Research Notes

LUKOIL: withstands the crisis

19.03.09

We resume our coverage of Russian oil major LUKOIL. The global financial crisis has taken a heavy toll on the oil industry worldwide, including in Russia. The drop in demand for oil has sent oil prices falling, and this has dented the revenues of oil companies, most of whom suffered record-high losses in 2008. In these circumstances, a company’s ability to rapidly adapt to new business conditions comes to the fore, and LUKOIL is a leader in the Russian oil industry in this regard.

For the next two or three years, during which the effects of the crisis will be felt the most, LUKOIL may receive a boost from the start of production at its new oilfields in the Caspian region and the Timan-Pechora oil province. The exploration and development of oilfields in these regions should be especially lucrative given the government’s offer of tax holidays on the mineral extraction tax (MET), which are expected to save up to USD 8 billion in discounted value by 2016. Management have repeatedly stated that the company’s key projects will go ahead as planned, and will be fully financed, despite the crisis. Any reduction of capex would mainly affect the company’s older oilfields, which, in our view, could bear the brunt of underfunding amid the crisis. The Yuzhno-Khylchuyuskoye field, which came on stream in 2008, will help the company shore up production levels in 2009 and 2010 as the company expects to extract up to 8% of its oil from this field. In 2013, the company is to phase in another oil field, the Filanovskogo, which is expected to bring the company up to 10% of its total oil output by 2016. LUKOIL has given itself the ambitious task of expanding its gas segment. By 2016, the company expects to nearly quadruple gas production as compared with current levels. Cooperation with Gazprom is crucial in accomplishing this task, and LUKOIL is already cementing ties with Gazprom. In our view, gas producers may face a considerable slowdown in production growth rates in the future unless they have enlisted the support of Gazprom. LUKOIL traditionally devotes a lot of attention to the generation of additional value within its vertically integrated production chain. In 2008, the oil refining and petrochemicals segments were supplemented with an electricity generation segment, which can add value to gas LUKOIL extracts by using it as a turbine fuel. The oil refinery modernization program is also underway and the company has every chance of adopting European standards for fuel within the terms set by the state. As a result of our valuation of LUKOIL shares using a DCF method, we assign a BUY recommendation to the shares, with a target price of USD 78 per share as of March 2010.

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Sector:  O&G
Company:  Oil company Lukoil

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