1638 120123-0915 Oil

RUSSIA | OIL AND GAS JANUARY 2012
Russian Oil and Gas The Blushing Bride
We believe that Transneft is the only stock in our sector where the expected returns could realistically swell by several times over the next few years if the company consummates investors desire for a payout. There are fundamental differences between Transneft and Gazprom in terms of future capex profile. We think Transnefts capex will peak this year at slightly over $7 bln, and 2012 could be the first year of some meaningful free cash flow generation. The free cash flow should explode over the next several years to $5 6 bln, raise interest in Transnefts investment profile within the financial community and potentially pave the way to privatization. While the government has several weapons it can employ against sharing cash with minority shareholders, we feel the risk reward profile of this 2 P/E stock is becoming increasingly appealing, while the level of disclosure is visibly improving. We raise our target price to $3,500 per preferred share. Parsing down gas consumption data, we have discovered that demand in most of the country has grown at just 0.5% a year since 2004, compared with average GDP growth of 4%. Structural changes in just four localized sectors accounted for over two thirds of national growth. Meanwhile, we expect gas production by independents to double within eight years. Since there is no reason to believe that the cyclical drivers of gas consumption growth in Russia will miraculously change, while the structural drivers are likely to moderate in the long run, the call on re exports becomes simply gigantic. We would not rule out Gazproms production needing to fall further from here and remain rather cautious on the stock until the gas giant starts treating its capex more carefully. Our positive take on NOVATEK has not changed, and we see the political concerns as imaginary rather than real. We see much more value in smaller oil names, such as Gazprom Neft, TNK BP Holding and Bashneft, which are our top picks in the sector over the blue chips due to their superior longer term production growth, better free cash flow generation and higher dividends. To ensure performance in the oil sector, we see no other way but to sacrifice stock liquidity in favor of asset quality. We cut our target price for Rosneft to $9.00 per share on the back of higher capex, while LUKoil may face the same fate once it discloses its strategy program.
Comparative multiples based valuation

EV/EBITDA 2012E 2013E Gazprom LUKoil NOVATEK Gazprom Neft Surgutneftegaz Tatneft TNK BP Holding Rosneft Transneft KazMunaiGas EP Alliance Oil Company Bashneft Eurasia Drilling Company
Note: Prices as of January 18, 2012. Source: Troika estimates
P/E 2012E 2013E 3.3 4.0 16.1 5.1 6.6 5.2 5.6 6.4 2.2 3.3 3.3 5.9 10.4 3.7 4.2 12.5 5.1 7.4 4.4 5.9 6.4 1.7 3.6 2.4 5.1 7.4
Target price $ per share 8.00 80.00 172 5.25 0.94 6.75 3.60 9.00 3,500 28.00 SEK160 68.00 39.00
Recommendation HOLD BUY BUY BUY HOLD BUY BUY BUY BUY BUY BUY BUY BUY
Oleg Maximov Alex Fak Valery Nesterov
+7 (495) 933 9830 Oleg_Maximov@troika.ru +7 (495) 933 9829 Alex_Fak@troika.ru +7 (495) 933 9832 Valery_Nesterov@troika.ru
2.6 2.9 12.6 3.6 0.6 4.3 3.6 3.9 1.9 0.8 3.2 4.3 5.4
2.8 3.0 10.0 3.7 0.7 3.7 3.8 3.8 1.5 0.9 2.4 3.8 4.2
In accordance with US SEC Regulation AC, important US regulatory disclosures and analyst certification can be found on the last page of this report. research@troika.ru, www.troika.ru
JANUARY 2012
RUSSIAN OIL AND GAS THE BLUSHING BRIDE
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Contents
The Water Skater.............................................................................................................................. 4 Unnatural Gas .................................................................................................................................. 5 The CH4 man............................................................................................................................... 5 4 15 68 and the city of the rich and famous .............................................................................. 7 The pie eating contest...............................................................................................................13 Transneft The Blushing Bride.......................................................................................................16 A step by step guide to the altar ..............................................................................................17 Debt repayment and Transnefts debt discomfort .....................................................................22 Chronicle of a death foretold ....................................................................................................23 A shotgun wedding ..................................................................................................................28 Condensate the Other Russian Oil ...............................................................................................30 From the inferno to the land of milk and honey.........................................................................30 From current to future champions ............................................................................................32 From mezzanine to luxury penthouse .......................................................................................38 From unconventional oil to the quest for conventional money ..................................................42 Is Alliance Oil Company in Play? .....................................................................................................47 The procession of suitors ..........................................................................................................50 Oil and Gas Production Outlook for 2012 ......................................................................................56 Liquids: production back to the USSR........................................................................................56 Initial liquids production estimate for 2012 ..............................................................................57 Top down view: call on brownfield performance ......................................................................58 Bottom up view: two Gazproms at the front of production growth ..........................................61 Gas: is a small break for Gazprom this year enough to make it grow? .......................................63 Valuations ......................................................................................................................................66 Financial Profiles ............................................................................................................................67 Alliance Oil Company................................................................................................................67 Bashneft ...................................................................................................................................68 Eurasia Drilling Company ..........................................................................................................69 Gazprom ..................................................................................................................................70 Gazprom Neft...........................................................................................................................71 KazMunaiGas EP.......................................................................................................................72 LUKoil.......................................................................................................................................73 NOVATEK .................................................................................................................................74 Rosneft .....................................................................................................................................75 Surgutneftegaz .........................................................................................................................76 Tatneft......................................................................................................................................77 TNK BP Holding........................................................................................................................78 Transneft ..................................................................................................................................79
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The Water Skater

Below is a one page rundown of what we are analyzing in this report. In Unnatural Gas, we attempt to define the gas consumption growth rate of the Russian economy and estimate how demand may be accommodated by supply, where the call on exports stands and whether adjustments in gas production ambitions by the main players could become warranted. We conclude that just four economic subsectors of four Russian regions, accounting for a tiny 15% of national gas consumption, have contributed 68% of the growth in gas demand of the entire nation since 2004. Stripping out this structural growth which proved fairly immune to recession the cyclical remaining 85% of the country was growing consumption at a rate of just 0.5% per annum. On the supply side, our updated bottom up model of Russian gas production now calls for an increase in output from independents alone by 110 bcm by 2020, suggesting that neither the past growth in demand nor the present export growth outlook would be sufficient to recycle the booming output. We see more pain for Gazprom on the operating side and would not exclude that its production needs to be cut further from here. In Transneft The Blushing Bride, we look at our long standing investment case for the oil pipeline monopoly. We believe that Transneft is the only stock in our sector where the expected returns could realistically swell by several times over the next few years if the company consummates investors desire for a payout. Based on all projects known to us, we think Transnefts capex will peak this year, and 2012 could be the first year of some meaningful free cash flow generation. This cash flow should explode over the next several years and raise interest in Transnefts investment case among the financial community. In Condensate the Other Russian Oil we discuss the potential of Russian gas condensate as its present and future champions pursue a prize of about $13 bln, a figure comparable with the current EBITDA of TNK BP, Russias third largest oil company. We believe condensate output may double between 2010 and 2020, hitting over 700 kbpd by that year, with the largest volume additions coming from Gazprom and SeverEnergia. In Is Alliance Oil Company in Play?, we try to look at where the potential of this rather unique company lies and whether it could outgrow its second tier status, but more importantly whether the company is a future takeover target for the larger players. Finally, the Oil and Gas Production Outlook for 2012 develops a short term view on Russias hydrocarbon production and highlights the emerging trends and moving parts of the countrys greatest resource. Our initial forecast calls for domestic oil production to rise about 130 kbpd in 2012 (1.2%) to around 10.4 mln bpd, topping the level of 1990 the last year of the Soviet empire. On the gas side, we think Gazproms output is likely to remain in a range of plus or minus 1% with a negative bias.
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Unnatural Gas
The CH4 man
We have long been intrigued and puzzled by Russian gas consumption, simply because it is by far the largest market by volume for Gazprom and the only market for the independent producers. Hence, a significant chunk of the gas sectors production volumes and profits relates to how future trends in local demand might shape up. After all, just 1% of compounded annual growth in natural gas consumption in Russia over the next 10 years would create nearly 45 bcm of new gas demand, or just a touch under what NOVATEK produced organically last year.
Gazprom natural gas flow, 2011E
15%
Russia
54% 31%
Non FSU FSU
Source: Company, Troika
We looked at some consultants forecasts only to find out that we could not understand a single thing in their econometric models. We browsed through the governments long term gas strategy and were shocked to learn that this fine, 145 page tome, drafted in 2008, devoted only 11 pages to the subject and on top of this was entirely wrong in its predictions.
Domestic gas consumption forecast*, bcm
480 465
465
450 435 420

417
405 390 2010 forecast made in 2008

* as set out in the governments Gas Strategy Through 2030 Source: Russia Gas Strategy through 2030
2010 actual
One passage in this document caught our attention and piqued our interest. The government seems to be seriously concerned about the increasing share of gas in the domestic energy balance. Gas is displacing coal and, according to the government creates a threat to the nations energy security. This is serious, we thought, and may lead to some sort of a state policy or a wish list at the very worst.
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Russian energy consumption by fuel type, 2000

5% 2% 20% 18%
Russian energy consumption by fuel type, 2010

6% 6% 21%
Oil Natural gas Coal Nuclear energy Hydro electricity
14%
Oil Natural gas Coal Nuclear energy Hydro electricity
55%
Source: BP Source: BP
53%
The government believes that the high share of gas in Russias energy consumption mix creates a threat to the nations energy security.
We would not be spelling out anything groundbreaking by recalling that Russia remains the most gas intensive major country in the industrialized world and the second largest gas consumer in per capita terms.
Gas intensity, 2010
3,000 Per capita consumption, cm
Canada Russia
2,500
US
2,000 1,500 1,000 500 0 0

China UK Germany Japan
50
100
150
200
250
300
Gas consumption/GDP, cm per $

Source: IMF, BP, Troika
Such massive gas intensity is usually explained by, among other factors, the industrial rather than service oriented nature of the economy, inefficient gas use and colder weather.
Industry sector contribution to 2010 GDP
35.0% 30.0% 25.0% 20.0% 15.0% 10.0% 5.0% 0.0% US Canada Japan UK Germany Russia
1,500 Russia Canada Germany US China 2,500
2,159 2,158
Heating degree days* faced by an average person

5,500
5,235
4,500 3,500
4,493
Russia is the second coldest country on earth as experienced by an average person chillier than any of the Nordic countries. The most frigid place on the planet, as far as human beings who have to live and work there are 3,252 concerned, is Mongolia.
Source: National statistics agencies
* heating degree days index (HDD) is the measure of the average temperature's departure below the human comfort level, assumed at 18 C. The data are weighted by population concentrations. Source: World Resources Institute
Since the industrial share in the economy is the only predictable variable (though we would love to get our hands on research exploring some long term weather trends in Russia), analysts usually employ some sort of future GDP gas consumption correlation with a clever econometric model to
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drive it one that usually brings about headache and misapprehension. And we would probably have fallen into the same trap had we not started digging a bit deeper into what Russian growth in gas demand is and what it is not, how much of it is structural and how much is cyclical.
4 15 68 and the city of the rich and famous

Before explaining what this title means, let us remember how Russian CH4 consumption evolved. From 2001 to 2010, the nations appetite for gas increased by 56 bcm (natural plus associated gas) or a compounded rate of 1.6% per year. There was a dip during the financial crisis of 2008 09, followed by a strong recovery.
Russian natural and associated gas consumption, bcm
440 420 400 380
362 376 365 392 384 418 406 413 396 417 431
360 340 320 2011E 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Source: Gazprom, Troika
The 2011 figures are not out yet, but we can already see that the country should have added at least 13 bcm, with remarkable growth of 3%. Looking back, this has probably been our single biggest forecasting flop, as we frankly could not have imagined such explosive expansion. This was partially due to a continued bounce from the crisis, partially due to low temperatures in 1Q11 (the rule of thumb is that a 1 degree C drop in temperature during the heating season may create an additional 20 40 mmcm/day in gas consumption), and partially due to thermal electricity generation (gas, coal and fuel oil) beginning to replace hydro generation due to the latters low water levels. Regional demand does not reveal any remarkable picture other than showing where consumption was growing a little bit more, and where a little bit less.
Gas consumption by federal district, bcm
2001 Central Volga Urals South Northwest Siberian Far East Total
Source: Gazprom
2002 98 102 65 50 32 14 4 365
2003 101 104 68 52 33 15 4 376
2004 100 107 73 51 35 15 4 384
2005 102 107 77 52 36 15 4 392
2006 104 110 81 53 37 16 4 406
2007 105 112 84 54 38 15 9 418
2008 103 110 80 55 38 16 11 413
2009 100 101 78 51 36 16 14 396
2010 105 108 82 53 39 17 13 417
2010 split by region 25% 26% 20% 13% 9% 4% 3% 100%
CAGR, 2001 10 0.7% 0.6% 3.2% 0.8% 2.1% 2.3% 14.6% 1.6%
CAGR, 2004 10 0.9% 0.1% 2.0% 0.8% 1.7% 2.0% 24.2% 1.4%
99 102 62 49 32 14 4 362
The same can generally be said about the demand breakdown by economic sector, which probably explains why the forecasts are erroneously running on the back of deceptive headline numbers.
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Gas consumption by sector, bcm

2001 Electricity Industry, of which Oil Gazprom Metals Fertilizer Cement Chemicals Machinery Agriculture Municipal Residential Other Total
Source: Gazprom
2002 142 101 11 17 29 19 5 7 3 10 31 43 49 365
2003 144 106 12 18 29 19 6 8 4 10 32 45 49 376
2004 149 111 14 18 29 20 6 9 4 10 30 45 49 384
2005 153 114 16 19 29 21 7 9 4 10 32 47 46 392
2006 159 118 17 19 30 21 7 9 4 10 34 49 47 406
2007 164 127 25 20 30 22 8 9 4 10 33 48 47 418
2008 165 120 22 20 29 21 7 9 4 9 32 49 47 413
2009 153 115 25 17 26 20 6 8 3 9 35 50 44 396
2010 163 121 26 18 28 21 8 9 3 9 37 51 46 417
2010 split by sector 39% 29% 6% 4% 7% 5% 2% 2% 1% 2% 9% 12% 11% 100%
CAGR, 2001 10 1.7% 2.3% 10.4% 0.6% 0.3% 1.8% 4.9% 4.2% 4.4% 0.9% 2.0% 2.2% 0.7% 1.6%
CAGR, 2004 10 1.5% 1.5% 11.0% 0.7% 0.9% 0.4% 3.3% 0.7% 5.5% 1.2% 3.3% 2.2% 1.3% 1.4%
141 99 11 17 29 18 5 6 4 10 31 42 49 362
However, once we started dissecting the numbers, we were surprised to learn how narrow and shaky this growth has really been. The first conclusion is that four economic subsectors in four Russian regions, which account for a tiny 15% of national gas consumption, contributed 68% to the nations entire growth in gas demand since 2004. These subsectors are the Sakhalin oil sector, the Tyumen Region oil, electricity and municipal sectors, the Moscow Region (but not the city of Moscow) electricity sector and the combined electricity sector of the Kaliningrad and Leningrad regions and the city of St Petersburg.
Share in Russian gas consumption, 2010
85%
Share in gas consumption growth since 2004

32%
Four subsectors in four regions Rest of Russia
Four subsectors in four regions Rest of Russia
15%
68%
Four subsectors contribute only 15% to Russian gas consumption but account for over two thirds of growth in national gas demand since 2004.
Stripping out these sectors results in Russias gas consumption growth since 2001 being cut in half to 0.8%, and from 1.4% to a mere 0.5% since 2004. This contrasts with average GDP growth of 4% and nearly 3% expansion in industrial production between 2004 and 2010.
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Gas consumption CAGR in Russia, 2004 10

8.0%
7.6%
6.0% 4.0% 2.0%
Stripping out four subsectors in four regions results in Russian gas consumption growth of a mere 0.5% since 2004 instead of the 1.4% headline number.
0.5%
0.0% Four subsectors in four regions accounting for 15% of consumption

Source: Troika
Rest of Russia
The second conclusion is that these four so called growth subsectors in the four particular regions are fairly immune to recession. Since the 2007 gas consumption peak, they have been growing at a rate of 3.9% per annum, while the rest of the country (85% of consumption) has contracted by almost 1%.
Gas consumption CAGR in Russia, 2007 10
5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 1.0% 2.0% Four subsectors in four regions accounting for 15% of consumption
Source: Troika
3.9%
The four so called growth subsectors in the four particular regions are fairly immune to recession in their gas consumption, unlike the rest of the country.
0.8%
Rest of Russia
This makes us think that the very narrow growth spots in Russian gas demand have structural rather than cyclical drivers behind them. Hence, extrapolating the national headline numbers onto the future outlook seems rather misguided to us. What is left is to identify the nature of these structural drivers. First, gas consumption growth from the Sakhalin Region oil sector is very particular, bears no resemblance to any underlying Russian economic trends and is not expected to repeat. This region constitutes only 2% of national gas consumption and accounted for a whopping quarter of the entire growth in gas demand since 2004 but is not even served by Gazproms Unified Gas Supply System (UGSS). Its entire growth is simply a function of the Sakhalin 1 and Sakhalin 2 PSA projects, where oil and gas production was launched in 2007 and 2009, respectively, with some volumes consumed internally. Therefore, one can safely assume that gas consumption trends in this region do not really impact anything outside these two oil projects and perhaps Gazproms social obligation to supply gas from the island to the mainland in Khabarovsk and Vladivostok.
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Share in consumption growth since 2004

Rest of Russia,
75%
Growth in the Russia's Far East gas consumption is a function of Sakhalin 1 gas production
6 5 4 3 2 1 0 (1) (2) 2007 2008 2009 2010
Sakhalin Region oil sector,

25%
Sakhalin Region constitutes only 2% of national gas consumption and accounted for a whopping quarter of the entire growth in gas demand since 2004, but does not even have Gazproms unified gas supply system.
Source: Troika
Sakhalin 1 gas y o y production growth, bcm Russian Far East gas consumption growth, bcm
Source: CDU TEK, Troika
Second is Tyumen Region gas consumption in the electricity, oil and municipal sectors, which account for 10% of national gas demand but have contributed over a quarter of Russian growth since 2004. This is probably not difficult to explain either. Tyumen Region (including Khanty Mansiisk Region) forms the heart of Russias oil production and has been increasing and utilizing (both internally and externally) associated gas extracted with crude oil, which does not end up in the nations pipeline network. This structural and not cyclical trend is ongoing but has no relationship with Russias economic performance or gas producers quest to find end markets for their gas at home other than partially displacing them. In fact, associated gas consumption in Russia, constituting only 16% of total gas demand (67 bcm in 2010), has risen 16 bcm since 2004, or by nearly the same amount as natural gas. It goes without saying that most production and hence consumption originated in Tyumen Region. Moreover, since 2006, the entire growth in Russian gas consumption has come on the back of associated gas, as natural gas began to contract well before the recession of 2008. In addition, once electricity market liberalization was started, power plants in West Siberia ramped up production, as they operate in the same electricity price zone as plants in Central Russia but have access to cheaper associated gas sourced from the oil companies. For example, Surgut GRES 2, owned by OGK 4, boosted electricity output from 30.9 TWh in 2004 to 36.6 TWh in 2010.
Contribution to growth of gas consumption in Russia since 2004 Growth in Russian gas consumption from 2006 to 2010
15
12
12 9
Natural gas
52% 48%
6 3
Petroleum gas
0 3
(1)
Natural gas
Source: Gazprom, Troika Source: Gazprom, Troika
Petroleum gas
Third is the Moscow Region (not Moscow city) electricity sector accounting for a tiny 1% of Russian gas consumption but 11% of the growth since 2004. What about Moscow itself the city of excess, rich and famous that accounts for over 6% of the nations gas demand? Gas consumption in the city has contracted over the past 10 years and is down 5% since the peak in 2007, contradicting the idea that gas consumption growth is an integral part of broader economic expansion. How come the surrounding Moscow Region is thriving in terms of gas consumption growth, while its richer
10
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metropolis is failing miserably? One reason is probably an exodus from the city to the suburbs, but more importantly there has been a significant deceleration in residential construction within the city limits against a very impressive boom outside of Moscow. Perhaps this is one reason why NOVATEK is targeting the Moscow Region market and forecasting that its gas deliveries there will quadruple between 2012 and 2020, while all other major regions (except Kostroma, where it recently took market share from Gazprom) are expected to stagnate in terms of the companys absolute sales to end customers.
Residential completions, 000 m2
9,000 7,500 6,000 4,500 3,000 1,500 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
Gas consumption CAGR in the city of Moscow vs Moscow Region, 2004 2010
5.0% 4.0% 3.0% 2.0% 1.0% 0.0% 1.0%
0.4% 4.0%
City of Moscow
Source: Troika
Moscow Region
City of Moscow
Source: State Statistics Service
Moscow Region
Finally, the electricity sector of Russias westernmost regions (Kaliningrad and Leningrad regions, and the city of St Petersburg) contributes only 2% of national gas demand but accounts for 7% of growth. We would speculate that the expansion there probably relates to the increasing export weight from the Baltic ports, as well as booming activity in the automobile manufacturing sector. The vehicle production capacity in this Russian Detroit currently stands at about 611,000 cars and, according to the media, may rise another 30% by 2015, which may sustain this structural trend in gas demand.
Automobile production in the Northwestern Federal District (including Kaliningrad), 000 vehicles
350 300 250 200 150 100 50 0 2000 2005 2006 2007 2008 2009 2010
Source: State Statistics Service
But the bottom line is that the rest of the countrys gas consumption growth is very mediocre and mature, especially in natural gas. If after oil prices have more than doubled, steel prices increased by 18% and GDP expanded 26% from 2004 to 2010, the bulk (85%) of the national gas consumption still cannot grow by more than 0.5% per annum, why would anyone bank on higher expansion going forward, if any at all? Why not contraction or stagnation at best, especially when it comes to more expensive natural gas produced by the gas majors and not associated gas that has a very specific end market? Future trends in the electricity sector only confirm our suspicions and high skepticism regarding robust gas consumption growth in Russia. For example, even assuming about a 1.2% CAGR for electricity consumption sourced from gas fired generation in Russia and installed gas fired capacity increasing from the current 104 GW to 121 GW in 2016 (with a 48% load factor at old stations
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and 65% at new, gas fired blocks constructed under capacity supply contracts abbreviated in Russian as DPM that are 30% more fuel efficient), growth in gas consumption by the electricity sector comes to zero.
Growth in gas consumption from electricity sector under 1.2% annual growth in electricity consumption, 2011E 16E, bcm
200 190 180 170 160 150 140 Latest gas Growth from new Decline in 2016E gas consumption by gas fired blocks consumption consumption by electricity sector constructed from electricity sector under DPM decommissioning with 1.2% of old stations CAGR in and lower load electricity factor consumption
Source: Troika estimates
163
164
Certainly, there is a push for higher demand via, for example, Gazproms gasification program for smaller villages and towns. We understand that the company is targeting the creation of 20 25 bcm in additional consumption over the next five years (growth from municipal and residential consumers of 0.5% per annum) from this social policy advocated by the government. But there is also a pull toward lower demand from efficiency savings or simply cutting consumption as a response to higher pricing (for example, via pulverized coal injection, or PCI, technology in the steel sector).
Evraz gas consumption, mmcm per year
1,500 1,200 900 600 0 300 (200) 0 1 3 4 5 6 Years after capex start Without PCI technology With PCI technology 2 10% 12% 14% 16% 18% 20% Annual inflation in domestic gas prices over next three years with zero change after 2014
* from the start of the project at end 2009, calculated using the example of Evraz Group Source: Troika estimates
NPV from PCI savings*, $ mln

600 400 200 Even if gas prices stop rising after 2014, PCI savings bring positive NPV with domestic gas price inflation of more than 12% over the next three years.
Source: Company, Troika estimates
Our best guess based on the performance of the cyclical rather then structural share of Russian gas demand (or 85% of total consumption) is likely to struggle somewhere between 0.0% and 0.5% at best going forward, especially if we strip out the robust growth in cheaper associated gas. Hence, for natural gas, which we obviously care the most about, the absolute growth between 2012 and 2016 could be somewhere between nothing and 10 bcm. It therefore seems to us that the gas pie itself is not going to become meaningfully bigger while the queue of active claimants and for now passive bystanders looking to take a bite of this pie is growing by leaps and bounds. And this brings us to the study of this pie eating contest, down to the micro level. We will now attempt to figure out how demand might be accommodated by supply, where the call on exports stands and whether adjustments in gas production ambitions by the main players could become warranted.
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The pie eating contest

Six months ago, we thought we were being rather optimistic with regard to our production curve outlook for the independents. Indeed we were, but not sufficiently. We raise our call on the independent producers by 8 bcm in 2016 to 140 bcm, but more importantly by 50 bcm in 2020 to 195 bcm. The medium term change is driven purely by higher production and a longer plateau from NOVATEKs Yurkharovskoye field (the company will raise its production capacity to 37 bcm by end this year), as well as small adjustments for SeverEnergia. The 50 bcm increase in gas production from the independents in 2020 comes on the back of NOVATEKs two Gydan fields that the company is now targeting for the domestic market, and smaller fields held by the company that will be launched after 2013. While all other variables remain exactly the same as before, our updated forecast puts significantly greater pressure on the domestic market.
Natural gas production from independents' largest projects, bcm
200 180 160 140 120 100 80 60 40
Yurkharovneftegaz (NOVATEK) Sibneftegaz (NOVATEK Itera) Tarkosaleneftegaz Khancheyneftegaz (NOVATEK)
and peak somewhere around 195 bcm in 2020. Gas output from independents could grow to 140 bcm in 2016...
Gydan fields (NOVATEK) NOVATEK smaller fields Kharampurskoye (Rosneft) Vankor gas (Rosneft) Rospan (TNK BP)
Production was about 85 bcm in 2011.
Nortgas (Gazprom R.E.D.I.) Pyakyakhinskoye (LUKoil) Nakhodkinskoye (LUKoil) SeverEnergia (NOVATEK Gazpromneft, Eni, ENEL)
20 0 2006 2007 2008 2009 2010 2011

Legacy from oil companies
2012E
2013E
2014E
2015E
2016E
2017E
2018E
2019E
2020E
2021E
2022E
2023E
2024E
2025E
2026E
2027E
2028E
2029E
Source: Companies, Troika
If all this production materializes, we can expect an additional 55 bcm of gas by 2016 and 110 bcm by 2020 from the independent producers to be dumped on the domestic market relative to what was produced last year. As we wrote in our July 2011 discussion of this issue, we believe the overwhelming majority of this forecast production is highly credible, either due to the political leverage of the operators, to the pipeline access priority accorded to the associated gas, or to the fact that contracts with Gazprom have already been struck. The credibility of most of these projects is further underlined by the fact that companies have already begun investments (the only exception being the Kharampurskoye field and NOVATEKs next generation Gydan fields).
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Potential natural gas additions from independents, 2011E 16E: total 55 bcm
6% 13% 16%
Potential natural gas additions from independents, 2011E 20E: total 110 bcm
11% 3%
NOVATEK NOVATEK associates LUKoil

17%
NOVATEK
34%
NOVATEK associates LUKoil Rosneft TNK BP Other
Rosneft TNK BP
5% 43%
23%
Other
1% 28%
Source: Troika
Source: Troika
In other words, we call for gas production by independents to potentially more than double within eight years. Effectively, this 110 bcm of natural gas in the long run (and half of this figure in the short run) become additional supply that the Russian market has to somehow digest. Since there is no reason to believe that the cyclical drivers of natural gas consumption growth will miraculously change for the better, while the structural drivers are likely to moderate in the long run, the call on re exports becomes simply gigantic. Over the long run, the 110 bcm of extra supply (assuming no production growth from Gazprom) may have to chase about 17 bcm of additional demand (under a 0.5% growth assumption), suggesting a glut of 93 bcm that will need to be dumped on someone else in the next nine years.
How much supply may be chasing demand, bcm
120 100 80 60 40 20 0
9
At 0.5% cyclical growth in demand and the supply projected from independents, 55 bcm may be chasing 9 bcm in the medium term...
55
110
and 110 bcm of supply may be trying to find 17 bcm of extra demand, putting enormous pressure on re export of Russian gas.
17
2011 16E
2011 20E
Extra demand in Russian gas consumption Extra supply from independents

Source: Troika
With the FSU market contracting, in our view, over the short and long run unless prices are cut significantly, and with deliveries to China still highly uncertain, Europe remains the only viable market for Russia. Our previous estimate was that demand in Europe will still (but barely) absorb the glut created by the independents on the domestic market, allowing Gazprom at least to stand still. The math no longer adds up, not in the medium term, and especially not in the long run.
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Gazprom growth in OECD Europe exports, bcm

100 80 60 40
39
The math no longer adds up in the short and especially long run as the glut signifcantly exceeds growth in demand.
63 46
93
20 0 2011 16 "Glut" to be re under high exported market share

Source: IEA, Troika estimates
2011 20 "Glut" to be re under high exported market share
The related question to ask is what growth in Russian gas consumption is required to accommodate the glut? In the medium term, until 2016, Russian natural gas consumption needs to grow by approximately 1%, or twice the cyclical level since 2004, to accommodate the independents and allow Gazprom to produce at last years levels of 510 bcm. In the long run, consumption would need to grow by 1.4% per annum almost three times the historical pace. Hence, further cuts in Gazproms production cannot be excluded if the gas giant allows all this independent production to materialize. If we are right on growth and the independents produce what we see, Gazproms production will need to fall by another 30 bcm or so in the long term, back to crisis levels. We have recently begun hearing here and there about a new concept the creation of the euphemistically titled strategic gas reserves for future generations. This would be a subtle way to allow Gazprom to produce less, but would still be a cut no matter how you slice it.
Growth in consumption required to dissolve the glut
1.5% 1.2% 0.9% 0.6% 0.3% 0.0% 2004 10 cyclical CAGR 2011E 20E cyclical growth in 2011 16 consumption CAGR 2011 20 consumption CAGR gas consumption, Troika required to accommodate required to accommodate forecast production by independents production by independents with no growth from with no growth from Gazprom Gazprom
0.5% 0.5% 1.4%
0.9%
Source: Troika
TROIKA DIALOG
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JANUARY 2012
Transneft The Blushing Bride

Heres another incident that happened only the other day. A little blonde Norman girl of twenty a buxom, unsophisticated beauty that would make your mouth water comes to an old priest. She bends down and whispers her sin into the grating. Why, my daughter, have you fallen again already? cries the priest. Ah, Father, answers the sinner with tears of penitence, But it gives him so much pleasure while costing me so little effort! The devil to Ivan Karamazov, Fyodor Dostoyevsky, The Brothers Karamazov Transneft celebrates its 20th birthday as a corporation this year. Yet never has it behaved so much as a public company as now. Over the past couple of months, the pipeline operator has begun making tentative steps toward greater interaction with the investment community. These include a new English language website, a detailed disclosure on capex (broken down by projects), an analyst data book, an MD&A and, crucially, a meeting with a select group of analysts where the companys CFO and first vice president Maxim Grishanin asked what it is that the market expects from the company. And, as if to mark the final shedding of her teenagehood with its insecurities and its acne, the company earlier this month opened a Facebook account.
All the things she said running through my head
May June August September October October October November November December
Source: Troika
Company hires a dedicated IR agency First CFO meeting with analysts in years (following 2010 IFRS results) Deputy Prime Minister Igor Shuvalov adds Transneft to a list of state assets to be privatized English language website launched after a break of around two years Second CFO meeting with analysts A section for investors is opened on the corporate website (in Russian and English) CEO commits to launching ESPO 2 in 3Q12, ahead of schedule The company publishes its first ever Analyst Databook, disclosing average system tariffs A third CFO meeting with select analysts; CFO asks analysts what measures the market would like to see from the company MD&A published (for 2Q11 and 3Q11) for the first time in recent memory
This is a complete turnaround from earlier statements by both the current CEO Nikolai Tokarev who said in February 2008 that he doesnt care about the performance of the preferred shares and his predecessor, Semyon Vainshtok, who used to say the state was the only shareholder whose interests he valued. If Transneft is a debutante taken to her first ball by the government, which insists that it smile at potential suitors and perhaps show some leg too, it is only after almost a decade of enjoying exclusive rights to her favors and affections. Investors have been noticeably aroused by something that seemingly took Transneft so little effort to do. The stock rocketed the day Grishanin treated analysts to a lunch. What makes the story particularly fetching is that it comes at the same time as two other trends point to the denouement of the investment case one way or another in the near future. First, Transneft has probably just passed the peak of its project capex. We expect investments in new pipelines to fall by 50% by next year and to be virtually over by 2016. Second, the runaway government spending increases the possibility of state asset privatizations, and the implications for Transneft minority shareholders could be momentous.
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Breakeven price for the Russian budget, $/bbl

118
Break even oil price for fiscal balance

140
Break even oil price for fiscal balance, $/bbl
Russia 2012E Algeria Iraq Russia 2011E UAE Iran Saudi Arabia
120
95 105
100
78
109 103
120 100 80 60
Qatar Oman
80
61
65
40
35 27 19 20
51
55
61
60
70
95
95
30
Kuwait
25
20 0
40 20 0 0% 5% 10% 15% Share in 2010 global oil production
2011E
Oil price
Breakeven oil price for the federal budget

Source: IMF, Troika, BP
It is in this context that we decided to take another look at our long standing investment case for the company. We believe that Transneft is the only stock in our sector where the expected returns could realistically swell by several times over the next few years if the company consummates investors desire for a payout. This is by no means guaranteed, however, and we could equally see an alternative scenario whereby minority suitors are left rather unsatisfied.
A step by step guide to the altar

Transneft has been involved in capex intensive pipeline projects since the 1990s, with the most major one being the Baltic Pipeline System (BPS) link to Primorsk, which opened in 2001. After a lull, investment restarted with a vengeance in 2006, when construction of the $13 bln Eastern Siberia Pacific Ocean (ESPO) pipeline began (the first stage terminated near the border with China). In 2009, following a Christmas dispute with Belarus, the company started to lay the $4 bln BPS II pipeline a pure bypass of Belarus with no extra revenues and therefore no commercial justification finishing the project this year only to discover that the berths at the end point Ust Luga port are subsiding. In October, it completed the $1.5 bln Purpe Samotlor link (which will initially transport oil from Rosnefts Vankor field but eventually become the main route for crude output from Yamal). Through it all, the company has modernized its infrastructure, which is now among the sprightliest in the world. Transnefts full figure portrait is a picture of lithe, rejuvenated limbs spreading from the heart in the Volga Urals region to touch nearly every corner of the country. All this came at a price: tariffs have quintupled since 2002 but have still not been enough to finance the last six years massive asset expansion.
TROIKA DIALOG
2012E
2003
2004
2005
2006
2007
2008
2009
2010
17
JANUARY 2012
Transneft tariff growth (Jan 2011=1.0)

5.0 Despite tariffs having nearly quintupled since 2002... 4.0 3.0 2.0 1.0 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Transneft's cash inflow and outflow since construction of ESPO began (4Q05 3Q11)
Net debt raised 26 %
Operating cash flow

73%
Other 1%
Note: Data given in ruble terms. Source: Troika estimates
they were barely enough to cover the capex program.
Cash inflow
$37.5 bln
Capex
99%
Dividends 1%
Source: Company; Troika estimates
This is the past, but what is the outlook? We count at least six other projects that Transneft is either completing or plans to be involved in. The important point, however, is that the companys total level of project investment probably peaked last year and is on its way down. ESPO 2. A 2,000 km link from the end point of ESPO 1 in Skovorodino to the Pacific Ocean. Expected cost: $11 bln over 2008 12, with only about $2 bln left to go, we estimate.
Eastern export routes: ESPO 1 and ESPO 2
Source: Transneft, Troika
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ESPO 1 expansion. From 30 mln tonnes to 50 mln tonnes per year to accommodate the ESPO 2 link to the Pacific. Expected cost: $2 bln over 2011 13, with $1.5 bln left to go. Zapolyarye Purpe. A 45 mln tonne continuation of Purpe Samotlor inching deeper into the greenfield Yamal basin. Completion of this link is crucial for the launch of several projects in the area, including the giant Messoyakha and Russkoye, Suzun, Tagul and Pyakyakhinskoye fields as well as crude production at the SeverEnergia project. Expected cost: $3.4 bln in 2012 16.
Vankor Purpe and Zapolyarye Purpe oil pipelines
Source: Kommersant, Troika
Tikhoretsk Tuapse. The $500 mln link to supply the refurbished Tuapse refinery with an additional 12 mln tonnes of crude is being financed entirely by Rosneft through an investment tariff component and for this reason is not included in our project total. Link to ESPO from Yurubcheno Tokhomskoye and Kuyumba fields. Transneft will probably construct the 600 km pipeline in 2013 15. The financing is not yet clear it could come from the companies involved in the development of the two fields (Rosneft, TNK BP and Gazprom Neft), under the same formula as the Tikhoretsk Tuapse link; or it could be borne by Transneft, with the
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JANUARY 2012
subsequent increase in the network tariff (under a scheme similar to Zapolyarye Purpe). We believe the first option is more likely and therefore exclude the projects $1.7 bln capex from our estimates.
Yurubcheno Tokhomskoye zone
Source: Neft i Kapital
Yug (South) project by Transnefteproduct. A 1,400 km pipeline that would transport diesel from the Samara, Syzran, Saratov and Volgograd refineries to the Novorossiisk port. We believe the pipeline will carry the originally slated 8.7 mln tonnes per year, and we dismiss the more recent guidance of 18 mln tonnes as unrealistic considering the expected supply of diesel. Expected cost: $3 bln over 2013 15, though the timing could be moved back by a year.
Transnefteproduct's Yug project
Source: Transneft
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TROIKA DIALOG
JANUARY 2012
Bourgas Alexandroupolis. We believe this project to bypass the Turkish straits which entails constructing a pipeline from the Bulgarian coast to the Mediterranean coast of Greece will not proceed, following the recent pullout of Bulgaria. We thus do not include it in our estimates. We also do not model Transnefts minor participation in the potential $2 bln Samsun Ceyhan link that would transect Turkey. Maintenance. Transneft plans to spend about $2.8 bln this year to maintain, replace and modernize its existing oil and product pipelines, and we assume annual investment of $3.0 bln or more going forward. As such, we estimate that capex peaked in 2010 11 or will do this year, and the decline should start in 2013. By 2016, we estimate, Transneft will be working on no other major project, only putting the final touches on Zapolyarye Purpe and perhaps Transnefteproducts Yug pipeline.
Transneft's capex program in 2008 17, $ mln
8,000 6,000 4,000 2,000 0
2011E 2012E 2013E 2014E 2015E 2016E 2017E 2008 2009 2010
Maintenance capex ESPO 1 expansion Kozmino Sea Terminal Purpe Samotlor Yug (Transnefteproduct)
ESPO 1 ESPO 2 BTS II Zapolyarnoye Purpe
Note: Excludes Tikhoretsk Tuapse (financing by Rosneft), Yurubcheno Tokhomskoye /Kuyumba link to ESPO (assume financing by the oil companies) and Bourgas Alexandroupolis (unlikely to be built). Source: Transneft, Troika estimates
It should also be remembered that four of the projects ESPO and ESPO 2, Zapolyarye Purpe, the link from Yurubcheno Tokhomskoye and Kuyumba fields to ESPO and Transnefteproducts Yug pipeline will deliver additional revenues to Transneft. The same cannot be said, alas, of BPS II, nor of Tikhoretsk Tuapse, which will source crude that would otherwise have gone for export. Currently, Transneft charges R1,888 to pick up a tonne of crude at any point along ESPO and deliver it to the end port of Kozmino, paying about R2,000/tonne, on average, to Russian Railways and thus losing money on the offtakes (equivalent to its cost of operating the ESPO 1 pipeline plus the difference in the tariffs collected and paid). It is expected that starting in 2013 or perhaps even in 4Q12, the company will be able to begin transporting crude to the Pacific Coast exclusively through its pipelines, targeting a rate that would make it equally profitable for operators of largely East Siberian fields to transport their oil westward or eastward via the ESPO. This would result in a lower rate on ESPO which would subsequently be reimbursed via a higher rate on the rest of the system, with other operators effectively subsidizing East Siberian producers. Either way, we estimate that the new projects would bring Transneft $2.6 bln in additional revenue in 2013, $3.0 bln by 2016, when the Zapolyarye Purpe pipeline is launched, and $3.5 bln by 2019, when production from the new Yamal fields reaches its plateau. This compares with about $20 bln in consolidated revenues that Transneft probably made in 2011. We do not model any growth in Transnefts tariffs after 2013, as we see no justification for price growth.
TROIKA DIALOG
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JANUARY 2012
Transneft revenues, $ mln

30,000 25,000 20,000 15,000 10,000 5,000 0 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2008 2009 2010
Crude transport, legacy network Crude oil resale and other revenues Crude transport, Zapolyarye Purpe
Product transport, existing network Crude transport, ESPO Product transport, Yug
As such, even assuming flat tariffs (and the existing taxation system), we could see Transneft bringing home almost $6 bln in free cash flow as early as 2013, potentially rising to $7.0 bln by 2016, when all three large East Siberian fields (Vankor, Talakan and Verkhnechonsk) enter their plateau, oil starts flowing from the Yurubcheno Tokhomskoye and Kuyumba projects, and the bulk of Yamal oil enters the Zapolyarye Purpe pipeline. This compares with the entire current market capitalization of $13 bln (we extrapolate MCap from the price of the traded preferred shares).
Transneft's expected cash flow in 2014
Net debt raised 0%
Operating cash flow

100%
Cash inflow
$12.0 bln
Capex
$5.5 bln
46%
Cash available for debt repayment and dividends

$6.5 bln
54%
Debt repayment and Transnefts debt discomfort

Transneft has said that it will channel the initial free cash flow into debt repayments. It will first seek to retire some $4.5 bln in expensive ruble debt taken on in 2009 and now largely held by VEB. Most of the rest of its debt is composed of the $10 bln loan from China which was taken on in 2009 10. The company is paying a low interest rate close to LIBOR on the Chinese loan and does not have to start principal repayments until 2014. We suspect, however, that it is not the finance reasoning that may prevail in the end, but a certain desire to be rid of indebtedness to a major geopolitical competitor.
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TROIKA DIALOG
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Transneft's gross debt balance, end 3Q11, $ mln equivalent

Ruble debt,
4,195, 23%
Eurodebt (in dollars and euros),

4,388, 24%
Loan from China (in USD),

10,000, 53%
Following the loan from China, paid in three installments over 2009 10, Transneft has kept its cash kitty full at around $10 bln. In 2011, during a dispute with China over the pricing of crude that Rosneft sells to the country (some of it via Transneft), the pipeline operator said it would be able to repay the Chinese credit early, and the high cash balance suggests this was more than just posturing. Transneft seems uncomfortable holding such a large loan from such a potentially fussy customer. It is not alone in this. Rosneft, the recipient of a $15 bln Chinese loan, has similarly been building up its cash pile, which reached $8 bln in 3Q11. We believe the repayment of the Chinese loan will take priority after the expensive ruble debt is repaid. Indeed, we could assume that in the worst case, the entire gross long term debt pile would need to be repaid or repurchased before the question of free cash flow distribution to other shareholders (the government and perhaps the minority shareholders) can even become relevant. In that case, considering some $17 bln in gross long term debt as of end 3Q11, we estimate this would happen only by mid 2015.
Chronicle of a death foretold

Once the debt is repaid, it will be time to share the spoils. We see five basic scenarios for where the cash can go. We list them here in order of increasing likelihood. 5) MORE PROJECTS? Loved pipeline operators are all alike; every disliked pipeline operator is disliked in its own way. We are not passing a judgment of our own but simply interpreting the markets, which values foreign peers at well into double digit P/Es while assigning low single multiples to Gazprom (gas pipeline operator and producer) and Transneft. But while Gazproms deadly sin is its ability to come up with mostly unprofitable projects, Transneft is largely isolated from that risk for several reasons. Here is why we think Transneft is not like Gazprom: The Great Leap Eastward. Both companies infrastructure has historically been oriented toward delivering energy to Europe. Both now have ambitions to sell to China and the rest of Asia. The important difference is that Transneft is more than half a decade ahead of Gazprom, and will be finishing its second link to the Asia Pacific market by year end. We believe that with the completion of current projects, Transneft will have covered Russias growth in crude and product export needs for decades to come.
TROIKA DIALOG
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JANUARY 2012
Transnefts revenues from pumping oil eastward, $ mln

4,000 3,000 2,000 1,000 0
2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E
45 39 30
Someone else always pays. Transneft lays down pipes for new projects only when throughput volumes are guaranteed by oil companies. That is the case with Zapolyarye Purpe, Tikhoretsk Tuapse and the potential link to Yurubcheno Tokhomskoye. It is partly the case with ESPO and ESPO 2, where we estimate that demand may surpass the 50 mln tonne initial capacity by 2019. The only time in the recent past when Transneft built a pipeline without guaranteed throughput was BPS 2, and that was partly paid for via higher tariff growth. Which brings us to the second point: oil companies not only guarantee volumes but have to pay for about a third of the running project capex via higher tariffs (an in reality, they pay for about three quarters of it, as we saw above). Transneft lays the pipes and makes money irrespective of whether the oil companies do. Gazprom, meanwhile, is laying the infrastructure for its own exports and assumes the ultimate pricing risk.
Transneft capacities vs extra throughput, mln tonnes*

80 60 40 20 0 BPS BPS 2 *** Capacity ESPO Zapolyarie Purpe Throughput at peak **
70 75
56 50
* throughput may exceed nameplate capacity due to pump station management and pipeline expansion ** on current estimates *** volumes going through BPS 2 will be diverted from existing destinations thus, the extra throughput is nil Source: Company, Troika estimates
It is not in the charity business. Despite the brouhaha over Transnefts charitable contributions, it is in fact a much stingier corporate citizen than Gazprom. The nature of its business limits its customers largely to oil companies, not end customers, and makes it a less likely candidate for social giveaways. There is no danger, for instance, of the equivalent to Gazproms $13 bln Sakhalin Khabarovsk Vladivostok gasification project. If the existing route is not profitable (like ESPO currently), Transneft gets subsidized by higher tariffs across the entire network. It is not expected to donate anything to its customers.
24
2020E
2010
2011
TROIKA DIALOG
JANUARY 2012
Transneft's charities through November 2011: total $223 mln

Veterans, 0% Direct donations to municipalities, 1% Religion, 6% Sports, 7% Orphans and children, 2%
Most of the contributions in 2011 went to a The disabled and particular cultural NGO in others, 0% St Petersburg, just as in previous years they went to such causes as the Presidential Bodyguards' Pension Fund. However, the total sum of $223 mln is less than 2% of Gazprom's spending on the social project Sakhalin Culture and arts, Khabarovsk Vladivostok.
84%
Source: Company
The bottom line is that we do not foresee any major projects beyond Zapolyarye Purpe, and believe that the threat of never ending construction is unlikely. 4) ACQUISITIONS? Management spending available cash on acquisitions is the bane of equity investors the world over. In Transnefts case, such fears should be tempered by the fact that there is not much to buy in terms of pipelines (Transneft is a near monopolist). The company has been unwilling to spend the $2.5 bln that Rosneft is asking for the Vankor Purpe pipeline, which it constructed independently. Transneft completed what appears to have been a cash neutral deal for the merger of the Primorsk and Novorossiisk ports, and there are no other major oil ports available in the country. The one danger is that Transneft would be forced to buy the Ust Luga terminal, but we believe that would happen only if the terminal fails commercially. Even in that case, the price tag is unlikely to be over $500 mln. Another potential threat is that the company may be pressed by the government to buy the stretches of the Druzhba pipeline that pass through Belarus and Ukraine. This would be rather unnecessary, because with plenty of alternative export capacity, there is no danger that Russian oil, unlike its gas, would ever be stranded should the neighbors decide to close the pipeline. Anyway, unlike with Gazprom which has been pressing to take control of the Belarusian and Ukrainian pipelines for years now Transneft has never publicly raised this issue.
Exports of crude oil through Russia, 2011
Tuapse, 2% China (ESPO), 7% Kozmino, 7% Druzhba South, 8% Other, 0% Primorsk,
33%
Novorossiisk,
21%
Druzhba North,
22%
Transneft controlled or had a stake in export outlets that processed 98% of the oil pumped from and through Russia in 2011. Therefore, further acquisitions of port infrastructure appear unlikely to us.
Source: CDU TEK
3) LOWER TARIFFS? First, a word on the tariffs themselves. We believe that the recent discussion about moving from a cost plus system of setting tariffs to a regulatory asset base (RAB) somewhat misses the point. First of all, RAB is designed to provide incentives for the operator to invest in new infrastructure
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JANUARY 2012
something that Transneft is already doing and will have largely finished by 2015 16. Second, assuming it is administered in a predictable way, RAB makes it easier for the company to attract debt financing again, the opposite of Transnefts plans. Third, our rough estimates suggest that tariff inflation under RAB would be very close to the tariff inflation under the cost plus system, making the debate irrelevant. Fourth, there are much easier ways to make tariffs more transparent (including within the cost plus framework) than instituting an entirely new and complicated regulatory system. Fifth, we find it unlikely that RAB would be introduced until the significant problems with RAB administration for the transmission and distribution power utilities (which switched to the system in 2009) are ironed out. Finally, the experience with RAB in the power utilities sector suggests that the myriad variables applied by the regulator especially the infamous revenue smoothing means that the tariffs can effectively be set at whatever rate the regulator or other interested parties want, which is not much different from the current system for pipeline tariffs and makes the entire exercise beside the point. Over the past decade, the Federal Tariff Service has increased Transnefts average tariff at a CAGR of 15%. To look at it another way, over the past decade, Transnefts tariff has gone up roughly in line with the near record run up in the oil price (but unlike for the oil companies, its taxes are not geared to strip it of most of the windfall profit). Transnefts average tariff is now higher than comparable rates in the US, adding another bob to the already burdensome government imposed tax and tariff burden on the oil companies.
Transportation tariffs (2002 = 1.0)
5.0 4.0 3.0 2.0 1.0
2002 2003 2004 2005 2006
Comparison of long haul tariffs, $/100 tonne km
Transneft avg
1.33
Transneft's tariffs are as good as Black Gold and more stable, too.
2012E 2007 2008 2009 2010 2011
US long distance (Neche, SD Griffith, IN)
0.85
Oil price inflation

Source: Troika
Tariff inflation
0.00
Source: Transneft, Enbridge
0.50
1.00
1.50
That is why we think that ultimately, the frenzied pace of tariff growth of the past few years will slow down considerably. In fact, we assume in our projections that it will come to a full stop in 2014. However, faced with several options as to how to allocate cash flow starting in 2015, we think it unlikely that the government would actually reduce tariffs, as that would be tantamount to transferring that cash to the oil companies something that would be opposed by both the management of Transneft and the Finance Ministry, the keeper of the government budget. 2) DIVIDENDS? Easy there. We will discuss later why, despite dividends being one of the least attractive options for distributing cash both from the standpoint of Transnefts management and the government, there is a good chance that payouts will be hiked, and perhaps sooner than our projected total debt repayment in 2015. For now, suffice it to say that for Transnefts management, a significant increase in dividends would mean giving up control over the free cash flows, while for the government, it would mean foregoing some 22% of the cash that it could reap from the company one way or another (proportionate to minority shareholders current stake in the company). Transnefts charter calls for a minimum 10% payout on the preferred shares. The company has been roundly criticized by minority investors for shifting its profit center since 2004 away from the
26 TROIKA DIALOG
JANUARY 2012
parent company level. This has allowed it to reduce its dividend payments to minority shareholders to less than 1% of IFRS consolidated net income. The company has proceeded with the practice despite the famous 2006 government decree instructing state controlled companies to use consolidated accounts when setting the dividend payment. We believe minority shareholders should define what it is exactly that they do not like about the current dividend policy. If they had expected the company to pay out dividends even as it spends some $5 7 bln per year on capex intensive projects, runs negative cash flow and borrows money, they were probably being unreasonable. However, we would agree that the manner in which the company went about decreasing the payments left a lot to be desired. True, it could not have simply changed the 10% payout clause in its charter, as it could not have relied on preferred shareholders voting against their own short term interests. But we think the management should have leveled with the investor community, explaining why as much cash as possible had to be ring fenced from payouts during the construction of projects. Instead, it largely ignored commenting on the issue, leaving the debate solely to its critics. When Vedomosti asked the current CEO Nikolai Tokarev back in 2008 why the dividend payments were based on unconsolidated results, he neglected to plead the financing difficulties altogether. Instead, he went into a jeremiad about three mysterious core shareholders who he said control almost the entire free float, punctuating his answer with the now infamous remark that I absolutely dont care at what price the shares trade. We will discuss later why we think Tokarev may change his mind in the future. 1) A SPECIAL TAX: THE PERFECT CRIME The way things stand now, we think the government would be incentivized to milk the windfall cash flow by imposing a special tax. To us, this remains a highly likely outcome. The motive: this way it can extract as big a portion of the cash flow as it wants without having to share a fifth of it with minority shareholders. The means: a tax could be imposed on the entire industry, and as a near monopoly, Transneft would be isolated as the true target (oil shipped via non Transneft pipelines in Russia could be excluded by an exemption which, say, waived the new tax on oil companies that piped their own crude). We have a precedent for a company specific tax: the export duty on gas , which affects only Gazprom by dint of its position as an export monopolist. Starting this year, Gazprom also has to pay a higher MET than other gas producers. Special taxes on a monopolist are easy to apply because they are legally imposed on the entire sector, and are hard to challenge in court for that very same reason. The opportunity: it will present itself as soon as the cash starts flowing and Transneft is transformed from a budding dependent teenager into a voluptuous, long limbed cash machine. The axe will be swung in a dark, lonely passageway somewhere between Purpe, Kozmino and Ust Luga, probably during the last legislative session of the year, with no one but wolves and minority shareholders for witnesses. Such an outcome would imply that Transneft is a value trap. Its fair value in this case would roughly be equivalent to the discounted value of its current dividend, or about $170 per share one tenth the level where it is trading now. And that, indeed, would have been our final verdict had we not received a curious invitation from the company one fine morning in November to meet with the CFO.
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JANUARY 2012
A shotgun wedding
Doolittle: But what I might be open to is an arrangement. All I ask is my rights as a father. And youre the last man alive to expect me to let her go for nothing. Well, whats a five pound note to you? And whats Eliza to me? Pickering: I think you ought to know, Doolittle, that Mr Higginss intentions are entirely honorable. Doolittle: Course they are, Guvnr. If I thought they wasnt, Id ask fifty. George Bernard Shaw, Pygmalion Why is it that after almost a decade of ignoring and indeed despising the groom, the bride has now begun flirting, albeit still rather tentatively? We think it is because her father has told her to, upon realizing that he might need the grooms money. With the governments budget now balancing at above $115/bbl oil, the state has begun seriously considering accelerating the privatization drive. Last year, Transnefts shares were included in the preliminary list of assets slated for sell off in 2012. Early this year, Deputy Prime Minister Igor Sechin poured some cold water on this, saying that a sale would be more propitious if done in 2013 something we agree with, as the state is likelier to get a better price after the capex peak passed this year. After all, one should not expect the state to let her go for nothing. While the wording of the original long list says that the governments stake in the share capital should not fall below 75% and therefore implies a sale of only about 3%, we believe that neither the wording, nor an IPO of 3% of shares, would make any sense. The whole point of the 75% rule is to prevent non state entities from clinching a blocking vote (25% under the Russian law). The state owns 100% of the voting shares right now, which means that it could sell up to 25% without falling foul of its own strategy. We believe that either the sale of up to 25% of voting shares (equivalent to about 19.5% of the share capital), or no sale at all, is more likely than a neither here nor there placement of just 3%. The latter scenario would suit neither the state (for whom revenues would be about $2 bln at best), nor the shareholders, nor Transnefts own management, which would find itself dealing with a small, pesky coterie of institutional investors holding voting stock and demanding access to board decisions. Transnefts preferred stock currently trades at a P/E of only about 2.0. The peers average is well over 20.0 (peers also trade at about ten times Transnefts EV/EBITDA multiple). The reason they are so high is because pipeline utilities are as steady a business as one can find nowadays. The risk of the oil price is borne entirely by the customers, the maintenance capex tends to be fairly low, and the partnership structure of many pipelines in the West encourages the distribution of essentially the entire profit to shareholders in the form of dividends. Except for the last one, these qualities also characterize Transneft. We believe that the government could fetch at least 10 times the proportionate net income for its stake in the company half the valuation of the Western peers if it promises the participating investors two things:
A predictable tariff policy this would most certainly not imply a switch to RAB, which has, if anything, introduced unpredictability into the setting of tariffs at power utilities. We believe investors would be happy enough were the tariffs tagged at current levels and then raised in line with inflation. A commitment to high and predictable dividends which, after the project capex is over, would necessitate that most of the free cash flow is distributed to shareholders. The state might also have to rein in Transnefts potential desire to repay its debt completely over 2013 15, as shareholders might not be willing to wait around while Transneft goes through the financially
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dubious exercise of repaying its low interest Chinese loan before they receive their share of the juicy operating profitability, which is running at a 50% margin. And that is why the markets are whipped into a frenzy by any hint on the privatization front. It is because to raise up to $15 bln from them now, the government would have to promise a generous distribution down the line. Privatization is the only incentive the government might have to treat minority shareholders fairly. And if the current preferred share investor base is among the same one the government would want to attract in an IPO offering, then the state would be unlikely to offend them. Besides, placing the voting stock at double digit multiples will be difficult unless the preferred shares are traded somewhere close to those valuations.
The father's dilemma
2012E EBITDA Profit tax Debt repayment (assume as scheduled) Capex Utilities in the West are trading Distributable FCF at an average of P/E of 20.0 Net income 10x '13 P/E placement of a 25% voting stake Finance Ministry revenues fully taxing the FCF Finance Ministry revenues placement, then share of FCF/dividends NPV to Finance Ministry assuming all FCF is taxed away NPV to Finance Ministry assuming placement, then its share of dividends Government stake before placement Government stake after placement Growth rate Discount rate
2013E 13,838 (2,077) (600) (5,559) 5,601 7,656 5,601 3,281
2014E 13,429 (1,939) (1,700) (5,525) 4,265 7,294 4,265 2,499
2015E 13,025 (1,803) (1,600) (4,999) 4,623 6,946 4,623 2,708
2016E 13,024 (1,752) (1,600) (4,120) 5,552 6,905 5,552 3,252
2017E 12,544 (1,614) (1,600) (3,588) 5,741 6,487 5,741 3,363 47,820 41,603 78.1% 58.6% Maintenance level
11,195 (1,624) (1,410) (7,415) 746 5,868 14,949 746 15,386
0% 10%
For the Finance Ministry, an IPO would make sense as a great stop gap measure for the budget, and if the placement is done at a P/E of 10.0 or more would carry nearly the same long term value as if the cash flow were stripped entirely via taxes.
We are not saying that selling so much stock on the market is realistic: the government may have to settle for a smaller share issue and attract Sovereign funds or global companies to the placement. The point is that Transnefts recent interest in investors goodwill suggests that the government may indeed be preparing for a possible future placement. After 20 years of celibate hauteur, the bride may find herself given away whether she wants to be or not.
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JANUARY 2012
Condensate the Other Russian Oil

From the inferno to the land of milk and honey
We do not think that the potential of Russian gas condensate has been sufficiently explained, unlike Russian oil and gas. Most analysis has naturally concentrated on NOVATEK's condensate flows and profits, given that nearly half of its EBITDA comes from liquids. But even basic questions, such as the future production outlook for the country, the short term prospects for NOVATEK and Gazprom and the long term potential for TNK BP, are rarely explored. To whet the appetite for the subject, we can serve three points for starters. First, unlike crude production, which should not meaningfully change in the foreseeable future, or natural gas extraction, whose expansion is subject to many moving variables, condensate output may double between 2010 and 2020, hitting over 700 kbpd by that year. We also call it early condensate, as over half of the total volume additions by the end of the decade should be front end loaded in the next four to five years. Second, output of wet gas (or gas with a condensate component) in Yamalo Nenetsk Region the heart of Russian gas production may reach the levels of dry Cenomanian gas (currently about 20%) within 10 years due to rise of the former and decline of the latter. Finally, the condensate dollar pie, i.e. EBITDA generated from it by all players, could amount to $13 bln a figure comparable with the current financials of TNK BP, Russias third largest oil company. We also suggest that the wet gas must have regulatory priority, as it brings many more cash dollars to the producers and tax dollars to the petro state budget relative to dry gas on a per unit basis due to the monetizable liquids component.
Wet gas brings more tax dollars than dry gas per unit of production, $/mcm
50.0 40.0 30.0 20.0 10.0
8.4 17.0 8.4
Wet gas brings more tax dollars than oil per unit of production, $/tonne
500
19
Wet gas brings nearly six times more tax dollars than dry gas for every mcm of gas produced. Should it not, then, have some regulatory priority?
1.9
400 300
35.9
119
84
180
200 100 0 Crude Oil MET

Condensate export duty Condensate MET
145
Wet gas brings more tax dollars than oil per every tonne of liquids produced.
359
0.0 Dry gas (independents) Gas MET Dry gas (Gazprom) Wet gas*
Wet gas* Oil export duty Condensate export duty Condensate MET
Oil products export duty Gas MET
* Under $100/bbl oil price, 66 60 system, condensate exports and condensate/gas content in production of 10% Source: Troika
* Under $100/bbl oil price, 66 60 system, 50% of crude is exported, 50% is refined and exported, condensate/gas content in production of 10% Source: Troika
In all, potential growth is phenomenal, the prize is substantial, taxation is accommodating, and both Gazprom and the independents have a chance to turn condensate into cash. Condensate is what bumps up a gas field from the mezzanine floor to a luxury penthouse, doubling or tripling domestic gas EBITDA depending on liquids content in production and the ability to monetize it. Hence, this report may at least start demystifying issues surrounding the very much under researched segment of this unconventional Russian oil. The topic itself is massive, colliding with crude, natural gas and petrochemicals simultaneously, and our purpose here is only to touch on the main issues.
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Bankable resource base : ABC1+C2 condensate reserves, mln tonnes

Gazprom* NOVATEK** SeverEnergia TNK BP (Rospan)***
* ABC1 reserves ** liquids reserves *** C1+C2 reserves Source: Companies
1,285 450 154 135
Gas condensates (valuable feedstock for motor fuels and petrochemicals) are very light hydrocarbon liquids often produced alongside natural gas. They are gas in reservoir, but condense to become liquids at surface temperatures and pressures. Such condensate bearing gas, or wet gas (Valanginian layers), lies 1,700 3,200 m beneath the surface (up to 4,500 m for Achimov layers) as opposed to dry gas (Cenomanian) layers located at depths of 1,100 1,700 m. After this cocktail emerges from the ground, the gas needs to be separated from the liquids, a process that is usually carried out at the field. Unstable condensates may be stabilized at the field's condensate splitters or through storage under atmospheric pressure and high temperatures in order to remove and capture light fractions. Or they can be shipped via condensate pipelines to processing plants for stabilization. After stabilization, gas condensate (along with other natural gas liquids, or NGLs) becomes marketable or alternatively can be fractionated further into petroleum products such as naphtha, diesel and jet fuel, and then transported to the end consumer.
Gas condensate marketing chain
Source: Troika
The first issue to explore is how much condensate Russia has produced historically and where output is heading. In 2010, Russia extracted 17.6 mln tonnes of raw product (excluding PSA projects), which accounted for almost 4% of the countrys total liquids output (oil and condensate). Gazprom and NOVATEK combined contributed about 87% of this figure if we strip out the Sakhalin 1 and Sakhalin 2 PSAs.
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Russia's crude vs condensate production split*

4%
Russia condensate producers split*

12%
10%
Gazprom Condensate Crude

18% 60%
NOVATEK PSA** All other
96%
* 9m11 Source: CDU TEK, Troika * 9m11 ** production sharing agreement, Sakhalin 1 and Sakhalin 2 projects Source: CDU TEK, Troika
This alone probably turns off the interest in gas condensate developments: NOVATEKs monetization is supposed to be understood by the market, Gazproms figures are difficult to disentangle from the grand scheme of the companys large natural gas and oil production, and everyone else is too marginal to bother. The high contribution of Gazprom and NOVATEK also pretty much explains why other companies have generally failed to properly monetize condensate in the past, no other company has had the production scale to build processing facilities and marketing networks, as none has produced more than 0.5 0.6 mln tonnes of unstable condensate per year. And yet things may start to become much more interesting with more players involved, while the trends at the current condensate champions are not that obvious either at first glance.
Russia unstable gas condensate production, mln tonnes
2000 Gazprom Gazprom Dobycha Astrakhan Gazprom Dobycha Orenburg Gazprom Dobycha Urengoi Gazprom Dobycha Yamburg Nortgas Severgazprom Gazprom, all other NOVATEK Tarkosaleneftegaz and Khancheyneftegaz Yurkharovneftegaz NOVATEK, all other in Yamalo Nenetsk Region Rosneft TNK BP Rospan Severneft PSA Sakhalin 1 Sakhalin 2 All other companies Russia total Russia, excluding PSA Share of condensate in Russia liquids production
2001 9.8 3.7 0.4 3.6 1.3 0.4 0.5 0.3 0.2 0.1 0.1 0.1 0.3 0.4 11.1 11.1 3.2%
2002 10.9 3.8 0.3 3.5 1.5 0.9 0.4 0.5 0.6 0.5 0.1 0.1 0.1 0.3 0.6 12.6 12.6 3.3%
2003 11.1 4.0 0.3 3.7 1.5 0.8 0.3 0.4 1.0 0.8 0.2 0.4 0.1 0.4 0.8 13.7 13.7 3.3%
2004 11.9 4.0 0.3 4.5 1.6 0.7 0.3 0.6 1.9 1.1 0.7 0.1 0.9 0.2 0.6 1.0 16.5 16.5 3.6%
2005 12.1 4.2 0.3 4.7 1.6 0.6 0.2 0.5 2.2 1.3 0.8 0.0 1.6 0.2 0.5 0.0 0.0 1.0 17.7 17.7 3.8%
2006 12.1 4.2 0.3 4.6 1.6 0.7 0.2 0.5 2.3 1.6 0.7 0.1 1.8 0.3 0.7 0.1 0.1 1.0 18.4 18.4 3.8%
2007 11.9 4.2 0.3 4.6 1.5 0.6 0.2 0.5 2.4 1.6 0.7 0.1 1.3 0.3 0.4 0.6 0.6 0.7 17.6 17.0 3.6%
2008 11.5 4.2 0.3 4.4 1.4 0.5 0.2 0.5 2.6 1.6 0.9 0.1 0.7 0.5 0.6 0.1 0.8 0.8 0.4 17.1 16.3 3.5%
2009 10.5 3.3 0.2 4.5 1.4 0.4 0.2 0.4 3.0 1.5 1.5 0.0 0.6 0.5 0.6 0.1 1.6 0.8 0.9 0.5 17.5 15.9 3.5%
2010 11.7 4.1 0.2 4.8 1.5 0.4 0.2 0.5 3.6 1.5 2.1 0.0 0.5 0.6 0.6 0.1 2.2 0.7 1.5 0.5 19.8 17.6 3.9%
9.5 3.4 0.4 3.5 1.5 0.4 0.3 0.1 0.0 0.0 0.1 0.1 0.3 0.3 10.4 10.4 3.2%
From current to future champions

Forecasting condensate production is tricky, as one needs to take a view on two things:
The wet gas production potential of a particular field, or model everything bottom up. How the condensate content in wet gas is changing over time.
After modeling all credible projects known to us and properties owned by Gazprom, NOVATEK, SeverEnergia and TNK BP, our best estimate calls for unstable gas condensate production in Russia to
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expand from slightly under 18 mln tonnes in 2010 to 28 mln tonnes in 2015 and further to 35 mln tonnes in 2020. If any one still doubts the growth outlook, follow the money trail: Gazprom and NOVATEK combined have firm commitments to increase condensate processing capacity at the Purovsky, Urengoi and Surgut processing plants by 10 mln tonnes to 24 mln tonnes to accommodate rising volumes from SeverEnergia and Achimov layers of Urengoi fields. This expansion is incredibly cheap; for example, NOVATEK plans to spend no more than $400 mln to add 6 mln tonnes of processing capacity, or about $70/tonne. While overall crude output is likely to become stagnant and gas production growth prospects (for Gazprom at least) remain highly uncertain, condensate production growth should be very robust with an 8.5% compounded rate until 2015.
Russian unstable gas condensate production estimate, mln tonnes
40.0 35.0 30.0 25.0 20.0 15.0 Gazprom 10.0 2008 2009 2010 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E Production was 19 mln tonnes in 2011... and could rise to 28 mln tonnes in 2015... and top 35 mln tonnes in 2020, doubling 2010's level. All other TNK BP SeverEnergia NOVATEK
Moreover, some analysts are calling for wet gas production in Yamalo Nenetsk Region to reach a par with dry gas (which currently dominates the nations output) within 10 years due to the decline of the latter and rising prospects of the former.
Changing structure of Russian gas production in Yamalo Nenetsk Region
100% 80%
64% 52%
60% 40% 20%
78%
36% 22%
48%
0% 2012E 2015E Wet gas

Source: NOVATEK
2020E
Dry gas
We are more constructive on condensate prospects than the government (which devised its latest forecasts back in 2008), likely due to more certainty now with respect to SeverEnergias wet gas production. We are also more optimistic than NOVATEK on production estimates for Yamalo Nenetsk Region, probably due to differences in opinion over the prospects for some other independents, such as TNK BP and LUKoil.
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Unstable gas condensate production estimates in Western Siberia and European Russia, mln tonnes*
40 30
28 35
Production estimates of condensate in Yamalo Nenetsk Region, mln tonnes

40 30
29
31 22 23
30 25
29
20 10 0
24 21 20
23
20 10 0
14 11 15 18 14 16
25 22 19 20
27
2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E

2012E 2015E Government Troika
Source: NOVATEK, Troika estimates
2020E
Troika
NOVATEK
* excludes onshore Yamal Source: General Scheme of Russian Gas Industry Development, Troika estimates
Our analysis suggests that several important future trends may start unraveling. First, the largest volume additions are expected to come from two players SeverEnergia and Gazprom but not NOVATEK itself. In fact, we believe that SeverEnergias condensate output will overtake NOVATEKs consolidated production as early as 2014 15. This is despite the fact that SeverEnergias natural gas production peak is expected to stay well below NOVATEKs (even below Yurkharovneftegaz). There is no black magic involved here; it is due to the ratio of condensate in the gas reserves at SeverEnergia fields being much higher than at NOVATEKs a concept we will explore below. As a side note, we advise paying particular attention to SeverEnergia. If NOVATEK is right in forecasting 8 mln tonnes of crude plus condensate output from SeverEnergia by 2015 (we are somewhat skeptical on the timing, as a proper crude transportation solution is missing), then there is no other single brownfield or greenfield project in Russia we know of (outside of Rosnefts Vankor expansion) that will bring more additional liquids from the ground in the next five years.
SeverEnergia estimated condensate production, mln tonnes
7.0 6.0
Yaro Yakhinskoye
SeverEnergia is poised to produce more condensate than NOVATEK.
5.0 4.0 3.0 2.0 1.0 0.0 2012E

North Yesetinskoye and East Urengoiskoye Samburgskoye Urengoiskoye
2014E
2016E
2018E
2020E
2022
2024
2026
2028
2030
By 2020, we believe that Gazprom and SeverEnergia will account for over three quarters of volume additions in Russia, while NOVATEKs own consolidated condensate production should stay at 4 5 mln tonnes (excluding Gydan fields).
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Estimated condensate volume addition, 2011 15

6% 16% 15%
Estimated condensate volume addition, 2011 20

3%
Gazprom SeverEnergia NOVATEK TNK BP

1% 19% 39%
Gazprom SeverEnergia NOVATEK TNK BP All other Over three quarters of the growth should be driven by Gazprom and SeverEnergia.
8%
All other
55%
Over half of the medium term growth should be driven by SeverEnergia.
38%
The second trend is that independents condensate output should be roughly on par with Gazproms in about four years from now, despite the fact that their natural gas output (commercial production that goes to the UGSS) is unlikely to account for more than 20% of national production. This simply underscores the concentration of independents on very cheap gas in Western Siberia with a value kicker liquids component, which we have explored elsewhere (See our July report, Russian Oil and Gas This Place Aint Big Enough for the Both of Us).
Split in condensate production between Gazprom and independents
100% 80% 60% 40% 20% 0% 2008 2011E Gazprom
30%
34% 50%
46%
70%
66% 50%
By 2015, production of unstable gas condensate by independents could be on par with Gazprom.
54%
2015E Independents
2020E
The third trend highlights Gazproms potential as well. Despite a highly uncertain (for us at least) natural gas production outlook at the gas giant, we see a strong upward trend in the companys condensate output.
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Gazprom estimated condensate production, mln tonnes

25.0 20.0 15.0 10.0 5.0 0.0 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E
18.9 11.7
The 54% growth in 2020 versus 2010 output comes on the back of the Valanginian layers of Zapolyarnoye field and Achimov layers of Urengoiskoye field and Nortgas.
Gazprom Dobycha Astrakhan Gazprom Doybcha Yamburg

Source: CDU TEK, Gazprom, Troika estimates
Gazprom Dobycha Urengoy (legacy) Nortgas
Gazprom Dobycha Urengoy (Achimgas) Gazprom all other
Gazproms 62% growth in 2020 from the 2010 output level will come on the back of Valanginian layers from the giant Zapolyarnoye field (where the impact is already being seen), Achimov layers at the Urengoi field, and Nortgas (assuming the latter stays with Gazprom).
Gazprom's estimated growth in condensate production, mln tonnes
25.0 20.0 15.0 10.0 5.0 0.0 2010 production Valanginian layers (Zapolyarnoye) Achimov layers (Urengoy) Nortgas Decline in legacy 2020E production Key short term driver. JV with German Winters hall is a key long term driver.
Zapolyarnoye is the key short term driver for Gazproms condensate output. The gas reserves base of Valanginian layers at Gazproms Zapolyarnoye field alone is comparable with NOVATEKs Yurkharovskoye field, while condensate reserves are more than double those at the independents largest field. Hence, it is actually puzzling for us to see Gazproms rather modest ambitions over the prospects for the field, where it targets natural gas output from wet layers to be less than half of Yurkharovskoyes at the peak, while condensate production is on par. One would think that gas production from wet layers based on the reserves base should be at least 30 bcm, or double Gazproms ambitions. The additional 15 bcm would have been comparable with Russias annual deliveries to Italy, for example. Such a trivial example again emphasizes Gazproms hidden potential at its very cheap brownfield, if only the company were willing to unlock it instead of going on a largely value destroying greenfield spending spree.
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2020E
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
JANUARY 2012
Modest ambitions: Gazprom's Zapolyarnoye (wet gas) vs NOVATEK's Yurkharovskoye

Liquids reserves, mln tonnes (ABC1+C2)
100 80 60 40 20 0 680
NOVATEK Yurkharovskoye Gazprom's Zapolyarnoye (wet gas)
Modest ambitions: Gazprom's Zapolyarnoye (wet gas) vs NOVATEK's Yurkharovskoye

4
Gazprom's Zapolyarnoye (wet gas) NOVATEK Yurkharovskoye
Peak liquid production, mln tonnes
3 2 1 0 0 5
If Gazprom's gas reserves from Zapolyarnoye wet gas are on par with NOVATEK's Yurkharovskoye, and condensate is double the gas independent's key field... 720 740 760
how can its peak production of gas be half of Yurkharovskoye field and condensate output be on par? This example shows the hidden potential of Gazprom's brownfield asset base that can be developed very cheaply. 10 15 20 25 30 35 40
700
Gas reserves, bcm (ABC1+C2)

Source: Companies, Troika Source: Companies, Troika
Peak gas production, bcm
Finally, growth of NOVATEKs condensate output, which accounted for nearly 90% of the countrys entire condensate production rise (excluding PSAs) since 2008, is expected to moderate already this year. We cannot reasonably see the companys condensate production expanding by more than 4 5% (without the SeverEnergia stake). Moreover, depending on the rate of decline in liquids production at Tarkosale and Khancheyneftegaz, we would not exclude flattish production growth in 2012. It is true that we can see NOVATEKs condensate output approaching or reaching about 4.5 mln tonnes toward mid decade even without South Tambey (Yamal LNG), SeverEnergia and the Gydan fields, as falling legacy production at Tarkosale and Khanchey should be offset by North Russkoye, Sterkhovoye, North Khancheyskoye and some smaller properties. But we do not expect to see more unless reserves at the Yamalo Nenetsk fields are revised upward meaningfully. Figuring out NOVATEKs condensate (not liquids, which include crude) production from legacy fields is actually a fairly simple task that requires piecing together two variables. First, the company intends to raise Purovsky processing plant capacity from 5 mln tonnes to 11 mln tonnes by 2014. Second is the plateau production of unstable condensate from SeverEnergia of 6.5 mln tonnes (100% of the output) that will be processed at the same Purovsky plant. Hence, the difference is NOVATEKs legacy (excluding Gydan fields) condensate peak production of some 4.5 5.0 mln tonnes.
NOVATEK estimated condensate production (excluding SeverEnergia, South Tambey and Gydan group of fields), mln tonnes
6.0 5.0 4.0 3.0 2.0 1.0 0.0 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E 2005 2006 2007 2008 2009 2010 We believe little growth should be expected in 2012 after rising 86% since 2005.
Tarkosaleneftegaz and Khancheyneftegaz

* Sterkhovoye, North Russkoye, South Urengoiskoye fields Source: Company, Troika estimates
Yurkharovneftegaz
NOVATEK, all other fields in Yamalo Nenetsk Region*
Luckily, NOVATEK has a 25.5% stake in SeverEnergia that will boost the companys overall condensate output. Given that about 70% of its guided 13.3 mln tonnes of liquids production is condensate toward the end of the decade and 1.4 1.5 mln tonnes will come from South Tambey (Yamal LNG), one can safely assume the output from legacy fields, new launches of smaller cheap wet gas fields in Yamalo Nenetsk, SeverEnergia and Gydan assets will stay under 8 mln tonnes.
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NOVATEK estimated condensate production (including SeverEnergia and Gydan group of fields), mln tonnes
8.0 6.0 4.0 2.0 0.0 2011E 2012E 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E
15.8%
2005
2006
2007
2008
2009
NOVATEK currently producing fields

2010
SeverEnergia
Gydan fields
From mezzanine to luxury penthouse

The slowdown in NOVATEKs legacy condensate output (excluding SeverEnergia and Gydan assets) is where the tonnes of output collide with dollars in profits, which brings us to the concept of the front loaded nature of condensate production, the timing of monetization and the falling condensate ratio in gas reserves over time.
Content of liquids in gas reserves of the largest current and future condensate producers*
16.0%
15.8% 14.2% 14.4% 14.6%
12.0%
11.9% 10.3%
8.0%
6.0% 4.8%
8.1%
8.7%
9.0%
4.0%
0.0% Urengoiskoye area (SeverEnergia) Novo Urengoiskoye, East Urengoiskoye (TNK BP's Rospan) Urengoiskoye Achimov layers (Gazprom) Severo Urengoiskoye (Gazprom's Nortgas) Zapolyarnoye Valanginian layers (Gazprom) Yurkharovskoye (NOVATEK) Khancheyskoye (NOVATEK) East Tarkosalinskoye (NOVATEK) Yaro Yakhinskoye (SeverEnergia) Samburgskoye (SeverEnergia) West Yurkharovskoye (NOVATEK) North Russkoye (NOVATEK)
*ABC1+C2 reserves Source: Companies
First, how large is the condensate value kicker now? Judging by the performance at various NOVATEK subsidiaries, its liquid side brings massive value. For example, at the small Khancheyneftegaz (which has the largest condensate content in output in NOVATEKs portfolio) total EBITDA per mcm produced stood at $105 in 9m11, nearly three times its gas only EBITDA and close to Gazproms profit from spot sales (of dry gas) to Europe, on our estimates.
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From mezzanine to penthouse: gas only vs gas plus liquids EBITDA, 9m11, $/mcm
200 160 120 80 40
37
Condensate increases NOVATEK's total EBITDA by 65 180%, depending on the subsidiary. The difference in EBITDA among subsidiaries is subject to condensate content in production.
62 68
105
The EBITDA per mcm of NOVATEK's Khancheyneftegaz nearly approached 127 Gazprom's non FSU dry gas EBITDA.
165
0 NOVATEK gas EBITDA Tarkosaleneftegaz gas and liquids EBITDA Yurkharovneftegaz gas and liquids EBITDA Khancheyneftegaz gas and liquids EBITDA Gazprom non FSU EBITDA on spot exports Gazprom non FSU EBITDA on oil linked exports
Hence, the higher the condensate content in gas, the larger the overall value of the field. The rule of thumb we derived is: if condensate content in gas production is 10% and you know how to monetize it properly, you double the dollar EBITDA; 20% content in output triples EBITDA at current prices. Therefore, SeverEnergia fields (initially yielding a 20 30% ratio of condensate in gas production), Gazproms Valanginian layers at Zapolyarnoye (20% ratio) and TNK BPs Rospan (over 25%) are the most valuable properties if their potential especially those of the latter two is fully unlocked.
Condensate/natural gas ratio, index: zero content=1.0 EBITDA
3.5 3.0 EBITDA index 2.5 2.0 1.5 1.0 0% 1% 2% 3% 4% 5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% Condensate/natural gas ratio
Note: The sensitivity is based on three standalone models of NOVATEK's Yurkharovskoye, East Tarkosalinskoye and Khancheyskoye fields. Source: Troika estimates
If the condensate content is 10% of gas output and the company knows what to do with it, the EBITDA doubles. A 20% condensate/gas ratio triples the EBITDA.
However, it is also true that such high condensate extraction relative to gas output is only expected to bring such windfall profits in the short term, diminishing the absolute dollar contribution of liquids over time.
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Contribution of condensate to EBITDA is falling over time*

75% 60% 45% 30% 15% 0% 2012E SeverEnergia 2015E 2020E 2025E 2030E
Yurkharovneftegaz
Tarkosaleneftegaz
* at flat commodity price assumptions Source: Troika estimates
The front loaded nature of condensate in output can be seen with the naked eye taking only a comparison of the content of condensate in gas reserves against the same content of condensate in gas production. For example, the ratio of condensate production in gas output at NOVATEKs Khancheyneftegaz was 21% in 2010, while the same ratio in reserves was only 8.1%. This is an extreme case, but the other producers are demonstrating precisely the same trend, whereby the bulk of condensate reserves is being extracted (monetized) in a relatively short period. Gazproms Valanginian layers at Zapolyarnoye, for example, are expected to yield 20% condensate in gas output at peak (3 mln tonnes per 15 bcm and 1.3 mln tonnes per 6.5 bcm this year), while the content in reserves stands at only 12%. The bottom line is that liquids value is being captured in the short term, but the sweet spot cannot be expected to last for very long.
Content of condensate in gas: reserves vs production
25.0% 20.0% 15.0%
14.2%
The content of condensate in gas output is much higher than the same content in reserves during the first few years of production, simply underscoring the front loaded nature of liquids monetization.
21.1% 21.5% 20%
10.0%
8.8% 8.6% 6.0% 4.8% 8.1% 9.0%
12.2%
12%
5.0% 0.0%
East Tarkosalinskoye Yurkharovskoye (NOVATEK) (NOVATEK)
Khancheyskoye (NOVATEK)
Severo Urengoiskoye (Gazprom's Nortgas)
Novo Zapolyarnoye Urengoiskoye, Valanginian layers East Urengoiskoye (Gazprom)* (TNK BP's Rospan)
Content of liquids in 2010 gas reserves

* estimated for 2012 Source: Companies, Troika
Content of liquids in 2010 gas production
Just as many oil fields are becoming gassy over time, wet gas fields are getting dryer with less condensate extracted per the same amount of gas over time. The recent peak, for example, when Khancheyneftegaz was producing well over 210 g of condensate for every cm of gas (21% ratio), was reached in 2010, while in 2011 the content fell to less than 180 g (18%). The larger Tarkosaleneftegaz is showing precisely the same pattern.
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Khancheyneftegaz and Tarkosaleneftegaz condensate/gas ratio in production

25% 20% 15% 10% 5% Sweet spot 10% 8% 6% 4% 2%
Khancheyneftegaz and Tarkosaleneftegaz ABC1+C2 reserves depletion

80% 60% 40% 20% 0%
2011E
2012E
2013E
2014E
2015E
2016E
2017E
2018E
2019E
2011E
2012E
2013E
2014E
2015E
2016E
2017E
2018E
2019E
2020E
2005
2006
2007
2008
2009
2010
KNG
TNG (rhs)
KNG
TNG
This does not mean that the companys gas side is getting significantly depleted and falling. On the contrary, both subsidiaries are experiencing very robust growth. It simply means that the marginal well at the fields is producing dry (and hence less profitable) gas and the opposite trend as seen in 2006 10. A case in point is 3Q11: gas production at Tarkosaleneftegaz nearly doubled y o y, while condensate dropped just over 3% y o y. Khancheyneftegaz gas also rose by 39% y o y, while condensate declined almost 13% y o y.
NOVATEK 3Q11: y o y growth in production of gas vs condensate
100%
97%
80% 60% 40%

39%
20% 0% 20% Tarkosalesneftegaz Khancheyneftegaz Condensate

27%
29%
3%
13%
Yurkharovneftegaz
Gas
While we have firm confidence that NOVATEKs gas production from Tarkosaleneftegaz will rise marginally in 2012 (simply against the low base of 1H11) and Khancheyneftegaz gas should remain flat at worst (though it is likely to grow a bit), condensate production at these subsidiaries should continue falling 1 5% y o y, we estimate. There is no free lunch in this world: just as liquids production was rising disproportionally to gas in previous years, it has already started falling disproportionally relative to gas production and will continue to do so going forward. Hence, it is only gas production growth from Yurkharovskoye driving condensate output and compensating for the decline at other fields.
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2010
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NOVATEK's Yurkharovneftegaz condensate production, mln tonnes

3.5 3.0 2.5 2.0 1.5 1.0 0.5 0.0 9.0% 8.5% 8.0% 7.5% 7.0% 6.5% 6.0% 5.5%
Despite a flat liquids/gas ratio, condensate production is poised to increase in 2012, and likely in 2013, on the back of higher wet gas production.
2011E
2012E
2013E
2014E
2015E
2016E
2017E
2018E
2019E
Condensate output, mln tonnes

Liquids/gas ratio in output (rhs)
From unconventional oil to the quest for conventional money

As the end game of it all is to make money, the final questions to explore are who is monetizing condensate, and how and where the opportunities lie. First, it is important to identify the total dollar pie of condensate. If NOVATEK, for example, generates about $370/tonne in EBITDA from its liquids business, the total value this year for the entire nation comes to over $7 bln on 19 mln tonnes of output. All else being equal (oil prices, costs and taxation), this EBITDA pie may grow to $13 bln in 2020 at our 35 mln tonne production estimate. For comparison, this is close to last years EBITDA of TNK BP Holding Russias third largest oil company. And for the size of the condensate pie itself, it does not really matter whether some oil and gas companies are monetizing the product fully, partially or not at all. If some company is selling stable condensate, liquefied petroleum gasses, or oil products resulting from condensate processing at below the market price, this does not diminish the size of the pie but rather transfers the value from producer to an intermediary (such as resellers of the product, petrochemical companies, and so on) or the end consumer. The tools for turning condensate into cash are well known: it is the high price of the stable condensate bumping against low MET. First, the condensate MET this year is flat at R556/tonne and translates into just about one eighth of the oil MET in 2012 at, say, $100/bbl oil. And second, judging from NOVATEKs experience, the condensate price is around $100 140/tonne higher than Urals, while the export duty is paid as if the discounted Urals crude were being exported.
Excess of oil MET over gas condensate MET at $100/bbl oil price, times
8.0 7.8 7.6 7.4 7.2 40 7.0 6.8 2012E
NOVATEK recent gas condensate premium to Brent, $/tonne

160
149 124
2020E
2005
2006
2007
2008
2009
2010
7.8
147 7.8
120 80
99 99 102
124
7.1
0 2013E 2014E 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11
Taking a higher commodity price and lower MET together results in a net price of condensate after all taxes and transportation costs being more than double the crude exports option.
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Gas condensate price after transportation costs and taxes, $/tonne, 9m11 average
1,200 1,000 800 600 400 200 0 Condensate price
Crude price after transportation costs and taxes, $/tonne, 9m11

900 750 600 450
798
954 415
300 150 0
188
Export duty
MET
Transportation cost
Net price
Crude export price

Export duty
MET
Transportation cost
Net price
Condensate exports are twice as profitable as crude oil exports
This is in a nutshell how NOVATEK is profiting from its liquids, using the infrastructure and marketing value chain that it pioneered in Russia and which contributes to nearly half of the companys EBITDA.
NOVATEK estimated 9m11 EBITDA split
Liquids,
44%
Gas,
56%
Wholesale,
48%
End customer,
52%
Condensate at SeverEnergia, which is poised to become Russias second largest producer of the product after Gazprom, should be monetized by NOVATEK to a significantly larger extent than its project partners, as the company will purchase the product at the Brent netback price plus some very small mark up and sell it at the existing $100 120/tonne premium to crude. Therefore, while the ownership of Russias gas independent in SeverEnergia stands at 25.5%, its share in condensate and NAV accounts for about a third due to higher value generated from condensate relative to its partners.
SeverEnergia ownership vs condensate EBITDA vs NAV split
100% 80% 60% 40% 20% 0% Ownership split Condensate EBITDA split NAV split (total: $12 bln)
Enel, 20% Eni, 29% Gazprom Neft, 26% NOVATEK, 26% Enel, 17% Eni, 26% Gazprom Neft, 22% NOVATEK, 35% Enel, 18% Eni, 26% Gazprom Neft, 23% NOVATEK, 33%
TNK BP is monetizing only with limited success at present, though the management is too smart not to realize it. Once Rospan reaches production scale, it is reasonable to assume that the company will
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build or rent processing facilities instead of selling the product at the crude price. But even selling condensate at domestic oil prices over the life of the project would contribute 50% of Rospans EBITDA, on our estimates. We estimate the projects NAV at over $5 bln, which is double the similarly sized Kharampurskoye (Rosneft) with the difference in NAV stemming purely from the liquids side of the TNK BP project, which Rosneft does not have in its reserves.
TNK BP's Rospan vs Rosneft's Kharampurskoye
5.5 5.0
Rospan
NAV, $ bln
4.5 4.0 3.5 3.0 2.5 2.0
Kharampurskoye's gas output is 25% more than Rospan's, but half of Rospan's NAV. The difference in NAV is condensate that Kharampurskoye does not have.
Kharampurskoye
12
14
16
18
20
22
Peak production, bcm per year

Understanding how Gazprom is cashing in on condensate is tricky because of very sketchy disclosure. First, Gazproms marketing chain is completely different from NOVATEKs. The independent sells most condensate abroad; Gazprom fractionates condensate further into oil products and then sells them domestically. For example, NOVATEKs stable condensate sales constitute over two thirds of the liquids production, versus only one third at Gazprom, with the rest being LPG and oil products. Gazproms condensate exports are miniscule (0.3 mln tonnes, we estimate) and delivered via the Transneft network.
NOVATEK 2010 liquids sales (produced from condensate) Gazprom estimated 2010 liquids sales (produced from condensate)
7%
Stable gas condensate* LPG Oil products**

27% 69%
40%
Stable gas condensate* LPG Oil products**
24%
Over two thirds of NOVATEK sales is stable condensate, while it only composes a third of Gazprom's, as it concentrates more on the further processing of condensate into oil products instead.
* includes transits * includes losses Source: NOVATEK, Troika * includes transits ** includes losses Source: Gazprom, Troika
33%
With lots of additions and subtractions, we arrive at a realized stable condensate price of about $246/tonne for Gazprom in 2010. While this is way below NOVATEKs $416/tonne after export duty, the price is very close to what NOVATEK is showing from its tiny sales at home ($248/tonne). As for light products fractionated from condensate, we arrive at over $700/tonne for 2010, which was around the price of wholesale high octane gasoline at the time. The point is that Gazprom seems to be getting bang for its buck on condensate as well. In all, we estimate that Gazprom was generating $4.7 bln in revenues after export duty from selling condensate and resultant products against NOVATEKs $1.5 bln back in 2010.
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Realized price of condensate in 2010, $/tonne

500 400 300 200 100 0 NOVATEK export price of condensate
Source: Companies, Troika estimates
Realized price of Gazprom's oil products from condensate in 2010, $/tonne

800 750 700
765
416
While Gazprom's realized price of stable condensate is way below NOVATEK's export net price, it is rather close to what the independent is realizing domestically.
248
246
650 600 550
Light products fractionated from condensate appear to get fully monetized by Gazprom.
762
NOVATEK domestic liquids price
Gazprom estimated realized price of condensate
500 Rosneft realized high octane gasoline price in Russia

Gazprom estimated realized price of oil products from condensate
Interestingly enough, NOVATEK is striving to utilize Gazproms marketing scheme with the Ust Luga processing facility. The plant is a greenfield fractionation facility with ultimate nameplate capacity of 6 mln tonnes, which should become operational at end 2012. Located on the Baltic Sea coast near St Petersburg, it aims to further process the companys stable gas condensate, currently lifted at its key producing units, into refined products such as naphtha, jet kerosene, diesel and heating oil with a light product yield of some 96 97%.
Ust Luga estimated product slate
4% 13%
39% 10%
Light naphtha Heavy naphtha Diesel Jet kerosene Heating oil
34%
We wrote in detail about Ust Lugas costs, capex and potential benefits elsewhere (see Downstream: NOVATEKs Ust Luga plant arbitraging the export duty in our Oil and Gas Quarterly of April 2011). The change in marketing scheme returns to us about $9 per NOVATEK GDR in NPV. This is unless the government taxes out NOVATEKs naphtha at 90% of the crude export duty, which is what it is doing for the oil companies. In this case, the NPV is only about $2 per NOVATEK GDR. But for its entire business history, NOVATEK has not been known for passing on the value elsewhere, including the government (one could actually state exactly the opposite); hence, we remain hopeful. In any case, this is one instance in which NOVATEK is actually learning from Gazproms experience on how to sell condensate more profitably.
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NPV of Ust Luga, $ per NOVATEK GDR

15.0 How naphtha is taxed will determine the value of Ust Luga because its upgrade is one large export duty arbitrage. 12.1 12.0 10.7
9.3 13.4
9.0
6.6
8.0 5.2 2.3 2.8 3.3 3.8
6.0 3.0
0.7
1.3
1.8
0.0 70 80 90 100 110 Oil price, $/bbl 120 130
Naphtha is taxed at 90% of crude

Naphtha is taxed at 66% of crude
So, where do the challenges stand and opportunities lie? They are utterly different for every current or future condensate champion. TNK BP is beginning the quest, years behind the two gas majors, with the biggest challenge being to place larger volumes from Rospan on the market in any shape or form. The opportunity is striking: nearly 4 mln tonnes of condensate output at the peak, which, for example, is just a touch below what NOVATEK was extracting last year on one third of the gas production by the largest independent. For NOVATEK, the challenge is to guard the condensate production at legacy fields from decline by launching smaller satellite wet gas properties in a timely manner. The opportunity is to grow and fully monetize SeverEnergia wet layers and create a full cycle condensate marketing chain: from raw liquid, all the way down to light oil products. Gazprom, on the other hand, needs to pay more attention to projects that actually make money, as the Soviet resource base is far from being exhausted. The deeper, condensate rich horizons of the gas giant's major producing fields have barely been scratched. Finally, the state should be looking forward, encouraging wet gas development via priority access to the railroad and pipeline infrastructure, and though fiscal stimulus for wet gas output and the resultant end products from condensate a rapidly growing, unconventional Russian oil that is emerging as an industry in its own right.
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Is Alliance Oil Company in Play?

Investors have questioned the merger between West Siberian Resources (WSR) and Alliance Oil Company ever since it was first proposed in 2007. The strategic reasoning made sense to hedge the formers pure upstream exposure with the latters nearly wholly downstream derived profitability. However, the fields of the small sized former WSR are scattered across three distant regions (itself a result of perhaps ill advised acquisition activity), while Alliance Oil Companys key asset Khabarovsk Refinery is in Russias Far East, a long distance from any of WSRs producing assets. Supplying feedstock crude to the refinery is possible only via expensive rail deliveries, and the addition of WSRs upstream assets did not change that.
Location of Alliance Oil Companys assets
Source: Troika
In addition, Khabarovsk Refinery was just beginning to undergo an expensive modernization program worth over $1 bln, even as cash was needed to develop WSRs greenfields in the Timan Pechora basin.
Alliance Oil Company capex, $ mln
500 400 300 200 100 0 2008 2009 2010 2011E 2012E 2013E 2014E 2015E Khabarovsk Refinery modernization Kolvinskoye
Investment in the two projects peaks simultaneously.
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Close to five years on, these problems have been only partly resolved. The underperforming assets in the Volga Urals area, where production began to decline last year, have been spun off into a JV with Repsol. This means that Alliance Oil Company is no longer responsible for the investment needed to maintain production at the fields, saving the cash for its efforts in Timan Pechora. The launch of the ESPO 2 pipeline, perhaps as soon as this year, will make crude transportation to Khabarovsk less expensive.
Comparative costs of delivering crude to refineries, 3Q11, $/bbl (average)
20.0 15.0 10.0 5.0 0.0 Gazprom Neft Rosneft TNK BP Alliance Oil Company Alliance Oil Company post ESPO 2 launch
Alliance Oil Company's much higher costs are due to the distance of Khabarovsk Refinery from most producing fields and the fact that crude is shipped most of the way by expensive rail freight. After the ESPO 2 launch, the second of these problems will be resolved.
But transport costs will remain high. Meanwhile, the simultaneous investments in Kolvinskoye and Khabarovsk pushed the companys gross indebtedness to over 3.0 times EBITDA last year, bringing it close to the 3.5 limit imposed in the covenants of its 2010 Eurobond issue. And with the launch of the Kolvinskoye field in September 2011, new questions have emerged in particular, about what the company will do once the field reaches its plateau, considering that most of the rest of the asset base is in a decline.
Alliance Oil Company's gross debt/EBITDA
3.6 3.0 2.4 1.8 1.2 0.6 0.0 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 Debt covenant ceiling
Sources: Company, Troika estimates
The skewed nature of the companys business, its high leverage and high risk profile have inspired speculation about M&A. One option is for Alliance Oil Company to buy new upstream assets, likely greenfields, once its capex program passes the peak and the newly launched Kolvinskoye contributes more cash. Indeed, the company is in talks about buying the Dulisma field in East Siberia (not far from the ESPO link) or a stake in the larger Taas Yuryakh (further north). Core shareholder Musa Bazhayev has said that the goal is to balance crude production and throughput at 4.5 mln tonnes (33 mln bbl) per year. (We model somewhat lower figures.) However, Alliance Oil Company may not be able to stretch its already high level of indebtedness, so an acquisition could be difficult to achieve until the company starts making free cash flow, likely toward end 2012 or 2013. Once the ESPO is launched, we also find it hard to see justification for buying fields that are closer to the refinery, because simple swaps could allow Alliance Oil Company
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to supply the plant with relatively cheaply delivered crude regardless of the location of its own fields (this is harder to do now, when the refinery is only accessible by rail). By that time, the ramp up at Kolvinskoye should also allow total oil production to exceed throughput at Khabarovsk.
Crude production (consolidated) vs throughput, mln bbl
30 25 20 15 10 5 0 2008 2009 2010 2011 2012E 2013E 2014E 2015E Samara Tomsk Timan Pechora (ex Kolvinskoye) Khabarovsk throughput
Tatarstan Kazakhstan Kolvinskoye
So, with long term growth hard to sustain, and reasons to grow it inorganically not obvious, one alternative is for the company to be gobbled up. Two things would be needed for that to happen. First, the core shareholders must want to sell. In March 2011, the controlling Bazhayev family disposed of a 6% stake in order to channel the money into their other projects (which include a growing platinum operation). However, the Bazhayevs may not wish to put Alliance Oil Company on the block until its main growth asset the Kolvinskoye field successfully reaches plateau level output (currently forecast at about 45 kbpd). This would remove the risk discount attached to the asset and raise the sale price. The 45 kbpd plateau may be reached by next year. But the fragile reservoir structure at Kolvinskoye may prevent a fast ramp up (something that on a smaller scale has already disappointed investors). A forced ramp up may result in uncontrollable water cut and the collapse of the reservoir, leading to a precipitous drop in production from the peak similar to what happened to LUKoils South Khylchuyu field in the same basin. Thus, if the core shareholders are even considering selling, they would first have to wait for Kolvinskoyes production curve to evolve. The second requirement for a sale, of course, is that someone must want to buy the company. That someone would preferably be betting that they could do more with Alliance Oil Companys assets than the company itself could. This brings us to the crux of this section. We take a look at Alliance Oil Companys assets through the eyes of a potential buyer and consider for whom such a takeover would make sense. We think that added value from the acquisition what is termed synergy in M&A parlance can be real, but is often imaginary or has nothing to do with creating current value:
Real synergies. These usually involve anything that spares the buyer from building its own infrastructure, whether that be roads, pipelines, or rail links to the fields or refining plants. For instance, if Rosneft, as per earlier indications, wanted to build a refinery on the Pacific Coast, and one already existed nearby (Khabarovsk), then it would make sense for Rosneft to acquire Khabarovsk instead. Notice that we are using a hypothetical example here. As we will see later on, real synergies are incredibly hard to come by in real life. Falsesynergies. These seem like a good idea at first, but the logic unravels upon harder thinking. For instance, it could be argued that the creation of the present day Alliance Oil Company in 2008
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did not achieve any real synergies. It did reduce the taxation risk (more for Alliance Oil Company shareholders than for WSR), but that could have been done easier via long term buy and sell contracts. The expected meaningful synergies in, and improvement of, the trading and marketing operations, as well as crude oil supply anticipated in the merger prospectus never materialized. We will see later on that most perceived synergies turn out to be false.
Soft reasons. These include political imperatives, the managements megalomania, and the natural corporate instinct to grow the franchise and sustain demand for the services of investment bankers. A purchase based on the managements belief that a certain trend will develop in the future and make the asset more valuable say, an increase in resource prices or an improvement in technology probably fits into this category, as well.
We believe that an apparent real synergy, and not one of the soft justifications, is the only decent fundamental reason to acquire another company. We do not pretend to have anywhere near the specific knowledge and insight of a typical corporate strategy department. Nor do we possess any knowledge of a pending transaction. What follows is simply an exercise in matchmaking. Chalk it up to our pre Valentines Day mood.
The procession of suitors

ROSNEFT THE TARDY ADMIRER At first glance, Rosneft seems like the most likely suitor. However, the case becomes less persuasive as one probes the possible synergies.
Naphtha overload. Rosneft plans to open a 4 mln tonne petrochemicals plant in Nakhodka port on the Pacific in 2016. The plant would mostly process naphtha and LPGs. Khabarovsk Refinery, located some 650 km from Nakhodka, is slated to produce 570,000 tonnes of naphtha once the modernization and expansion are completed. This alone may have been enough to tempt Rosneft to look into buying Alliance Oil Company. However, export duties on naphtha were unexpectedly raised late last year from 67% to 90% of the crude duty, flooding the domestic market with what is effectively straight run gasoline. Moreover, the petrochemicals plant would be sitting on the naphtha export route through Kozmino (near Nakhodka), capturing the feedstock at export parity prices. Finally, Rosnefts own three refineries in the region Angarsk, Achinsk and Komsomolsk are producing about 2.5 mln tpy of naphtha (including 1 mln tonnes from Komsomolsk), almost five times more than Khabarovsk is slated to produce and enough to supply the petrochemicals plant with mostly in house feedstock.
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Rosnefts and Alliance Oil Companys refining assets in the Far East and Eastern Siberia
Source: Troika
Timan Pechora connection. Rosnefts Labaganskoye and Naulskoye greenfields are not far from Alliance Oil Companys Kolvinskoye, so some piggybacking on the existing infrastructure would be possible, in theory. However, the two fields combined are almost twice the size of Kolvinskoye at their peak, while still not large enough to make much of a difference to Rosnefts upstream profile. And for now, it is Kolvinskoye that is taking advantage of someone elses existing infrastructure (including terminals and pipelines belonging to the Polar Lights JV and to LUKoil) with little of its own to contribute apart from a field specific pipeline.
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Kolvinskoye oil field relative to oil majors assets in Timan Pechora
Tomsk/Achinsk pair up. Alliance Oil Companys upstream assets in Tomsk Region are close to Rosnefts Achinsk Refinery. However, some 3 mln bbl (400,000 tonnes) of crude from the four Tomsk fields are probably too irrelevant to make much of a difference for the 7.5 mln tonne refinery. Their size also rules out much of a synergy for Gazprom Nefts Omsk Refinery in the region. Generally in Russia, a single companys fields and refineries do not need to be close to one another because swaps with other companies can help reduce transport costs. The two exceptions where swaps are hard to do (due to a lack of nearby fields or trunk pipeline infrastructure) are Rosnefts Komsomolsk and Alliance Oil Companys Khabarovsk, though this would also be partly solved with the launch of the ESPO 2 pipeline.
No potential synergies or even their combination seem to be large enough to seduce Rosneft. A while back, however, the company could have passed our key test and realized more value from Alliance Oil Companys assets, using the ESPO pipeline. Transneft has long since finished the first part of the link from Taishet to Skovorodino, more than halfway to Khabarovsk but is currently refusing Alliance Oil Company the use of the pipeline. This has to do with the fact that Transneft loses money on the route but makes up for part of it by offering bunkering services to oil companies at the end point of the rail link in Kozmino which, of course, it will not be able to do for Khabarovsk bound crude. The arrangement, however, effectively allows Rosneft to deliver its own crude to its Komsomolsk Refinery, mostly via pipeline (as the company is the user of bunkering
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services in the end port), while Alliance Oil Company is paying close to $20/bbl for the trouble of freighting crude largely by rail. Had the ESPO 2 project been shelved (something that was seriously considered in 2009), then Rosneft could have automatically made at least $150 mln more from Khabarovsk than Alliance Oil Company could. However, the ESPO 2 is slated for completion in 3Q12, Alliance Oil Company claims that it has been guaranteed throughput in it, and so the magic moment of asymmetrical value creation appears to have passed.
Cost of delivering crude to the refinery, $/bbl
20.0 18.0 16.0 14.0 12.0 10.0 8.0 Meget Khabarovsk (Alliance Oil Company)
Some $6/bbl difference in delivery costs from the same point to nearly the same destination is explained by Rosneft effectively taking advantage of the ESPO 1 to supply crude for part of the way to its Komsomolsk Refinery.
Meget Komsomolsk (Rosneft), implied
BASHNEFT THE CHESS PLAYER On the face of it, Bashneft appears to be the least likely to be interested in Alliance Oil Company. Both are downstream skewed, so the tax hedging motive would not apply. Both are leveraged, although Bashnefts debt/EBITDA is half that of Alliance Oil Companys. Both are trying to ramp up greenfields in Bashnefts case, Trebs and Titov with the goal of raising oil production to throughput capacity. And while the fields are in the same region, we have seen before that Kolvinskoyes lack of significant infrastructure leaves it of little synergetic value to other players in the area. Both companies, however, are also competing for the same East Siberian assets Dulisma and Taas Yuryakh. This is where the elusive real synergy described above could become naturally apparent. Instead of bidding up the price, Bashneft (the larger of the two companies by far) could let Alliance Oil Company buy the fields on the cheap and then buy Alliance Oil Company itself. This might be worth it because the estimated value of the stakes in the two fields is on the same order of magnitude as Alliance Oil Companys entire current market cap. In this context, Bashnefts statements over the past few months that it has stopped talking with the seller of the assets are notable. However, this logic would work only if there were no other contenders for the fields. As the blocks lie close to the existing assets of TNK BP and Surgutneftegaz, such a move which is tantamount to what is called sham sacrifice in chess would be difficult to pull off. Meanwhile, there is little else in Alliance Oil Company that would complement Bashnefts existing assets. GAZPROM NEFT THE SINGLE
MINDED OBSESSIVE
If Alliance Oil Company is ever sold, the chances that Gazprom Neft would be a buyer are as good as those for anyone else. This is not so much due to any fundamental complements, but rather to one of the soft reasons we discussed above. Gazprom Neft has pledged to be producing 100 mln tonnes of oil equivalent by 2020, though, crucially, it has not outlined any specific focus. The extra barrels are supposed to flow in Russia and abroad, from greenfields, new acquisitions and JVs, in the form of oil and gas. Seen in that light, Alliance Oil Company could serve to simply patch up any gap on Gazprom Nefts path to its single minded ambition. Khabarovsk Refinery is probably an impediment to a sale. Gazprom Neft is among the least likely of the integrated majors to figure out a way to use it, having no eastern ambitions at all apart from a half stake in the Kuyumba field and already boasting the third highest refining cover in the country.
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But it would not be the most illogical acquisition in Gazprom Nefts history (that prize goes to the NIS refineries in Serbia).
Refining cover in Russia, 2011
150% 120% 90% 60% 30% 0% Alliance Oil Company TNK BP Holding LUKoil (Russia) Surgutneftegaz Bashneft Gazprom Neft Tatneft* Rosneft
* Tatneft's refining cover is due to rise to about 25% in 2012, assuming full scale production at the recently launched Taneco plant Source: Companies, CDU TEK, Troika estimates
LUKOIL AND SURGUTNEFTEGAZ A PLAYER PAST HIS PEAK AND A MIDDLE
AGED VIRGIN
LUKoil and Surgutneftegaz face the same problems that Alliance Oil Company will encounter in about three years a declining legacy base and no greenfield assets that can spur a recovery in overall production in the near term. This is why purchasing Alliance Oil Company would be an unlikely solution for either of them, even if stabilizing output was all they were seeking. Moreover, the companys fields are too small to make much of a difference for instance, at its currently projected peak, Alliance Oil Companys entire upstream asset base would pump less than two thirds as much oil as Surgutneftegaz single Talakan field. And Surgutneftegaz has never made a major purchase: it received Talakan for a fraction of the original selling price after YUKOS winning bid was reversed, and its purchase of a stake in the Hungarian Mol in 2010 was clearly short term and was unwound within less than two years.
Legacy production declines at LUKoil and Surgutneftegaz in 2011 vs Alliance Oil Company's entire output, kbpd
100 80 60 40 20 0 20 40 60 LUKoil Surgutneftegaz Alliance Oil Company total output, 2011 Alliance Oil Company total output, 2013E
(35) (16) 50 79
Source: CDU TEK, Troika estimates
TNK BP THE HAPPY BACHELOR TNK BP needs Alliance Oil Company the least among the integrated majors. Its greenfield profile is proportionally the second strongest after Gazprom Nefts (but without ambitions of reaching for the stars) and its low downstream exposure may turn out to be a blessing if the government is serious about raising the export duty on fuel oil over the next few years. It is also, historically, a rather uninspired acquirer, preferring the development of in house greenfields financed by one of the best
54 TROIKA DIALOG
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legacy asset cash flow machines in the nation. Besides, TNK BP lately seems to have chosen the strategy of expanding overseas. REPSOL CAPRICCIO ESPAGNOL Repsols true intentions with respect to Alliance Oil Company remain a mystery to us for the simple reason that we do not cover the Spanish company and therefore know little about its strategy. Playing up to its national stereotype, the Iberian suitor has been blowing hot and cold in its relationship with the Russian company. It first looked on passively as its 10% stake in WSR was reduced to less than 4% in the combined company. It then mulled a complete pullout before changing tack and creating a JV with Alliance Oil Company in an orgy of deal making late last year, through which it rather generously paid for non controlling stakes in the companys declining Volga Urals fields and for which it then bought the gas developer Eurotek. While we would not rule out Repsol increasing its share in Alliance Oil Company, we think a complete takeover is unlikely without the Spanish company first making Russia one of its expansion priorities. With plenty of nubile greenfield conquests in Latin America, there appears to be no need for Repsol to do that yet. In addition, operating without a major Russian partner in the current environment is a tricky proposition. The conclusion, then, is that it may be harder to sell off Alliance Oil Company now than it initially looks, even before delving into the specifics of valuation. Meanwhile, despite strong growth potential in 2012 13, the company will find it difficult to organically grow in a few years and could struggle to maintain the interest of EM investors hungry for growth. As such, we believe that Alliance Oil Company, despite difficulties, remains the only real takeover prospect under our coverage, though this is rather unlikely to happen in the next two to three years.
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Oil and Gas Production Outlook for 2012

Liquids: production back to the USSR
In the beginning of the year, we usually attempt to develop a short term view on Russias hydrocarbon production and highlight the emerging trends and moving parts of the countrys greatest resource. Before discussing how 2012 may shape up, we cannot help but briefly make three interconnected points that, looking back, surprised us the most in 2011. First, not only did oil output hit a new post Soviet high, which was frankly obvious 12 months ago, it also strengthened toward the second half of the year, with current run rates of over 10.3 mln bpd. This alone suggests that the y o y comparisons in early 2012 will be highly favorable.
Russian oil output, mln bpd
13 11
10.8
Soviet Russia
Output has not only hit a post Soviet high...

11.4 11.2 11.4 11.0
Current Russia
10.4 9.9 9.3 9.2 9.4 9.6 9.8 9.9
9 7 5 1985 1986 1987 1988 1989
Transitional Russia
8.5
8.0
7.1
6.4
6.2
6.1
6.1
6.1
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
6.1
2000
6.5
2001
7.0
2002
7.6
2003
2004
2005
2006
2007
2008
2009
2010
10.1
Source: Energy Ministry, Troika
Russian oil production, mln bpd

10.4 10.3 10.2 10.1 10.0 Jan 10
but also grew strongly throughout last year with a recent run rate of over 10.3 mln bpd
Jul 10
Jan 11
Jul 11
Second, all companies except LUKoil handily topped not only our initial expectations, but their own guidance, both on greenfields and brownfields.
Companies strongly topped their own guidance and our initial forecasts last year, kbpd
2011 estimate or guidance (early 2011) Rosneft Surgutneftegaz LUKoil TNK BP Holding Gazprom Neft Bashneft Gazprom Sakhalin 1&2
Source: Companies, CDU TEK, Troika estimates
2011 actual 2,187 1,220 1,713 1,459 607 305 292 274
Actual/ guidance 2.1% 0.5% 2.1% 0.9% 0.9% 3.8% 7.5% 4.5%
2,142 1,214 1,749 1,445 601 294 272 262
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2011
10.3
JANUARY 2012
The third and probably biggest surprise was the exceptional performance of brownfields, which saw virtually no decline in 2011. Hence, despite collapse at LUKoils South Khylchuyuskoye field that was barely offset by gains from Rosnefts Vankor and TNK Uvat, brownfields were unexpectedly the moving part that shaped Russian oil output.
Russian 2011 production breakdown, kbpd
10,500
46 90 10,144 32 25 12 71 10 10,270
10,300
10,100 Vankor and TNK Uvat have barely compensated for LUKoil's loss in Timan Pechora 10 liquids Gain from Gain production Talakan and from Verkhnechonsk Vankor
* TNK Uvat and LUKoil's Caspian ** Gazprom and NOVATEK Source: CDU TEK, Troika
9,900
Looking back, the almost no decline in legacy output was the biggest surprise of 2011. 11 liquids production
9,700 Gain from Gain from Gain Loss from Loss from other condensate** from PSA South brownfield greenfield* Khylchuyuskoye
Initial liquids production estimate for 2012

That is all in the past, and the key question now is how 2012 will shape up. The short term oil production outlook is important for the equity market, not only because it impacts the price of oil, with Russia being the second largest oil producer in the world, but because this output reflects the individual performance of companies. Production trends have a significant impact on the states taxation policy toward the sector, in our view, in addition to the economic performance of the country and its budget needs. With this in mind, we seek to understand the production outlook for the country this year from two angles: top down and bottom up. With the former, we effectively try to derive the rate of decline required at brownfield sites to keep production in the country flat y o y, and check whether this decline rate is reasonable. The latter approach naturally sums the production of individual companies. Our initial forecast calls for domestic oil production to rise by about 130 kbpd y o y in 2012 (1.2%) to around 10.4 mln bpd, topping the level of 1990 the last year of the Soviet empire. Moreover, we cannot see how Russian liquids production can possibly fall this year against two (possibly three) greenfield launches, continued strong growth in current greenfield projects, expanding capex, and steady (for now) brownfield output.
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Russia oil and condensate output, mln bpd

2010 Rosneft* LUKoil TNK BP Holding Surgutneftegaz Gazprom Neft Tatneft Slavneft Bashneft RussNeft Gazprom Tomskneft Salym PD Sakhalin 1 Sakhalin 2 NOVATEK All other Russia total
* Consolidated Source: CDU TEK, Troika estimates
2011 2.19 1.71 1.46 1.22 0.61 0.53 0.36 0.30 0.27 0.29 0.21 0.17 0.16 0.12 0.08 0.59 10.27
y o y 2.2% 5.3% 0.9% 2.1% 1.3% 0.3% 1.5% 6.8% 5.9% 7.1% 0.5% 2.5% 12.8% 4.8% 15.0% 9.3% 1.2%
2012E 2.23 1.69 1.46 1.23 0.63 0.53 0.36 0.31 0.28 0.32 0.21 0.17 0.16 0.12 0.09 0.64 10.40
y o y 1.9% 1.5% 0.3% 0.4% 3.6% 0.0% 0.9% 0.6% 2.3% 9.0% 0.0% 1.9% 0.0% 4.1% 4.0% 7.7% 1.2%
2.14 1.81 1.44 1.20 0.60 0.52 0.37 0.28 0.26 0.27 0.21 0.17 0.14 0.12 0.07 0.54 10.14
Top down view: call on brownfield performance

In 2011, greenfield projects, Sakhalins PSAs and condensate produced by Gazprom and NOVATEK added 135 kbpd to the domestic output figure, with three East Siberian fields responsible for the entire gain. Greenfield output was 1.35 mln bpd, or 13% of Russian production. Hence, the rest, which we loosely define as brownfield, produced 8.92 mln bpd.
Brownfield/greenfield split, 2011
8.92 mln bpd 87%
Greenfield, condensate and PSA
1.35 mln bpd 13%
Brownfield
Source: Troika
This year, we are looking for greenfield growth to accelerate by almost 179 kbpd based on the oil companies guidance and our own estimates to 1.53 mln bpd. Almost three quarters of this growth should come from the same East Siberian fields, Gazproms increase in liquids production from the gas giants Valanginian layers of the Zapolyarnoye field and the launch of Prirazlomnoye in the Pechora Sea. On top of this, the rate of decline at LUKoils South Khylchuyuskoye will be much less of a drag on Russias greenfield production than last year.
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Greenfield, condensate and PSA production estimates, kbpd

2010 Vankorneft (Rosneft) Verkhnechonskneftegaz (TNK BP) Talakan and other Yakutia (Surgutneftegaz) TNK Uvat (TNK BP) Naryanmarneftegaz (LUKoil) Nizhnevolzhskneft (LUKoil Caspian) Sakhalin 1 Sakhalin 2 Gazprom (liquids) NOVATEK (liquids) SeverEnergia (liquids) Total
2011 301 101 108 106 79 6 158 116 292 83 1,350
2012E Change 360 131 130 124 53 37 158 120 318 87 10 1,529 59 30 22 18 (26) 31 5 26 4 10 179
255 52 67 79 149 1 140 121 273 77 1,214
In general, on the greenfield side, we are looking only for the Prirazlomnoye oil project to be launched this year, the contribution of which to the nations production, together with SeverEnergia liquids, will still be marginal in 2012. Looking a bit further out, next year should be much more exciting, with three new fields starting commercial production (Bashnefts Trebs and Titov, Gazprom Nefts Novoportovskoye, and LUKoils Pyakyakhinskoye) on top of the peak at Vankor and strong condensate growth from SeverEnergias two fields (Samburgskoye and Urengoiskoye). We thus see Russias liquids production growth continuing beyond 2012.
Russian oil greenfield projects
650 600 550 500 450 Reserves (ABC1+C2), mln tonnes 400 350 300 250 200 150 100 50 0 Y. Korchagin (LUKoil)
29
Vankorskoye (Rosneft) 524
Messoyakhskoye (Gazprom Neft/ TNK BP) Yurubcheno Tokhomskoye (Rosneft)

499 552
Russkoye (TNK BP)

408
Novoportovskoye (Gazprom Neft) Talakanskoye (Surgutneftegaz)

200 238
Kuyumbinskoye (Gazprom Neft/ TNK BP)

277
Verkhnechonskoye (TNK BP) 120
Prirazlomnoye (Gazprom)
72
Trebs and Titov (Bashneft)

140
V. Filanovsky (LUKoil)
169
Tagulskoye (TNK BP)

196
Lisovsky and Sanarskoye (Rosneft)

200
Savostyanovo (Rosneft) 160 Suzunskoye (TNK BP) 44 Labaganskoye (Rosneft) 26 2014 2015 2016 2017 2018 2019 Naulskoye (Rosneft)
51
South Khylchuyuskoye (LUKoil) 83 2008 2009
Pyakyakhinskoye (LUKoil) 61 2011 2012 2013
2007
2010
Commercial production start

Source: Companies, Troika
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In all, for domestic output to remain flat y o y in 2012 at 10.27 mln bpd, legacy production must decline by no more than 2%, we estimate.
Greenfield/brownfield split required for overall 2012 output to stay flat y o y, mln bpd
2010 Greenfield, PSA, condensate Brownfield Russia total
2011 1.35 8.92 10.27
2012E 1.53 8.74 10.27
Growth 13.3% 2.0% 0.0%
1.21 8.93 10.14
For Russian oil output to stay flat y o y in 2012, legacy production needs to decline by no more than 2%. Recent trends point to a much lesser decline at brownfield sites.
Having estimated the required rate of decline at legacy fields for Russias overall oil output to stay flat, the next question is whether a decline of 2% would be reasonable. We do not think so, as the current trends point strongly to a positive direction. In fact, Russias legacy production has declined by no more than 0.5% since September 2010, which makes us rather optimistic for this year.
Russian brownfield production, kbpd
9,400 9,300 9,200 9,100 9,000 8,900 8,800
1Q07 2Q07 3Q07 4Q07 1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11
Russian brownfield y o y production decline

0.0%
Russian brownfield production has virtually stopped declining since 1Q10.
0.5% 1.0% 1.5% 2.0% 2.5%

1Q08 2Q08 3Q08 4Q08 1Q09 2Q09 3Q09 4Q09 1Q10 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11
Russian brownfield production has declined less than 0.5% y o y every month since September 2010.
Source: Troika
Source: Troika
We have highlighted the reasons for this turnaround on several occasions: Rosnefts flat production at its legacy fields and growth from the small companies, which managed to nearly offset the falls in brownfield production at TNK BP, LUKoil and Surgutneftegaz.
Russia brownfield performance, kbpd
9,100 9,000 8,900 8,800 8,700 8,600 8,500 2010 legacy Gain from Gain from all Rosneft, others Gazprom Neft, Bashneft and Tatneft Loss from the Big 3* 2011 legacy
8,930 30 109 70
The decline in Russian brownfield is confined to three companies.
8,920
* Surgutneftegaz, TNK BP and LUKoil Source: Troika
In all, if we are right about the growth in greenfield production, our 2012 Russian oil output forecast of 10.4 mln bpd calls for a decline in brownfield output of just 0.6%, which is well supported by the latest trends.
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Russian oil production forecast for 2012, mln bpd

2011 Greenfield Brownfield Total
2012E 1.53 8.87 10.40
y o y 13.3% 0.6% 1.2%
1.35 8.92 10.27
Bottom up view: two Gazproms at the front of production growth

LUKOIL: THE LAST YEAR OF DECLINES? After a bad year, with a 5.3% decline in production, low credibility and periodic changes in corporate strategy, we are willing to give LUKoil some benefit of the doubt. While we do not yet understand how exactly the companys oil production may stay flat this year, we do see a very significant deceleration in the production decline, with a possible small turnaround toward end 2012, though the first half of the year will remain challenging. Our modest optimism is based on two factors. First, South Khylchuyuskoye, which has contributed three quarters of the overall decline, has already collapsed and likely bottomed. Second, legacy output was bouncing around the 1.62 mln bpd level throughout all of last year. Therefore, it is simply math and a game of low base effects, and not so much the companys statements of some extraordinary effort to turn the decline around. Our initial forecast calls for just a 1.5% y o y drop in Russia against flat brownfield performance. If LUKoil can somehow increase output at its legacy assets via higher capex, the rate of decline would be smaller.
LUKoil production estimate, kbpd
2010 Consolidated production Legacy Naryanmarneftegaz 1,809 1,660 149 2011 1,713 1,635 79 2012E Troika 1,688 1,635 53 y o y 1.5% 0.0% 32.5%
With output at South Khylchuyuskoye having already collapsed and probably bottomed, the worst is behind for LUKoil.
Source: Company, Interfax, Troika estimates
ROSNEFT: GUIDING CONSERVATIVELY AGAIN? For several years in a row, Rosneft has officially under promised, only to outperform throughout the year. This year is no exception. The companys official guidance, reported at end last year, calls for just about 1.2% y o y growth in consolidated oil production. Given no change in Vankors ramp up, this guidance implies that legacy output sliding 1.8%. While we think a decline is likely, we are modeling just a 1.0% drop in brownfield production, which translates into overall growth of 1.9%.
Rosneft production estimate, kbpd
2010 Consolidated production Legacy Vankor
2011 2,187 1,886 301
2012E Troika 2,228 1,867 361
y o y 1.9% 1.0% 20.0%
2012E company 2,214 1,852 361
y o y 1.2% 1.8% 20.0%
2,140 1,885 255
We regard Rosneft's guidance as overly conservative.
TNK BP: GUIDING A TOUCH AGGRESSIVELY? Unlike Rosneft, we feel that TNK BPs guidance is a bit ambitious, though the company has strong credibility and has continually surprised on the upside on everything from production to cash flow to dividends. Nevertheless, we start the year with a forecast of just 0.3% y o y production growth against its implied guidance of 1.0%.
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TNK BP Holding production estimate, kbpd

2010 Consolidated production Legacy Verkhnechonsk TNK Uvat
2011 1,459 1,252 101 106
2012E Troika 1,463 1,208 131 124
y o y 0.3% 3.5% 29.4% 17.0%
2012E company 1,473 1,219 131 124
y o y 1.0% 2.6% 29.4% 17.0%
1,445 1,314 52 79
SURGUTNEFTEGAZ: POISED TO GROW FOR A SECOND YEAR IN ROW We think Surgutneftegaz target, recently voiced by the CEO and suggesting 1.6% y o y growth, is very ambitious. We only think this is possible if brownfield production remains flat, a scenario we find difficult to consider seriously at this point. Nevertheless, we do expect some growth of about 0.4%.
Surgutneftegaz production estimate, kbpd
2010 Consolidated production Legacy Talakan and other Yakutia greenfields
2011 1,220 1,112 108
2012E Troika 1,226 1,096 130
y o y 0.4% 1.5% 20.2%
2012E company 1,241
y o y 1.6%
1,196 1,129 67
THE TWO GAZPROMS: THE TOP LIQUIDS PERFORMERS We think Gazprom and Gazprom Neft will have a very good year on the liquids side, though for completely different reasons. We call for Gazprom Nefts consolidated production to rise 3.6% y o y on the back of a strong performance from the legacy business (mostly the South Priobskoye field) and inclusion of the East Orenburgskoye field, acquired from Gazprom last year. Moreover, we think things will get much better for Gazprom Neft later, on both the oil and gas fronts with the launches of SeverEnergia fields, the Novoportovskoye field on Yamal in the next two years, and the Messoyakhinskoye and Kuyumbinskoye fields later in the decade. With a very impressive greenfield pipeline, Gazprom Neft is a long term winner in Russia, along with TNK BP and possibly Rosneft.
Gazprom Neft production estimate, kbpd
2010 Consolidated production
2011 607
2012E Troika 629
y o y 3.6%
599
We project Gazproms liquids output growth at 9% y o y on the back of condensate from the Zapolyarnoye field and the final launch of offshore Prirazlomnoye. The state was mulling the introduction of export duty breaks for Prirazlomnoye a field that should peak at about 130 kbpd toward mid decade. If this materializes and the gas giant turns it over to Gazprom Neft (at a reasonable price), we think the market would take it positively.
Gazprom liquids production estimate, kbpd
2010 Liquids production Crude oil legacy Crude oil Prirazlomnoye Gas condensate
2011 292 37 255
2012E Troika 318 37 20 262
y o y 9.0% 2.5%
273 38 235
Finally, Bashneft, which had another great year with 6.7% production growth in 2011, is likely to decelerate to less than 1.0% before expanding again on the back of Trebs and Titov fields in northern Timan Pechora as soon as next year.
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Bashneft production estimate, kbpd

2010 Consolidated production
2011 303
2012E Troika 305
y o y 0.6%
2012E company 305
y o y 0.6%
284
Gas: is a small break for Gazprom this year enough to make it grow?
Russian gas output (natural and associated) expanded 3% to 670 bcm last year. While this is a record, the growth came on the back of independent producers, Gazprom losing all the gains it accumulated earlier in the year. The companys production was falling for the last five months of 2011, amid lower demand from Europe, a falling share in Russia and a warm winter to date. Domestic gas demand increased by more than 13 bcm in 11m11, we estimate, while Gazproms deliveries of its own gas declined by 2 bcm y o y, the difference quickly being filled by the independents. The gas giant finished the year with 509 bcm, up a mere 0.2%.
Growth, 11m11, y o y
16 12 8 4 0
2 15 13
Domestic gas demand increased by more than 13 bcm in 11m11, while Gazproms deliveries of its own gas declined 2 bcm y o y, the difference quickly being filled by independents.
4 Growth in domestic natural gas consumption Gazprom's own gas implied deliveries on domestic market Natural gas production by independents
The domestic production trends this year are quite interesting, in our view. Gazprom is going to catch a small break from the independent producers before a massive flood of gas again in 2013 15. There will be only one large project launch from the independents SeverEnergias Samburgskoye field, which is expected to produce 2.5 bcm. On top of this, NOVATEKs Yurkharovskoye field should boost output by some 2 bcm y o y to 34 bcm, most additions coming in 2H12. Finally, NOVATEKs East Tarkosalinskoye and Khancheiskoye fields could grow by about 2 bcm from a low base.
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Independent gas companies projects for domestic market

1,600
1,400 South Tambeiskoye (NOVATEK) 1,200

1,256
ABC1+C2 reserves, bcm
1,000
Kharampurskoye (Rosneft) 891 Salmanovskoye (NOVATEK)

767
800 Yurkharovskoye (NOVATEK)

701
600 Beregovoye (Sibneftegaz: NOVATEK, Itera)

295
Urengoiskoye license area (SeverEnergia)

568
400
Nakhodkinskoye (LUKoil)
238
200
Khancheiskoye (NOVATEK)
86
Sterkhovoye (NOVATEK) Pyreinoye (Sibneftegaz: NOVATEK, Itera) 48

80
Kynsko Chaselsky Samburgskoye (Rosneft) 233 (SeverEnergia) Vankorskoye 193 (Rosneft) Geofizicheskoye
160
Yaro Yakhinskoye license area (SeverEnergia)

188
(NOVATEK) 212 North North Chaselsky Yesetinskoye (SeverEnergia) (SeverEnergia) 135 173
Pyakyakhinskoye (LUKoil) 141
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 Commercial production start
We estimate that independents organically added around 15 16 bcm of natural gas to the system in 2011. This year, however, it is difficult for us to see more than 7 9 bcm simply from the bottom up analysis of every individual field of the independent producers.
Estimated natural gas production from independents, bcm
150 120
119
Independents organically added around 15 16 bcm of natural gas to the system in 2011. This year, however, it is difficult to see more than 7 9 bcm being added.
135 107 88 97
90 60 30 0 2010
73
2011E
2012E
2013E
2014E
2015E
While 2012 is a temporary break for Gazprom, we view its current production guidance of 528 bcm this year, which suggests expansion of nearly 20 bcm, as highly questionable. We simply fail to see how the European, Russian and FSU markets can absorb 27 29 bcm of additional gas from Russia (Gazprom plus independents) given an extremely high likelihood of lower consumption in the FSU, possible deceleration in growth from Russia and sluggish demand in Europe.
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Natural gas production in Russia, 2011, bcm

600 595 590 585
1 15 597
Implied 2012 natural gas production at Gazprom's current guidance, bcm

630 620 610 600
9
18
580 575 570 2010 natural gas production ex PSA

581
590 Gazprom growth Independents' growth 2011 natural gas production 580
597
The question is how can this 27 bcm possibly be accommodated?
625
2011E natural Gazprom growth gas production guidance ex PSA

Independents' growth
2012 implied natural gas production
Despite the Bovanenkovskoye fields launch on Yamal this year, we think Gazproms output is likely to remain in a range of plus or minus 1%. In 2013 and after, however, we will see a flood of new and cheap gas projects, such as SeverEnergias Urengoiskoye and Yaro Yakhinskoye fields, commercialized Vankor gas, LUKoils Pyakyakhinskoye on top of peak capacity at Yurkharovskoye, further growth at Samburgskoye and TNK BPs Rospan (2014 15). All together, these should add 10 15 bcm per annum, making Gazproms life much more complicated than it seems at the moment. We continue to see Gazproms capacity build up on Yamal as difficult to justify and believe the companys mega projects are likely to stay in limbo. Therefore, we think that last years production level is probably the best Gazprom can achieve during the next couple of years.
Gazprom's major projects
5,500 5,000 4,500 4,000 Reserves, ABC+C2, bcm 3,500 3,000 2,500 2,000 1,500 1,000 500 0 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 Yuzhno Russkoye (Yamalo Nenetsk Region)
834
Bovanenkovskoye (Yamal)
4,375
Shtokmanovskoye (Barents Sea)

3,810
Zapolyarnoye (Yamalo Nenetsk Region)

3,100
Urengoi Achimov layers (Yamalo Nenetsk Region)

1,300
Kovyktinskoye (East Siberia) Chayandinskoye (East Siberia, real output after 2021)
1,240 2,000
Kharasaveiskoye (Yamal)
1,259
Zapolyarnoye Valangynian layers (Yamalo Nenetsk Region)

735
2013
2014
2015
2016
2017
2018
2019
Commercial production start
TROIKA DIALOG
2020
65
JANUARY 2012
Valuations
Unit based financials, $/boe
2007 Revenues Gazprom LUKoil NOVATEK Gazprom Neft Surgutneftegaz Tatneft TNK BP Holding Rosneft KazMunaiGas EP EBITDA Gazprom LUKoil NOVATEK Gazprom Neft Surgutneftegaz Tatneft TNK BP Holding Rosneft KazMunaiGas EP Net income Gazprom LUKoil NOVATEK Gazprom Neft Surgutneftegaz Tatneft TNK BP Holding Rosneft KazMunaiGas EP
Comparative multiples based valuation

2009 2010 32.5 154.1 14.1 142.4 71.1 82.8 77.9 80.9 74.5 12.3 23.0 6.9 27.0 17.9 13.6 18.9 24.5 33.5 8.7 13.2 4.9 13.4 9.8 8.3 12.4 13.4 24.7 2011E 42.9 207.2 17.2 191.7 98.1 111.3 102.5 116.3 100.9 17.1 30.4 8.7 38.2 22.5 17.7 26.3 28.2 40.2 12.2 18.3 5.9 22.0 13.5 10.8 17.3 15.7 26.9 2012E 43.6 197.8 18.9 184.0 91.8 104.5 96.9 115.2 97.7 16.6 29.1 9.2 32.6 19.6 17.8 22.0 25.0 43.5 10.9 17.7 6.8 18.1 11.7 11.8 14.0 13.5 30.9 2013E
2008 35.9 158.2 14.5 146.8 83.5 97.8 89.5 97.4 84.9 15.0 24.5 6.8 33.5 15.5 10.2 18.9 24.0 53.4 7.8 13.4 4.3 20.7 11.9 2.7 12.6 15.7 28.9
P/E 2012E 2013E 3.7 4.2 12.5 5.1 7.4 4.4 5.9 6.4 1.7 3.6 2.4 5.1 7.4 10.0 8.4 8.4 8.2 9.6 8.0 8.0 7.6 6.2 7.2 6.8 7.9 9.0 Russia and FSU Gazprom LUKoil NOVATEK Gazprom Neft Surgutneftegaz Tatneft TNK BP Holding Rosneft Transneft KazMunaiGas EP Alliance Oil Company Bashneft Eurasia Drilling Company Emerging markets PetroChina Petrobras China National Offshore Oil Corporation Oil & Natural Gas Corporation Developed markets ExxonMobil ChevronTexaco ConocoPhillips Royal Dutch Shell BP Total Eni Statoil Repsol YPF
companies and Troika estimates for Russian and FSU companies. Source: Thomson, Troika
23.7 118.7 11.9 88.4 60.7 75.6 68.8 69.4 62.3 8.8 22.1 5.6 24.4 14.0 14.2 16.9 19.7 41.6 6.5 13.8 3.6 17.4 5.8 9.2 11.3 18.1 18.4
28.1 116.3 12.1 107.5 56.3 65.0 60.5 64.3 54.3 10.2 19.7 5.3 21.8 14.8 13.6 15.5 18.5 23.6 7.5 10.1 3.5 13.4 8.6 9.4 10.1 9.0 23.5
44.3 202.1 21.4 186.4 88.8 108.8 95.9 113.7 93.5 15.6 28.6 11.0 32.1 17.7 20.7 21.0 24.8 39.0 9.6 16.8 8.3 18.1 10.4 13.8 13.2 13.2 27.7
3.3 4.0 16.1 5.1 6.6 5.2 5.6 6.4 2.2 3.3 3.3 5.9 10.4 10.6 9.2 8.5 8.7 10.2 8.2 8.4 8.1 6.5 7.7 7.4 8.4 10.0
Note: Prices are as of January 18, 2012. Thomson consensus estimates are used for foreign
66
TROIKA DIALOG
JANUARY 2012
Financial Profiles
Alliance Oil Company
Income statement (IFRS), $ mln
2009 Revenues Operating costs EBIT Depreciation EBITDA Net interest expenses Forex gain/(loss) EBT Tax Income before minority interest Minority interest Net income
2010 2,196 1,888 307 132 439 (22) 4 290 (63) 226 (4) 222
2011E 3,089 2,578 510 151 661 (60) (16) 434 (100) 334 (4) 330
2012E 3,378 2,520 858 201 1,059 (45) (16) 797 (175) 622 (4) 618
2013E 3,856 2,651 1,206 246 1,452 (75) (16) 1,115 (245) 870 (4) 865
2014E 3,779 2,603 1,175 247 1,422 (65) (16) 1,094 (241) 854 (4) 849
2015E 3,631 2,514 1,116 248 1,364 (59) (16) 1,041 (229) 812 (4) 808
1,726 1,273 454 108 390 (34) (1) 418 (73) 345 (1) 344
Balance sheet (IFRS), $ mln

2009 Fixed assets and investments Current assets Stock and inventories Accounts receivable Cash and securities Total assets Current liabilities Accounts payable Short term debt Long term liabilities Long term debt Other long term liabilities Total liabilities Minority interest Equity Share capital Retained earnings Total liabilities and equity
2010 2,618 730 141 263 178 3,347 436 250 127 1,106 912 194 1,542 31 1,774 1,275 499 3,347
2011E 3,635 767 238 254 127 4,402 934 463 413 1,337 1,143 194 2,271 27 2,104 1,275 828 4,402
2012E 4,431 775 219 278 131 5,207 954 439 456 1,508 1,314 194 2,462 23 2,722 1,275 1,446 5,207
2013E 4,445 1,311 214 317 633 5,756 905 456 390 1,245 1,051 194 2,150 19 3,587 1,275 2,312 5,756
2014E 4,472 1,859 201 290 1,221 6,331 844 448 337 1,035 841 194 1,879 15 4,436 1,275 3,161 6,331
2015E 4,512 2,396 182 259 1,808 6,908 786 432 295 867 673 194 1,653 11 5,244 1,275 3,969 6,908
1,998 729 116 142 392 2,727 584 238 345 537 365 172 1,120 30 1,577 1,277 300 2,727
Cash flow statement, $ mln

2009 EBITDA Provisions and non cash items Taxes Interest paid (Increase)/decrease in working capital Increase in other assets Operating cash flow Capex Other investments Free cash flow Increase/(decrease) in debt Net cash flow Change in cash position
2010 439 26 (63) (22) 379 (651) (59) (330) 306 (24) (38)
2011E 661 7 (100) (60) 125 (155) 478 (1,029) (551) 500 (51) (51)
2012E 1,059 14 (175) (45) (28) (38) 787 (997) (211) 214 3 3
2013E 1,452 19 (245) (75) (17) (43) 1,090 (260) 830 (329) 502 502
2014E 1,422 19 (241) (65) 32 (43) 1,124 (273) 851 (263) 588 588
2015E 1,364 18 (229) (59) 33 (42) 1,085 (288) 797 (210) 587 587
390 31 (73) (34) 314 (206) (32) 76 76 74
TROIKA DIALOG
67
JANUARY 2012
Bashneft
Income statement (US GAAP), $ mln
2009 Revenues Operating costs EBIT Depreciation EBITDA Net interest expenses Forex gain/(loss) Net other expenses EBT Tax Income before minority interest Minority interest Net income
2010 13,341 11,071 2,270 711 2,504 (290) (2) 36 2,014 (468) 1,546 (117) 1,429
2011E 16,816 14,253 2,563 627 3,190 (398) (2) 81 2,245 (463) 1,781 (150) 1,632
2012E 16,245 13,870 2,376 638 3,014 (360) 77 2,093 (419) 1,674 (140) 1,535
2013E 16,632 13,945 2,687 649 3,336 (346) 85 2,426 (485) 1,941 (162) 1,779
2014E 16,798 14,096 2,702 660 3,362 (323) 86 2,465 (493) 1,972 (164) 1,807
2015E 16,968 14,256 2,712 672 3,384 (304) 86 2,494 (499) 1,996 (166) 1,829
6,775 6,157 618 631 1,249 20 5 643 (170) 473 (53) 420
Balance sheet (US GAAP), $ mln

2009 Fixed assets and investments Current assets Stock and inventories Accounts receivable Cash and securities Other current assets Total assets Current liabilities Accounts payable Other current liabilities Long term liabilities Long term debt Other long term liabilities Total liabilities Minority interest Equity Share capital Retained earnings Total liabilities and equity
2010 11,239 3,752 625 680 1,067 1,380 14,991 2,516 1,551 170 4,483 3,118 1,365 6,999 2,717 5,275 1,237 4,038 14,991
2011E 10,648 5,227 392 857 2,598 1,380 15,876 2,287 1,387 104 4,572 3,172 1,400 6,859 2,867 6,150 1,237 4,913 15,876
2012E 10,803 5,937 411 828 3,318 1,380 16,740 2,315 1,399 104 4,612 3,212 1,400 6,927 3,006 6,806 1,237 5,569 16,740
2013E 11,002 7,030 438 848 4,365 1,380 18,032 2,364 1,461 104 4,682 3,282 1,400 7,046 3,168 7,818 1,237 6,581 18,032
2014E 11,249 7,982 466 856 5,280 1,380 19,231 2,753 1,520 104 4,410 3,010 1,400 7,163 3,332 8,736 1,237 7,499 19,231
2015E 11,548 8,897 497 865 6,155 1,380 20,445 2,822 1,583 104 4,463 3,063 1,400 7,285 3,498 9,662 1,237 8,425 20,445
10,158 2,531 385 323 1,166 657 12,689 1,260 1,170 27 2,989 1,676 1,313 4,249 3,135 5,305 1,247 4,058 12,689

2009 EBITDA Provisions and non cash items Taxes Interest paid (Increase)/decrease in working capital Increase in other assets Operating cash flow Capex Other investments Free cash flow Increase/(decrease) in debt Dividends Additional share issues/(purchase) Net cash flow Forex and monetary effects on cash Change in cash position
2010 2,504 (333) (468) (357) (682) 151 815 (492) (1,503) (1,331) 2,145 (1,290) (367) (843) 8 (835)
2011E 3,190 339 (463) (476) (108) 440 2,922 (753) 1,729 (1,642) 391 478 478
2012E 3,014 410 (419) (484) 22 (300) 2,244 (1,203) 1,340 (878) 462 462
2013E 3,336 337 (485) (492) 15 (29) 2,682 (1,515) 1,196 (767) 429 429
2014E 3,362 342 (493) (500) 22 (205) 2,528 (1,381) 1,352 (889) 463 463
2015E 3,384 351 (499) (508) 23 (591) 2,160 (1,046) 1,705 (904) 802 802
1,249 (169) (170) (21) (88) 225 1,026 (589) (1,388) (1,176) 1,618 (316) (229) (103) (5) (108)
68
TROIKA DIALOG
JANUARY 2012
Eurasia Drilling Company

2009 Revenues Operating costs EBIT Depreciation EBITDA Net interest expenses Forex gain/(loss) Net other expenses EBT Tax Income before minority interest Net income
2010 1,812 1,517 295 142 437 (7) (7) (1) 279 (72) 207 207
2011E 2,633 2,185 448 159 607 (16) 2 30 463 (106) 357 357
2012E 3,082 2,605 476 248 724 (38) 438 (100) 338 338
2013E 3,557 2,904 653 270 923 (31) 622 (142) 480 480
2014E 3,974 3,177 797 292 1,088 (23) 774 (177) 597 597
2015E 4,567 3,523 1,044 314 1,358 (13) 1,031 (235) 796 796
1,382 1,168 214 106 320 (3) (4) 3 209 (44) 165 165

2009 Fixed assets and investments Current assets Stock and inventories Accounts receivable Cash and securities Other current assets Total assets Current liabilities Accounts payable Short term debt Deferred taxes and provisions Other current liabilities Long term liabilities Long term debt Other long term liabilities Total liabilities Equity Share capital Retained earnings Total liabilities and equity
2010 877 1,077 146 235 629 67 1,954 451 259 118 54 21 318 286 32 769 1,185 680 505 1,954
2011E 1,764 900 231 342 260 67 2,664 672 381 191 79 21 495 463 32 1,167 1,498 680 818 2,664
2012E 1,911 1,015 268 400 279 67 2,926 735 438 161 115 21 424 393 32 1,159 1,767 680 1,087 2,926
2013E 2,057 1,251 297 462 426 67 3,308 774 488 132 133 21 353 322 32 1,127 2,181 680 1,502 3,308
2014E 2,204 1,570 328 516 660 67 3,774 806 533 103 149 21 283 251 32 1,088 2,686 680 2,006 3,774
2015E 2,202 2,234 362 593 1,212 67 4,435 857 592 74 171 21 212 180 32 1,069 3,366 680 2,686 4,435
729 795 117 191 434 53 1,523 351 228 32 53 37 170 150 20 521 1,002 471 531 1,523

2010 437 2 (72) (12) (46) 14 323 (284) (41) 35 215 (213) 204 204 (8) 196
2011E 607 41 (106) (26) (45) 471 (1,080) (624) 250 (45) (404) (404)
2012E 724 4 (100) (42) (3) 583 (387) 234 (100) (69) 27 27
2013E 923 4 (142) (36) (22) 728 (416) 343 (100) (65) 146 146
2014E 1,088 6 (177) (29) (24) 866 (439) 450 (100) (93) 234 234
2015E 1,358 10 (235) (23) (30) 1,079 (312) 781 (100) (115) 552 552
320 9 (44) (13) 117 21 410 (107) (19) 286 (81) (34) (23) 146 8 154
TROIKA DIALOG
69
JANUARY 2012
Gazprom
2009 Revenues Operating costs EBIT Depreciation EBITDA Net interest expenses Forex gain/(loss) Monetary gain/(loss) Net other expenses EBT Tax Income before minority interest Minority interest Net income
2010 118,661 81,947 36,713 8,025 44,739 (596) 688 25 5,160 41,990 (9,084) 32,906 (971) 31,935
2011E 157,203 103,860 53,342 9,373 62,715 (925) 1,666 4,049 58,132 (12,077) 46,055 (1,344) 44,710
2012E 160,807 111,654 49,153 12,184 61,337 (859) 157 3,960 52,410 (11,006) 41,404 (1,212) 40,192
2013E 163,319 120,439 42,880 14,789 57,669 (681) 3,723 45,921 (9,643) 36,278 (1,062) 35,216
2014E 166,638 128,901 37,737 16,993 54,729 (520) 3,533 40,750 (8,558) 32,193 (942) 31,250
2015E 168,925 136,135 32,790 19,034 51,824 (416) 3,346 35,720 (7,501) 28,219 (826) 27,393
93,798 66,798 26,999 7,000 34,000 (1,175) (628) 2 6,211 31,409 (5,908) 25,501 (445) 25,056

2009 Fixed assets and investments Current assets Stock and inventories Accounts receivable Cash and securities Other current assets Total assets Current liabilities Accounts payable Short term debt Long term liabilities Long term debt Deferred profit tax liability Other long term liabilities Total liabilities Minority interest Equity Share capital Retained earnings Total liabilities and equity
2010 241,350 61,103 10,667 24,819 14,434 11,182 302,453 33,116 26,860 6,256 55,289 36,821 10,909 7,559 88,405 9,386 204,662 10,649 194,012 302,453
2011E 282,091 71,999 14,073 30,697 14,180 13,049 354,089 41,892 35,079 6,813 55,446 34,883 12,495 8,068 97,338 10,730 246,022 10,649 235,372 354,089
2012E 317,611 77,889 14,815 33,357 16,663 13,053 395,500 47,016 40,494 6,522 54,800 32,806 13,925 8,068 101,816 11,942 281,742 10,649 271,093 395,500
2013E 347,664 80,615 15,796 32,664 19,102 13,053 428,279 48,027 41,703 6,324 54,309 31,063 15,178 8,068 102,336 13,004 312,939 10,649 302,290 428,279
2014E 375,513 83,124 16,787 33,328 19,955 13,053 458,637 50,253 44,116 6,137 53,770 29,412 16,290 8,068 104,023 13,946 340,667 10,649 330,018 458,637
2015E 401,321 83,406 17,595 33,785 18,973 13,053 484,727 51,840 45,880 5,959 53,180 27,848 17,264 8,068 105,020 14,772 364,935 10,649 354,286 484,727
222,317 56,224 9,549 28,074 8,318 10,283 278,542 34,871 20,330 14,542 55,629 39,602 10,673 5,354 90,500 10,639 177,403 10,831 166,572 278,542

2009 EBITDA Provisions and non cash items Taxes (Increase)/decrease in working capital Increase in other assets Operating cash flow Capex Other investments Free cash flow Increase/(decrease) in debt Interest paid Dividends Additional share issues/(purchase) Net cash flow Forex and monetary effects on cash Other sources/(uses) of funds Change in cash position
2010 44,739 3,603 (8,567) 8,464 (115) 48,124 (34,335) (252) 13,537 (4,063) (1,101) (1,815) 7 6,565 (211) (22) 6,332
2011E 62,715 0 (10,491) (1,064) (1,612) 49,548 (41,051) (4,016) 4,481 (1,388) (3,099) (251) (258) (44) 3 (254)
2012E 61,337 0 (9,576) 2,012 (2,612) 51,161 (38,968) (3,806) 8,386 (1,428) (4,471) 2,487 57 (4) 2,483
2013E 57,669 0 (8,391) 922 (1,405) 48,795 (37,368) (3,526) 7,901 (1,443) (4,019) 2,439 2,439
2014E 54,729 0 (7,446) 759 (1,560) 46,482 (37,368) (3,277) 5,837 (1,462) (3,522) 854 854
2015E 51,824 0 (6,527) 498 (1,734) 44,062 (37,368) (3,077) 3,617 (1,475) (3,125) (983) (983)
34,000 2,608 (4,508) (1,524) (1,723) 28,852 (25,017) (6,209) (2,373) 2,322 (1,849) (526) (2) (2,428) 149 (35) (2,314)
70
TROIKA DIALOG
JANUARY 2012
Gazprom Neft
2010 32,772 28,177 4,595 1,619 6,214 (288) (22) (71) 4,214 (844) 3,370 (285) 3,085
2011E 44,316 37,471 6,844 1,988 8,832 (230) (239) 282 6,658 (1,380) 5,278 (192) 5,085
2012E 44,053 38,352 5,700 2,106 7,807 (243) (87) 245 5,616 (1,123) 4,493 (162) 4,331
2013E 44,636 39,140 5,496 2,195 7,691 (154) 290 5,633 (1,127) 4,506 (163) 4,343
2014E 44,797 39,549 5,248 2,313 7,561 (78) 459 5,629 (1,126) 4,503 (163) 4,341
2015E 44,964 39,982 4,982 2,439 7,421 (7) 637 5,612 (1,122) 4,489 (162) 4,327
24,166 20,737 3,429 1,475 4,904 (261) 50 679 3,897 (816) 3,081 (68) 3,013

2009 Fixed assets and investments Current assets Stock and inventories Accounts receivable Cash and securities Other current assets Total assets Current liabilities Accounts payable Short term debt Other current liabilities Long term liabilities Long term debt Other long term liabilities Total liabilities Minority interest Equity Share capital Retained earnings Total liabilities and equity
2010 24,971 7,093 1,862 2,674 1,146 1,411 32,064 4,851 2,780 1,694 377 6,415 4,942 1,473 11,266 2,111 18,687 509 18,178 32,064
2011E 26,497 9,126 2,086 3,384 2,246 1,410 35,622 5,217 3,155 1,685 377 5,046 3,508 1,538 10,262 2,303 23,056 509 22,547 35,622
2012E 28,049 11,313 2,231 3,592 4,079 1,411 39,362 5,608 3,534 1,697 377 5,071 3,533 1,538 10,679 2,465 26,218 509 25,709 39,362
2013E 29,985 12,897 2,388 3,495 5,603 1,411 42,881 5,618 3,544 1,697 377 5,071 3,533 1,538 10,689 2,628 29,565 509 29,056 42,881
2014E 32,101 14,481 2,555 3,508 7,008 1,411 46,583 5,815 3,741 1,697 377 5,071 3,533 1,538 10,885 2,791 32,907 509 32,398 46,583
2015E 34,413 15,873 2,734 3,521 8,208 1,411 50,286 6,027 3,953 1,697 377 5,071 3,533 1,538 11,098 2,953 36,235 509 35,726 50,286
23,110 6,802 1,737 2,926 868 1,271 29,912 5,692 3,128 2,148 416 5,563 4,162 1,401 11,255 2,506 16,151 575 15,576 29,912

2009 EBITDA Provisions and non cash items Taxes (Increase)/decrease in working capital Increase in other assets Operating cash flow Capex Other investments Free cash flow Increase/(decrease) in debt Interest paid Dividends Additional share issues/(purchase) Net cash flow Forex and monetary effects on cash Change in cash position
2010 6,214 (247) (718) 388 (141) 5,496 (3,301) (1,551) 644 419 (336) (728)
2011E 8,832 1,789 (920) (510) (1,279) 7,912 (3,792) 73 4,193 (343) (716)
2012E 7,807 (822) (1,419) (32) 854 6,388 (4,491) 73 1,970 (361) (1,170)
2013E 7,691 (846) (1,140) (50) 896 6,551 (5,100) 73 1,524 (363) (996)
2014E 7,561 (867) (1,099) 17 849 6,462 (5,353) 73 1,182 (363) (999)
2015E 7,421 (1,042) (1,050) 20 1,022 6,371 (5,846) 73 598 (363) (998)
4,904 772 (1,485) (297) (475) 3,419 (2,607) (2,272) (1,460) 1,122 (367) (937)
(1,642)
13
(1)
47
3,134
439
164
(181)
(764)
(1,629)
46
3,134
439
164
(181)
(764)
TROIKA DIALOG
71
JANUARY 2012
KazMunaiGas EP
2010 4,778 2,868 1,910 241 2,151 (51) (23) 146 1,982 (390) 1,592 (4) 1,588
2011E 5,837 3,808 2,029 296 2,325 (49) 5 (19) 1,965 (419) 1,546 10 1,556
2012E 6,161 3,735 2,426 317 2,743 (50) 2,377 (428) 1,949 1,949
2013E 5,898 3,754 2,144 317 2,461 (50) 2,094 (349) 1,745 1,745
2014E 6,005 3,845 2,160 317 2,478 (50) 2,111 (331) 1,780 1,780
2015E 6,004 3,940 2,064 317 2,381 (50) 2,014 (311) 1,703 1,703
3,565 2,227 1,338 211 1,549 (22) 647 (0) 1,963 (515) 1,448 94 1,542

2009 Fixed assets and investments Current assets Stock and inventories Accounts receivable Cash and securities Other current assets (cash deposits) Total assets Current liabilities Accounts payable Short term debt Deferred taxes and provisions Other current liabilities Long term liabilities Long term debt Other long term liabilities Total liabilities Minority interest Equity Share capital Retained earnings Total liabilities and equity
2010 5,514 4,181 127 633 669 2,752 9,695 1,150 321 408 108 313 677 423 254 1,826 7,869 1,453 6,416 9,695
2011E 5,879 5,103 138 632 1,601 2,732 10,981 1,218 294 405 107 411 672 419 252 1,890 9,092 1,442 7,650 10,981
2012E 6,482 6,033 151 647 2,466 2,769 12,515 1,268 322 411 108 427 681 425 256 1,949 10,566 1,461 9,105 12,515
2013E 6,856 6,892 158 629 3,337 2,769 13,748 1,281 335 411 108 427 681 425 256 1,962 11,785 1,461 10,324 13,748
2014E 7,242 7,768 164 631 4,205 2,769 15,010 1,304 349 411 108 436 681 425 256 1,985 13,025 1,461 11,563 15,010
2015E 7,636 8,591 171 633 5,018 2,769 16,227 1,329 364 411 108 446 681 425 256 2,010 14,217 1,461 12,756 16,227
3,726 4,987 105 410 725 3,747 8,713 1,109 232 308 183 386 858 620 238 1,967 6,746 1,608 5,138 8,713

2009 Profit before tax Adjustments for non cash items Income tax paid Share in associates (Increase)/decrease in working capital Operating cash flow Capital expenditures Other investments, net Investing cash flow Increase/(decrease) in debt Dividends Additional share issues (purchase) Financing cash flow FX and monetary effects on cash Change in cash position Cash at beginning of period Cash at end of period
2010 1,982 (82) (631) (385) (99) 785 (588) 375 (214) (139) (327) (167) (633) (1) (62) 731 669
2011E 2,242 147 (515) (647) 62 1,289 (726) 928 203 (49) (429) (478) (65) 949 672 1,621
2012E 2,386 157 (589) (796) 16 1,174 (835) 929 94 (50) (446) (496) 71 843 1,622 2,466
2013E 2,114 114 (492) (697) 26 1,065 (668) 929 261 (50) (403) (452) (3) 871 2,466 3,337
2014E 2,131 71 (482) (735) 14 999 (668) 929 261 (50) (409) (459) 67 868 3,337 4,205
2015E 2,034 27 (448) (664) 15 965 (668) 929 261 (50) (394) (443) 31 813 4,205 5,018
1,930 (179) (782) 17 23 1,008 (293) (1,415) (1,708) (44) (312) (145) (500) (0) (1,200) 1,927 728
72
TROIKA DIALOG
JANUARY 2012
LUKoil
2010 104,956 93,423 11,533 4,154 15,687 (538) (122) 597 11,470 (2,351) 9,119 (113) 9,006
2011E 133,702 118,412 15,290 4,297 19,587 (509) (297) 992 15,476 (3,501) 11,976 (183) 11,792
2012E 125,721 111,663 14,058 4,443 18,501 (483) 52 645 14,273 (2,871) 11,401 (183) 11,218
2013E 127,132 113,705 13,427 4,587 18,014 (495) 613 13,544 (2,776) 10,768 (174) 10,595
2014E 126,641 114,148 12,492 4,744 17,237 (522) 613 12,584 (2,579) 10,004 (161) 9,843
2015E 126,159 114,821 11,338 4,911 16,248 (658) 613 11,292 (2,315) 8,978 (145) 8,833
81,083 71,305 9,778 3,937 13,715 (533) (520) 338 9,063 (1,994) 7,069 (58) 7,011

2009 Fixed assets and investments Current assets Stock and inventories Accounts receivable Cash and securities Other current assets Total assets Current liabilities Accounts payable Short term debt Deferred taxes and provisions Long term liabilities Long term debt Other long term liabilities Total liabilities Minority interest Equity Share capital Retained earnings Total liabilities and equity
2010 63,400 20,617 6,231 11,153 2,368 865 84,017 10,775 7,706 2,125 944 13,634 9,069 4,565 24,409 411 59,197 4,715 54,482 84,017
2011E 68,502 26,764 7,050 11,868 6,753 1,093 95,266 13,068 8,698 3,426 944 13,032 7,696 5,336 26,100 411 68,755 4,715 64,040 95,266
2012E 77,753 26,674 6,721 12,358 6,531 1,064 104,427 13,309 8,900 3,465 944 13,196 7,751 5,446 26,505 411 77,511 4,715 72,796 104,427
2013E 86,778 26,202 7,131 12,539 5,468 1,064 112,980 13,806 9,397 3,465 944 13,301 7,751 5,550 27,107 411 85,462 4,715 80,747 112,980
2014E 94,928 25,493 7,093 12,838 4,499 1,064 120,420 13,959 9,550 3,465 944 13,397 7,751 5,647 27,356 411 92,653 4,715 87,938 120,420
2015E 99,815 27,215 7,051 13,134 5,966 1,064 127,030 14,204 9,795 3,465 944 13,484 7,751 5,734 27,688 411 98,931 4,715 94,216 127,030
61,180 17,839 5,432 9,484 2,274 649 79,019 9,694 6,734 2,058 902 12,946 9,265 3,681 22,640 388 55,991 4,714 51,277 79,019

2010 15,687 1,524 (2,126) (718) (1,316) 490 13,541 (6,596) (700) 6,245 35 (1,471) (4,710) 99 (5) 94
2011E 19,587 886 (2,971) (759) (539) (1,510) 14,694 (8,337) 262 6,620 (2,234) 4,385 4,385
2012E 18,501 728 (2,761) (754) 7 (311) 15,408 (13,401) 233 2,240 (2,462) (222) (222)
2013E 18,014 751 (2,672) (761) (93) (249) 14,989 (13,625) 216 1,580 (2,643) (1,063) (1,063)
2014E 17,237 732 (2,482) (761) (108) (926) 13,692 (12,226) 216 1,682 (2,653) (970) (970)
2015E 16,248 627 (2,228) (761) (10) (927) 12,950 (9,144) 216 4,023 (2,558) 1,465 1,465
13,715 (254) (1,575) (520) (2,502) 19 8,883 (6,483) (2,440) (40) 1,489 (1,337) (65) 47 (12) 35
TROIKA DIALOG
73
JANUARY 2012
NOVATEK
2010 3,851 2,197 1,654 218 1,872 5 34 (11) 1,682 (356) 1,326 8 1,335
2011E 5,991 3,255 2,736 305 3,042 45 (105) (99) 2,578 (547) 2,031 2,031
2012E 7,098 3,962 3,136 325 3,461 52 32 3,220 (681) 2,539 2,539
2013E 8,466 4,448 4,018 341 4,359 52 91 4,162 (880) 3,282 3,282
2014E 9,607 4,912 4,695 354 5,049 52 258 5,005 (1,058) 3,947 3,947
2015E 10,190 5,262 4,928 369 5,297 52 404 5,384 (1,139) 4,246 4,246
2,861 1,790 1,071 177 1,249 (10) (10) (7) 1,045 (218) 827 11 838

2009 Fixed assets and investments Current assets Stock and inventories Accounts receivable Cash and securities Other current assets Total assets Current liabilities Accounts payable Short term debt Deferred taxes and provisions Other current liabilities Long term liabilities Long term debt Other long term liabilities Total liabilities Minority interest Equity Share capital Retained earnings Total liabilities and equity
2010 8,370 968 61 284 335 288 9,339 1,881 933 824 125 1,963 1,542 422 3,844 677 4,818 1,009 3,809 9,339
2011E 8,789 2,337 63 328 1,658 288 11,126 914 265 421 227 3,301 2,785 516 4,215 660 6,251 1,009 5,242 11,126
2012E 9,809 3,092 68 389 2,352 282 12,901 917 298 421 198 3,301 2,785 516 4,218 643 8,040 1,009 7,031 12,901
2013E 10,361 4,877 75 464 4,056 282 15,238 962 321 421 219 3,301 2,785 516 4,263 626 10,349 1,009 9,340 15,238
2014E 11,018 7,024 81 526 6,134 282 18,042 1,008 346 421 241 3,301 2,785 516 4,309 609 13,124 1,009 12,115 18,042
2015E 11,744 9,302 88 558 8,373 282 21,045 1,044 373 421 250 3,301 2,785 516 4,345 592 16,108 1,009 15,099 21,045
5,538 912 60 283 351 218 6,449 786 244 461 81 1,219 795 424 2,005 637 3,807 1,013 2,794 6,449

2009 EBITDA Provisions and non cash items Taxes (Increase)/decrease in working capital Increase in other assets Operating cash flow Capex Other investments Free cash flow Increase/(decrease) in debt Dividends Net cash flow Forex and monetary effects on cash Other sources/(uses) of funds Change in cash position
2010 1,872 26 (282) (139) 1,477 (706) (1,561) (790) 1,116 (325) 1 (3) (8) (10)
2011E 3,042 (212) (423) 27 388 2,821 (864) 1,957 (20) (614) 1,322 1,322
2012E 3,461 135 (526) (63) (631) 2,376 (895) 1,481 (20) (767) 695 695
2013E 4,359 195 (680) (36) (231) 3,606 (893) 2,713 (20) (990) 1,704 1,704
2014E 5,049 362 (818) (23) (292) 4,279 (1,011) 3,268 (1,189) 2,078 2,078
2015E 5,297 507 (880) (3) (310) 4,612 (1,094) 3,517 (1,279) 2,239 2,239
1,249 31 (134) 24 1,169 (510) (623) 37 227 (240) 23 4 (18) 9
74
TROIKA DIALOG
JANUARY 2012
Rosneft
2009 Revenues Operating costs EBIT Depreciation EBITDA Net interest expenses Forex gain/(loss) Net other expenses EBT Tax Income before minority interest Minority interest Extraordinary gain Net income
2010 63,047 49,548 13,499 5,597 19,096 (33) 32 (182) 13,316 (2,644) 10,672 (272) 2 10,402
2011E 92,558 76,213 16,344 6,081 22,425 198 (300) (90) 16,152 (3,460) 12,692 (176) 12,516
2012E 93,457 79,680 13,776 6,497 20,273 98 (37) 13,837 (2,747) 11,090 (161) 10,928
2013E 94,469 80,484 13,985 6,670 20,655 54 (171) 13,868 (2,733) 11,135 (161) 10,974
2014E 96,491 82,777 13,714 6,799 20,512 148 (291) 13,571 (2,675) 10,896 (161) 10,735
2015E 98,393 84,438 13,955 6,954 20,909 328 (283) 14,001 (2,760) 11,241 (161) 11,080
46,826 37,698 9,128 4,350 13,478 (89) 71 (591) 8,519 (2,000) 6,519 (5) 18 6,532

2009 Fixed assets and investments Current assets Stock and inventories Accounts receivable Cash and securities Other current assets Total assets Current liabilities Accounts payable Short term debt Deferred taxes and provisions Other current liabilities Long term liabilities Long term debt Other long term liabilities Total liabilities Minority interest Equity Share capital Retained earnings Total liabilities and equity
2010 70,786 23,043 2,111 7,512 4,184 9,236 93,829 11,693 3,861 5,498 1,971 363 26,632 18,057 8,575 38,325 969 54,535 5,619 48,916 93,829
2011E 77,108 30,679 3,247 9,383 9,410 8,640 107,788 17,303 5,124 8,661 3,153 365 23,462 14,894 8,568 40,766 1,145 65,877 5,619 60,258 107,788
2012E 85,725 32,480 3,395 9,474 10,971 8,640 118,205 18,083 5,888 8,661 3,169 365 23,442 14,894 8,548 41,525 1,306 75,373 5,619 69,754 118,205
2013E 93,038 34,495 3,429 9,576 12,849 8,640 127,533 18,015 5,817 8,661 3,172 365 23,422 14,894 8,528 41,437 1,468 84,628 5,619 79,009 127,533
2014E 98,420 38,410 3,527 9,781 16,462 8,640 136,830 18,499 6,238 8,661 3,235 365 23,402 14,894 8,508 41,901 1,629 93,300 5,619 87,681 136,830
2015E 103,636 42,425 3,597 9,974 20,213 8,640 146,061 18,984 6,717 8,661 3,241 365 23,382 14,894 8,488 42,366 1,790 101,905 5,619 96,286 146,061
68,063 15,169 1,886 6,458 2,017 4,808 83,232 13,443 3,697 7,838 1,627 281 24,252 15,669 8,583 37,695 706 44,831 5,603 39,228 83,232

2009 EBITDA Provisions and non cash items Taxes Interest paid (Increase)/decrease in working capital Operating cash flow Capex Other investments Free cash flow Increase/(decrease) in debt Dividends Additional share issues/(purchase) Net cash flow Forex and monetary effects on cash Change in cash position
2010 19,096 369 (2,891) (618) (784) 15,172 (8,931) (3,508) 2,733 170 (741) 13 2,175 (18) 2,157
2011E 22,425 91 (3,665) (495) (246) 18,110 (11,661) 6,449 (1,194) 5,256 5,256
2012E 20,273 (12) (2,767) (495) 741 17,740 (14,746) 2,994 (1,432) 1,562 1,562
2013E 20,655 (56) (2,754) (495) 113 17,463 (13,866) 3,597 (1,719) 1,878 1,878
2014E 20,512 38 (2,695) (495) 352 17,713 (12,037) 5,676 (2,063) 3,613 3,613
2015E 20,909 220 (2,780) (495) 349 18,204 (11,977) 6,226 (2,475) 3,751 3,751
13,478 (1,119) (1,561) (690) 211 10,319 (7,252) (1,536) 1,531 (246) (626) (5) 654 (26) 628
TROIKA DIALOG
75
JANUARY 2012
Surgutneftegaz
Income statement, $ mln
2009 Revenues Operating costs EBIT Depreciation EBITDA Net interest expenses Forex gain/(loss) Net other expenses EBT Tax Income before minority interest Net income
2010 30,347 26,100 4,247 3,405 7,652 1,071 18 (20) 5,315 (1,116) 4,199 4,199
2011E 42,763 36,441 6,322 3,476 9,798 1,189 (54) (20) 7,437 (1,562) 5,875 5,875
2012E 40,170 35,097 5,073 3,496 8,569 1,393 52 (20) 6,499 (1,365) 5,134 5,134
2013E 38,840 34,606 4,234 3,500 7,734 1,571 (20) 5,784 (1,215) 4,570 4,570
2014E 38,794 35,618 3,176 3,505 6,682 1,718 (20) 4,875 (1,024) 3,851 3,851
2015E 38,746 36,733 2,014 3,510 5,524 1,880 (20) 3,874 (814) 3,060 3,060
24,083 20,614 3,470 2,846 6,316 978 205 (20) 4,632 (973) 3,660 3,660
Balance sheet, $ mln

2009 Fixed assets and investments Current assets Stock and inventories Accounts receivable Cash and securities Other current assets Total assets Current liabilities Accounts payable Short term debt Other current liabilities Long term liabilities Other long term liabilities Total liabilities Minority interest Equity Share capital Retained earnings Total liabilities and equity
Source: roika estimates
2010 12,540 25,441 574 2,131 14,491 8,244 37,980 2,800 2,575 10 215 948 948 3,748 6 34,226 6,512 27,714 37,980
2011E 13,530 30,380 632 2,991 17,885 8,872 43,910 3,664 3,439 10 215 1,056 1,056 4,720 6 39,184 6,512 32,672 43,910
2012E 14,335 33,737 659 2,858 20,545 9,674 48,072 3,835 3,610 10 215 1,150 1,150 4,985 6 43,081 6,512 36,569 48,072
2013E 14,977 36,488 701 2,733 22,680 10,374 51,465 3,657 3,432 10 215 1,233 1,233 4,891 6 46,569 6,512 40,057 51,465
2014E 14,867 39,674 745 2,730 25,125 11,074 54,541 3,774 3,549 10 215 1,304 1,304 5,078 6 49,457 6,512 42,945 54,541
2015E 14,607 42,334 770 2,726 27,064 11,774 56,941 3,869 3,644 10 215 1,360 1,360 5,229 6 51,706 6,512 45,194 56,941
11,315 22,698 509 1,689 12,957 7,544 34,013 2,313 2,088 10 215 871 871 3,185 6 30,822 6,512 24,310 34,013

2009 EBITDA Provisions and non cash items Taxes Interest paid (Increase)/decrease in working capital Increase in other assets Operating cash flow Capex Other investments Free cash flow Dividends Net cash flow Change in cash position
2010 7,652 1,236 (1,039) (6) (3) 18 7,858 (4,578) (950) 2,330 (795) 1,535 1,535
2011E 9,798 1,319 (1,454) (6) 19 22 9,698 (4,437) (950) 4,311 (917) 3,393 3,393
2012E 8,569 1,676 (1,271) (6) 138 (63) 9,043 (4,195) (950) 3,898 (1,238) 2,660 2,660
2013E 7,734 1,777 (1,131) (6) (94) 21 8,301 (4,134) (950) 3,218 (1,082) 2,136 2,136
2014E 6,682 1,939 (953) (6) 76 20 7,758 (3,400) (950) 3,407 (963) 2,444 2,444
2015E 5,524 2,116 (758) (6) 73 19 6,968 (3,268) (950) 2,750 (811) 1,939 1,939
6,316 1,286 (906) (6) 125 22 6,837 (3,914) (950) 1,972 (995) 977 977
76
TROIKA DIALOG
JANUARY 2012
Tatneft
2010 15,401 13,292 2,109 412 2,521 108 (64) (31) 2,122 (456) 1,666 (130) 1,535
2011E 20,759 17,919 2,840 468 3,308 68 (87) 21 2,842 (721) 2,121 (100) 2,021
2012E 19,502 16,707 2,795 534 3,329 102 40 2,937 (631) 2,306 (111) 2,195
2013E 20,308 17,023 3,285 573 3,859 111 50 3,447 (741) 2,706 (130) 2,576
2014E 20,516 17,301 3,214 613 3,827 127 61 3,402 (731) 2,671 (129) 2,543
2015E 20,669 17,383 3,287 621 3,908 175 75 3,536 (760) 2,776 (134) 2,643
12,091 9,928 2,162 373 2,535 113 (25) 94 2,345 (552) 1,793 (42) 1,751

2010 14,233 4,341 496 2,286 359 1,199 18,574 2,647 1,522 1,124 1 4,447 2,457 1,990 7,094 391 11,088 3,240 7,848 18,574
2011E 15,732 5,941 629 2,515 1,597 1,199 21,673 4,278 1,848 2,429 1 4,171 2,126 2,045 8,449 498 12,725 3,240 9,485 21,673
2012E 17,402 6,337 624 2,628 1,886 1,199 23,739 4,474 2,018 2,454 1 4,242 2,141 2,101 8,716 609 14,414 3,240 11,174 23,739
2013E 19,120 6,871 676 2,671 2,325 1,199 25,991 4,503 2,048 2,454 1 4,308 2,141 2,167 8,812 739 16,440 3,240 13,200 25,991
2014E 19,894 8,303 706 2,698 3,699 1,199 28,197 4,618 2,163 2,454 1 4,374 2,141 2,232 8,992 868 18,337 3,240 15,097 28,197
2015E 20,711 9,750 723 2,718 5,110 1,199 30,461 4,675 2,219 2,454 1 4,441 2,141 2,300 9,116 1,002 20,343 3,240 17,103 30,461
11,984 4,527 389 2,114 830 1,194 16,511 3,693 1,315 2,372 6 2,376 552 1,824 6,069 266 10,176 3,266 6,910 16,511

2009 EBITDA Provisions and non cash items Taxes Interest paid (Increase)/decrease in working capital Operating cash flow Capex Other investments Free cash flow Increase/(decrease) in debt Interest paid Dividends Additional share issues/(purchase) Net cash flow Change in cash position
2010 2,521 122 (456) (383) (74) 1,730 (2,565) 420 (415) 653 108 (492) (13) (158) (158)
2011E 3,308 29 (721) (36) (94) 2,486 (1,923) (10) 554 1,000 68 (385) 1,237 1,237
2012E 3,329 21 (631) 63 96 2,877 (2,173) (10) 693 102 (506) 289 289
2013E 3,859 66 (741) (65) 20 3,139 (2,252) (10) 877 111 (550) 439 439
2014E 3,827 65 (731) 57 20 3,238 (1,335) (10) 1,893 127 (645) 1,375 1,375
2015E 3,908 68 (760) 20 20 3,256 (1,374) (10) 1,872 175 (637) 1,410 1,410
2,535 93 (552) (165) 111 2,022 (2,806) (65) (849) 1,092 113 (317) (16) 23 23
TROIKA DIALOG
77
JANUARY 2012
TNK BP Holding
2010 41,113 32,981 8,132 1,812 9,944 252 (81) 27 8,330 (1,530) 6,800 (260) 6,540
2011E 54,562 42,543 12,019 1,971 13,990 150 (230) (25) 11,914 (2,269) 9,645 (457) 9,188
2012E 51,721 42,197 9,523 2,239 11,762 379 9,902 (2,066) 7,836 (380) 7,457
2013E 50,819 42,201 8,619 2,515 11,133 638 9,257 (1,931) 7,325 (355) 6,971
2014E 50,891 43,425 7,466 2,752 10,218 774 8,241 (1,719) 6,521 (316) 6,206
2015E 51,189 45,303 5,887 2,972 8,859 735 6,621 (1,381) 5,240 (254) 4,986
31,172 24,900 6,272 1,714 7,986 164 (50) 171 6,557 (1,228) 5,329 (154) 5,175

2010 20,313 10,568 942 7,740 1,696 190 30,881 4,634 4,323 152 159 5,144 3,384 1,760 9,778 894 20,209 4,651 15,558 30,881
2011E 21,666 14,588 907 10,272 2,612 798 36,255 6,305 5,994 152 159 5,447 3,384 2,063 11,752 1,351 23,152 4,651 18,501 36,255
2012E 24,112 16,772 904 9,737 5,333 798 40,883 6,387 6,076 152 159 5,832 3,384 2,448 12,220 1,730 26,934 4,651 22,283 40,883
2013E 26,270 19,515 964 9,567 8,186 798 45,785 6,566 6,255 152 159 6,212 3,384 2,828 12,778 2,085 30,922 4,651 26,271 45,785
2014E 28,209 22,000 1,030 9,581 10,591 798 50,209 6,886 6,575 152 159 6,583 3,384 3,199 13,469 2,401 34,339 4,651 29,688 50,209
2015E 30,223 23,511 1,107 9,637 11,969 798 53,734 7,296 6,985 152 159 6,941 3,384 3,557 14,237 2,655 36,843 4,651 32,192 53,734
18,847 9,194 707 7,917 483 87 28,041 4,782 3,448 634 700 3,096 1,591 1,505 7,878 729 19,434 5,468 13,966 28,041

2010 9,944 559 (1,437) (167) 195 36 9,130 (3,184) (1,546) 4,400 1,569 (5,154) (52) 763 (8) 755
2011E 13,990 230 (2,166) (106) (826) 811 11,932 (4,180) 16 7,768 (6,245) 1,524 1,524
2012E 11,762 604 (1,980) (106) 620 165 11,064 (4,684) 16 6,396 (3,675) 2,721 2,721
2013E 11,133 863 (1,851) (106) 289 165 10,493 (4,673) 16 5,836 (2,983) 2,853 2,853
2014E 10,218 999 (1,648) (106) 241 165 9,869 (4,691) 16 5,194 (2,788) 2,406 2,406
2015E 8,859 960 (1,324) (106) 276 165 8,830 (4,986) 16 3,860 (2,482) 1,378 1,378
7,986 292 (1,032) (114) 411 88 7,631 (2,337) (843) 4,451 429 (5,214) (273) (607) 6 (601)
78
TROIKA DIALOG
JANUARY 2012
Transneft
2010 14,728 9,215 5,514 2,364 7,878 (464) 7 150 5,207 (1,075) 4,131 (207) 3,924
2011E 20,674 12,853 7,821 2,699 10,521 (344) 96 1,128 8,701 (1,740) 6,961 (346) 6,615
2012E 21,670 13,650 8,020 3,076 11,096 (557) 150 7,612 (1,522) 6,090 (303) 5,787
2013E 24,088 13,801 10,287 3,450 13,737 (472) 150 9,965 (1,993) 7,972 (396) 7,575
2014E 24,212 14,637 9,575 3,730 13,305 (260) 150 9,464 (1,893) 7,572 (376) 7,195
2015E 24,466 15,544 8,922 4,009 12,931 (38) 150 9,033 (1,807) 7,227 (359) 6,867
11,096 5,754 5,342 1,486 6,828 (459) 43 31 4,956 (1,091) 3,865 (43) 3,822

2009 Fixed assets and investments Current assets Stock and inventories Accounts receivable Cash and securities Other current assets Total assets Current liabilities Accounts payable Short term debt Long term liabilities Long term debt Other long term liabilities Total liabilities Minority interest Equity Share capital Retained earnings Total liabilities and equity
2010 40,491 13,595 566 1,962 9,289 1,778 54,086 3,640 3,292 349 24,037 18,769 5,268 27,678 1,107 25,302 10 25,292 54,086
2011E 45,222 18,170 2,294 4,845 10,869 162 63,392 5,964 5,249 715 24,106 18,706 5,400 30,070 1,453 31,869 10 31,859 63,392
2012E 49,919 16,561 2,229 5,048 9,124 160 66,480 6,051 5,409 642 21,096 15,778 5,318 27,147 1,755 37,578 10 37,568 66,480
2013E 52,409 16,956 2,215 6,105 8,476 160 69,365 6,554 6,017 537 15,574 10,256 5,318 22,128 2,152 45,086 10 45,076 69,365
2014E 54,581 16,831 2,270 6,402 7,999 160 71,412 6,797 6,367 430 9,895 4,577 5,318 16,692 2,528 52,192 10 52,181 71,412
2015E 55,968 18,401 2,333 6,737 9,171 160 74,369 7,106 6,762 345 5,401 83 5,318 12,507 2,887 58,974 10 58,964 74,369
33,398 13,888 430 2,645 9,447 1,366 47,285 2,635 2,257 378 21,956 18,050 3,906 24,591 881 21,814 10 21,803 47,285

2009 EBITDA Provisions and non cash items Taxes Interest paid (Increase)/decrease in working capital Operating cash flow Capex Other investments Free cash flow Increase/(decrease) in debt Interest paid Dividends Additional share issues/(purchase) Net cash flow Forex and monetary effects on cash Change in cash position
2010 7,878 (3,277) 1,625 1,581 (20) 7,787 (7,413) 144 518 1,038 (1,156) (47) (25) 327 (101) 226
2011E 10,521 (176) (1,740) (2,654) 176 6,127 (7,448) (1,322) (349) (765) (48) (2,483) (2,483)
2012E 11,096 (1,522) 21 9,595 (7,384) 2,211 (2,052) (777) (78) (695) (695)
2013E 13,737 (1,993) (434) 11,309 (5,550) 5,759 (5,627) (657) (68) (592) (592)
2014E 13,305 (1,893) (2) 11,410 (5,513) 5,897 (5,786) (432) (89) (410) (410)
2015E 12,931 0 (1,807) (3) 11,121 (5,007) 6,114 (4,579) (200) (85) 1,250 1,250
6,828 (1,485) 522 88 (52) 5,901 (6,391) (819) (1,309) 9,147 (715) (10) (103) 7,010 60 7,070
TROIKA DIALOG
79
JANUARY 2012
Disclosure appendix
IMPORTANT US REGULATORY DISCLOSURES
An affiliate of Troika Dialog USA makes a market in the securities of Alliance Oil Company, Bashneft, Eurasia Drilling Company, Gazprom, Gazprom Neft, KazMunaiGas EP, LUKoil, NOVATEK, Rosneft, Surgutneftegaz, Tatneft, TNK BP Holding, Transneft. The research analysts, strategists, or research associates principally responsible for the preparation of this research report have received compensation based upon various factors, including quality of research, investor client feedback, stock picking, competitive factors, firm revenues and overall investment banking revenues.
Analyst certification
The following analyst(s) hereby certify that the views expressed in this research report accurately reflect such research analyst's personal views about the subject securities and issuers and that no part of his or her compensation was, is, or will be directly or indirectly related to the specific recommendations or views contained in the research report: Alex Fak, Oleg Maximov, Valery Nesterov.
80
TROIKA DIALOG
Senior Management Chairman of Board of Directors and CEO, Troika Dialog Chief Economist, Managing Director
Ruben Vardanian
Evgeny Gavrilenkov
Research Department Head of Research Paolo Zaniboni Strategy Chief Strategist Strategist Oil and Gas Senior Analyst Senior Analyst Analyst Utilities Senior Analyst Assistant Analyst Alexander Kotikov Andrey Trufanov Oleg Maximov Alex Fak Valery Nesterov Chris Weafer Ovanes Oganisyan
+7 (495) 258 0511 +7 (495) 787 2381 Real Estate +7 (495) 933 9886 +7 (495) 933 9868 Senior Analyst Analyst Transport +7 (495) 933 9830 +7 (495) 933 9829 +7 (495) 933 9832 Analyst Analyst Market Analysis Analyst Economy Senior Economist Junior Economist Fixed Income Head of FI Research Alexander Kudrin Senior Analyst Alexey Bulgakov Analyst Analyst Assistant Analyst Ukraine Strategist Economist Senior Analyst Senior Analyst Senior Analyst Analyst Analyst Kazakhstan Analyst Analyst Zaurbek Zhunisov Ainur Medeubayeva Ekaterina Sidorova, CFA Sergey Goncharov Nikolay Minko +7 (495) 933 9847 +7 (495) 933 9866 +7 (495) 933 9849 +7 (495) 933 9854 + 7 (495) 933 9857 Anton Stroutchenevski Sergei Konygin +7 (495) 933 9843 +7 (495) 933 9848 Mikhail Ganelin Igor Vasilyev +7 (495) 933 9851 +7 (495) 933 9842 Julia Gordeyeva, CFA Igor Vasilyev +7 (495) 933 9846 +7 (495) 933 9842
Nadezhda Kireeva
+7 (495) 933 9855
+7 (495) 933 9841 +7 (495) 933 9831
Telecoms, Media and IT Analyst Assistant Analyst Anna Lepetukhina Yana Kuznetsova +7 (495) 933 9835 +7 (495) 933 9834
Metals and Mining, Chemicals Senior Analyst Analyst Analyst Assistant Analyst Mikhail Stiskin Irina Lapshina Anton Rumyantsev Alexander Levinskiy +7 (495) 933 9839 +7 (495) 933 9852 +7 (495) 933 9840 +7 (495) 258 0511
Manufacturing, Small and Mid Cap Analyst Analyst Assistant Analyst Financials Senior Analyst Consumer Senior Analyst Analyst Assistant Analyst Assistant Analyst Mikhail Ganelin Igor Vasilyev Ivan Belyaev +7 (495) 933 9851 +7 (495) 933 9842 +7 (495) 933 9853
Roman Zakharov Iryna Piontkivska Yevhen Hrebeniuk Ivan Kharchuk Sergey Nevmerzhitsky Alexander Tsependa Maria Repko
+38 (044) 207 3780
Andrew Keeley
+44 (20) 7936 0439
Mikhail Krasnoperov Georgy Tarakanov Artur Galimov Maria Sukhanova
+7 (495) 933 9838 +7 (495) 933 9858 +7 (495) 933 9833 +7 (495) 933 9856
Head Office, Moscow

4, Romanov Pereulok Moscow 125009, Russia Phone +7 (495) 258 0500 Fax +7 (495) 258 0547 +7 (495) 258 0511 +7 (495) 258 0550 +7 (495) 258 0510 +7 (495) 258 0525 +7 (495) 258 0555 +7 (495) 258 0572 +7 (495) 258 0530
Krasnoyarsk
26, Prospekt Mira Krasnoyarsk, 660049, Russia Phone +7 (3912) 91 8100; fax +7 (3912) 918 102
Volgograd
11, ul. Mira Volgograd, 400131, Russia Phone +7 (8442) 96 8211; fax +7 (8442) 335 198
Research Equity Sales Fixed Income Sales Trading Options Trading Structured Products Treasury Products
Naberezhnye Chelny
52/16 (3/01), Prospekt Mira Naberezhnye Chelny, 423810, Russia Phone +7 (8552) 39 5100; fax +7 (8552) 395 103
Voronezh
43, ul. Plekhanovskaya Voronezh, 394000, Russia Phone +7 (4732) 35 5647; fax +7 (4732) 619 961
Nizhni Novgorod
Lobachevski Plaza Business Center 10/16, ul. Alekseevskaya , 6 etazh Nizhni Novgorod, 603006, Russia Phone +7 (831) 220 1949
Yaroslavl
22, ul. Trefoleva Yaroslavl, 150000, Russia Phone +7 (4852) 67 0407; fax +7 (4852) 670 406
St Petersburg
Petrovski Fort Business Center 4, let. A, Finlyandski prospect St. Petersburg, 194153, Russia Phone +7 (812) 332 3300; fax +7 (812) 332 6657
Novosibirsk
1, Prospekt Dimitrova Novosibirsk, 630004, Russia Phone +7 (383) 210 5502; fax +7 (383) 210 5503
Troika Dialog USA

Carnegie Hall Tower 152 West 57th Street, 44th floor New York, NY 10019 Phone +1 (212) 300 9600; fax +1 (212) 300 9601
Chelyabinsk
Office 507, Business Center Arkaim Plaza 38, ul. Karla Marksa Chelyabinsk, 454091, Russia Phone +7 (351) 778 6120; fax +7 (351) 778 6121
Perm
58, ul. Lenina Perm, 614000, Russia Phone +7 (342) 218 6146; fax +7 (342) 218 6149
Troika Dialog UK
85 Fleet Street, 4th floor London, EC4Y 1AE Phone +44 (20) 7583 3257; fax +44 (20) 7822 0779
Ekaterinburg
Office 504 505, Business Center Palladium, 5th floor 10, ul. Khokhryakova Ekaterinburg, 620014, Russia Phone +7 (343) 310 7000; fax +7 (343) 379 2164
Rostov on Don
206, ul. Krasnoarmeyskaya Rostov on Don, Russia Phone/fax +7 (863) 268 8899
Troika Dialog Ukraine

6, Rylskyi Pereulok, 6th floor Kyiv 01025, Ukraine Phone +380 (44) 207 3780; fax +380 (44) 207 3784
Irkutsk
19, ul. Lenina Irkutsk, 664003, Russia Phone/fax +7 (3952) 563 636
Samara
204, ul. Molodogvardeiskaya Samara, 443001, Russia Phone +7 (846) 378 0000; fax +7 (846) 273 3328
Troika Dialog Kazakhstan

Block B, Business Center Hermes, 5th floor 101, ul. Tole Bi, Almaty, Kazakhstan Phone +7 (727) 355 3355; fax +7 (727) 355 3356
Kazan
Suvar Plaza Office Center 6, ul. Spartakovskaya Kazan, 420107, Russia Phone/fax +7 (843) 526 5522
Tyumen
2/9A, ul. 8 Marta, 2 etazh Tyumen, 625000, Russia Phone +7 (3452) 39 5450; fax +7 (3452) 395 451
Troika Dialog Group, Cyprus

57 Digeni Akrita Ave Zachariades Building, Office 301 Nicosia CY 1070 Phone +357 (22) 87 5380; fax +357 (22) 875 393
Khabarovsk
Khabarovsk City Business Center 22a, ul. Postysheva Khabarovsk, 680030, Russia Phone +7 (4212) 415 162; fax +7 (4212) 415 165
Ufa
100/1, ul. Dostoevskogo Ufa, 450077, Russia Phone +7 (347) 279 8880; fax +7 (347) 279 8881
Krasnodar
41, ul. Krasnaya Krasnodar, 350000, Russia Phone/fax +7 (861) 210 6061
Vladivostok
6, ul. Mordovtseva Vladivostok, 690091, Russia Phone +7 (423) 249 9925; fax +7 (423) 249 9926
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RUSSIA | OIL AND GAS JANUARY 2012

Russian Oil and Gas The Blushing Bride

Comparative multiples based valuation

Oleg Maximov Alex Fak Valery Nesterov

RUSSIAN OIL AND GAS THE BLUSHING BRIDE

PAGE INTENTIONALLY LEFT BLANK

RUSSIAN OIL AND GAS THE BLUSHING BRIDE

RUSSIAN OIL AND GAS THE BLUSHING BRIDE

The Water Skater

RUSSIAN OIL AND GAS THE BLUSHING BRIDE

Non FSU FSU

Source: Company, Troika

450 435 420

405 390 2010 forecast made in 2008

RUSSIAN OIL AND GAS THE BLUSHING BRIDE

Russian energy consumption by fuel type, 2000

Russian energy consumption by fuel type, 2010

Oil Natural gas Coal Nuclear energy Hydro electricity

Oil Natural gas Coal Nuclear energy Hydro electricity

2,000 1,500 1,000 500 0 0

Gas consumption/GDP, cm per $

Heating degree days* faced by an average person

Source: National statistics agencies

RUSSIAN OIL AND GAS THE BLUSHING BRIDE

4 15 68 and the city of the rich and famous

Source: Gazprom, Troika

2002 98 102 65 50 32 14 4 365

2003 101 104 68 52 33 15 4 376

2004 100 107 73 51 35 15 4 384

2005 102 107 77 52 36 15 4 392

2006 104 110 81 53 37 16 4 406

2007 105 112 84 54 38 15 9 418

2008 103 110 80 55 38 16 11 413

2009 100 101 78 51 36 16 14 396

2010 105 108 82 53 39 17 13 417

2010 split by region 25% 26% 20% 13% 9% 4% 3% 100%

RUSSIAN OIL AND GAS THE BLUSHING BRIDE

Gas consumption by sector, bcm

2002 142 101 11 17 29 19 5 7 3 10 31 43 49 365

2003 144 106 12 18 29 19 6 8 4 10 32 45 49 376

2004 149 111 14 18 29 20 6 9 4 10 30 45 49 384

2005 153 114 16 19 29 21 7 9 4 10 32 47 46 392

2006 159 118 17 19 30 21 7 9 4 10 34 49 47 406

2007 164 127 25 20 30 22 8 9 4 10 33 48 47 418

2008 165 120 22 20 29 21 7 9 4 9 32 49 47 413

2009 153 115 25 17 26 20 6 8 3 9 35 50 44 396

2010 163 121 26 18 28 21 8 9 3 9 37 51 46 417

2010 split by sector 39% 29% 6% 4% 7% 5% 2% 2% 1% 2% 9% 12% 11% 100%

Share in gas consumption growth since 2004

Four subsectors in four regions Rest of Russia

Four subsectors in four regions Rest of Russia

RUSSIAN OIL AND GAS THE BLUSHING BRIDE

Gas consumption CAGR in Russia, 2004 10

6.0% 4.0% 2.0%

0.0% Four subsectors in four regions accounting for 15% of consumption

RUSSIAN OIL AND GAS THE BLUSHING BRIDE

Share in consumption growth since 2004

Sakhalin Region oil sector,

RUSSIAN OIL AND GAS THE BLUSHING BRIDE

Source: State Statistics Service

RUSSIAN OIL AND GAS THE BLUSHING BRIDE

NPV from PCI savings*, $ mln