largely ruble denominated and among the lowest in the world, underpinned by vast conventional domestic legacy production; and the ruble devaluation has cushioned the negative effect from the fall in oil prices. This combination will help Russian producers stay competitive even if oil prices remain low."

The Russian majors' share price performance was hit harder than other peer groups when the oil price collapsed, with the added challenge of Western sanctions in response to the Ukraine crisis.

"Rosneft and LUKOIL were prevented from accessing Western capital markets,” says Dr. Kretzschmar. “The sanctions imposed by the EU/US were intended to significantly hinder Russia's oil and gas production potential, by banning the use of Western technology and equipment used to extract volumes from Russia's vast tight oil, Arctic, and deepwater resources – key for long-term domestic production. But the slight rebound in oil prices this year, stronger Russian ruble and higher dividend yields, have led to stronger performance within the industry peer group in the recent months.”

As the Russian majors are heavily weighted to conventional oil and gas production, Wood Mackenzie says that merger and acquisition (M&A) strategy is likely to be guided by access to new resource themes around the world and that geopolitics will have a big part to play. Dr. Kretzschmar explains, “The sanctions imposed on Russia are pushing its majors abroad to new resource bases in Latin America, Africa, and Asia – with most of the global hot spots still open for business with Russia.”

In doing so, Wood Mackenzie says Russia would boost its expertise in more challenging resource themes including unconventional, liquefied natural gas (LNG), and deepwater developments.

Dr. Kretzschmar adds, "This move would help diversify Russia’s inventory away from its domestic conventional focus and help to ensure access to new longer-term growth opportunities, which has become a strategic goal for Gazprom and LUKOIL. Rosneft's highly leveraged balance sheet means that the company is unlikely to undertake any large scale acquisitions in the near-term, but smaller-scale strategic deals are on the agenda. At the same time, drilling activity is increasing on the company's domestic legacy assets.

“This increase in domestic drilling is in part thanks to recent ruble devaluation, which lost 50% of its value against the US dollar in the second half of 2014. This has provided some relief for the Russian majors with predominately ruble denominated cost bases. We also believe that the structural shift in the ruble-US dollar exchange rate could provide long-term benefits for Russian producers. Although Rosneft and LUKOIL have decreased exploration and production budgets by 26% year-on-year average in US dollars, they actually increased spend in Russian ruble terms.” 

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