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Rosneft makeover 'on the way'

Chief executive Igor Sechin has outlined bold reforms for Russia's largest oil company, but will they be put into practice?

Institutional investors have yet to be swayed by Rosneft's promise to rein in its mergers and acquisition activity, improve its chequered corporate governance and buy back $2bn of its own stock.

The oil producer, which accounts for 40% of Russia's output, said in early May it intends to shrink capital expenditure by 20%, to 800bn roubles ($12.6bn), and boost its working capital by 200bn roubles by the end of the year. The company announced the targets as "additional initiatives" for its Rosneft-2022 corporate strategy, originally approved in December 2017.

The company said it would also soon start the planned buyback of its underperforming stock in an effort to "enhance shareholder returns".

"Successful implementation of Rosneft-2022 is our top priority," said chief executive Igor Sechin, who has been the architect of the firm's large-scale acquisitions of rivals TNK-BP and Bashneft. "It will help to further boost our competitive advantage in the volatile external environment."

But many investors remain cynical about Rosneft's revamp, as they have heard similar noises in the past about de-risking, only for management to rip up plans and proceed with aggressive and opportunistic M&A.

"The market remains sceptical of Rosneft's recently announced targets, especially the $2bn buyback," said Ilkin Karimli, senior energy analyst at Credit Suisse. "As such, delivery through quarterly results and the launch of the buyback programme will lead to gradual de-risking of the investment case."

Rosneft, which is expected to start the buyback in the coming months, said it will be financed through "organic free cashflow generation and divestments of non-core assets".

Poised to ramp up production

Russia's oil reduction pact with Opec and the Kremlin's tax management for the upstream remain the two most crucial factors affecting Rosneft's plans.

Russia's energy minister Alexander Novak and his Saudi counterpart Khalid al-Falih indicated at the St Petersburg Economic Forum in May that the two biggest crude producers would soon agree on a plan to release more oil into the market.

If the production freeze is lifted, Rosneft is expected to launch activity at major new greenfield sites, which has been put on hold over the past two years. East Siberia's Uyrubcheno-Tokhomskoye and Russkoye in the northern Yamal Nenets region are expected to get the green light, while output at capex-heavy projects, like Vankor and Suzunskoe, will climb.

On Sechin's watch, Rosneft has become the embodiment of poor corporate governance

Dmitry Loukashov, senior oil analyst at VTB Capital, believes Rosneft will continue its aggressive drilling at Yuganskneftegaz. Here the highest-margin oil barrels are produced thanks to tax incentives, but Loukashov expects activity at some other assets to decrease.

Rosneft has boasted it can raise output by as much as 100,000 barrels per day within days if restrictions under the Opec pact are eased.

A report by Renaissance Capital suggests Rosneft is already testing its current capacity limits and executives told investors as much during a visit to its facilities in Siberia in May. In tests carried out over three days, the company increased output by 57,000 b/d on day one, 70,000 b/d on day two, and expected 80,000-85,000 b/d on day three.

The ramp-up was designed to "test the actual production limits ahead of the likely relaxation of Opec constraints," said Alexander Bugansky, a senior oil analyst at Renaissance Capital. He added that "more near-term production upside" was likely.

It's not unusual for oil firms' production levels to deviate from month to month, but it's not yet clear whether Rosneft's output increase will be sustained. The latest Russian oil production data indicate Rosneft increased its output by 0.2% in May compared to the prior month. Analysts at VTB Capital said the Samotlor oilfield in Western Siberia was the main contributor to production growth, because drilling had surged by 23% during the month.

Sharp profit rise

On 15 May, the company reported a sevenfold jump in first-quarter net profit to 81bn roubles ($1.5bn), on the back of rising oil prices.

Rosneft's board of directors has already approved the new strategy, which includes a bold target for liquids production to climb by 14% to 250m tonnes a year (1.98bn barrels a year) by 2022. Sechin said he expected the new strategy would increase the company's market capitalisation by 25-30% over the next five years and produce 500m tonnes more oil over the next 20 years than previously forecast.

Gas production is forecast to rise to 100bn cubic metres a year by 2020, with the growth coming from the Rospan, Kharampur and Kynsko-Chaselskaya group of fields, as part of an ambitious drive to capture 20% of the domestic gas market.

Rosneft remains the most leveraged oil company in Russia, and its deleveraging is perhaps investors' greatest hope with respect to its investment case. However, the company continues to expand its global reach in India, Nigeria and Iraqi Kurdistan, and hasn't disclosed its net debt position in the last two earnings reports.

At the end of Q3 2017, Rosneft claimed its net debt was $37.5bn; but analysts at Sberbank CIB put the figure at double that, when $35bn of pre-payments on supplies were factored in.

International woes

Overseas, deteriorating output in Venezuela is posing a threat to Rosneft. The company invested billions of dollars in projects there, and is also owed about $1.6bn by the country's state-owned oil producer.

Sechin, who has invested a lot of personal capital in Venezuela, recently said that Rosneft would make a "final investment decision" in 2020 on whether to develop two gasfields it bought there.

Rosneft also faces headaches in semi-autonomous Kurdistan, where it has spent $1.8bn to secure oil deliveries over the past two years. That has angered the federal Iraqi government, which insists it negotiate all oil deals inside the country.

Rosneft and Nigeria's Oranto Petroleum signed a memorandum of understanding at the recent St Petersburg International Economic Forum to cooperate on oil and gas projects in Africa. Oranto, with its sister company Atlas Petroleum International, holds more acreage than any other African independent and has been seeking partners for the development of several fields throughout Africa.

Under its new strategy, Rosneft has said it will now conform with a decree obliging it to make payouts worth 50% under International Financial Reporting Standards, having repeatedly ignored it in the past.

Dubious track record

Perhaps the part of Rosneft's new strategy that's hardest to take on board is its pledge to improve "investment governance, project management practices and the procurement function", analysts say.

On Sechin's watch, Rosneft has become the embodiment of poor corporate governance. It's driven by one man's ambition to crush other companies to enable his behemoth to stride the global stage alongside ExxonMobil, the world's largest traded oil company.

Most disturbing for investors has been Sechin's direct involvement in the arrests of Alexey Ulyukaev, a former economy minister, and Vladimir Yevtushenkov, the owner of conglomerate Sistema. Both Ulyukaev, who was sentenced to eight years in penal servitude, and Yevtushenkov opposed Rosneft's acquisition of Bashneft.

"We are strong believers in the fundamental value of Rosneft that is not fully appreciated by today's volatile equity markets," Sechin said in the strategy report.

Rosneft's M&A spree, which totals $100bn since President Vladimir Putin came to power in 2000, has dented its investment story. Likewise, promises about deleveraging, increasing dividends and improving governance sound hollow without concrete steps.

Until then, Rosneft remains largely a play on the oil price.

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