Fitch Ratings has affirmed Russia’s Joint Stock Oil Company Bashneft (Bashneft) Long-term foreign and local currency Issuer Default Ratings (IDR) at 'BB'. The Outlooks have been revised to Positive from Stable. A complete list of rating actions is at the end of this release

The Positive Outlook reflects our expectation that over the medium term the company will maintain stable brownfield production levels and strong credit metrics for a 'BB' rated company, ie, funds from operations (FFO) gross leverage below 2x and FFO interest coverage of above 8x. It also reflects that its Trebs and Titov (T&T) greenfield project is on track to produce its first oil later this year. Bashneft is a second-tier Russian integrated oil company with 2012 upstream production of 308 thousand barrels of oil equivalent per day (mbbl/d) and refinery throughput of 415mbbl/d.

Key rating drivers

Stable Brownfields Production

In 2012, Bashneft’s crude production was up 2% yoy to 308 mbbl/d, which contrasts well with that of some other Russian oil companies such as OAO LUKOIL (BBB-/Stable) that reported a 1% decline in hydrocarbon production in that year. We recognise Bashneft’s efforts in increasing its brownfield production but believe that the company has limited headroom to further increase oil output in Bashkiria, its historical stronghold.

T&T Improves Upstream Profile

Bringing the T&T oilfields on-stream, in a joint venture (JV) with LUKOIL, which has a 25% stake, is important for improving Bashneft’s upstream profile and bringing it up to match its historically more sizable downstream operations. The company expects the JV to produce its first oil in H213 and to achieve peak production of as much as 95mbbl/d by 2018–2019. However, the free cash flow generated by the JV may not be fully available to service Bashneft’s debt as Bashneft will have to coordinate the JV’s dividend and capex policy with LUKOIL.

Competitive Reserves and Costs

Bashneft’s proved oil reserves of 2,007 million barrels of oil at end-2012 imply an 18-year reserve life, in line with that of Russian peers. In 2012, its production costs were manageable at USD6.6/bbl, below that of most international peers but above that of the Russian majors, due to smaller, more mature oilfields compared with those of OJSC OC Rosneft (BBB/RWN) or LUKOIL. Fitch expects that Bashneft’s operational metrics will remain sound in the medium term.

Strong Downstream and Retail

Bashneft is the fourth-largest refiner in Russia; its three refineries have 480mbbl/d total primary capacity and Nelson index of 8.55. In 2012, refining and marketing contributed around 30% to the company’s EBITDA (based on IFRS accounts). The company’s EBITDA to barrel of oil produced of USD28/bbl in 2012 is one of the highest among Russian peers, partially due to downstream being significantly higher than upstream in size — by 34% by volume in 2012, unlike most other Russian majors. Planned further upgrades of its refineries should improve Bashneft’s refining complexity, increase light product yield and help it maintain solid refining margins.

Conservative Leverage to Remain

At end-2012 Bashneft’s FFO net adjusted leverage was 1.3x, up from 1.0x in 2011, and its FFO coverage improved to 8.4x in 2012 from 6.4x in 2011. Based on the agency’s Brent price deck of USD100/bbl in 2013, USD92/bbl in 2014 and USD85/bbl in 2015, we expect that Bashneft’s gross leverage will remain below 2x in 2013–2016 and its coverage be above 8.0x.

Standalone Uncapped Ratings

Fitch rates Bashneft on a standalone basis, and assesses its linkage with Sistema Joint Stock Financial Corp (Sistema; 'BB-'/Stable), its majority shareholder as moderate. We note that Bashneft remains a key asset for Sistema along with OJSC Mobile TeleSystems (MTS, BB+/Stable). In 2012, Bashneft contributed around 35% to Sistema’s EBITDA, and Sistema’s ability to service its debt may depend on dividends it receives from Bashneft.

Bashneft has material related party transactions, eg during 2012 it made a number of deposits with a total amount of RUB24.8bn of cash (or 7.5% of its net revenue) with the Sistema-owned OJSC MTS Bank (B+/Stable). However, by the end of the year most of these funds had been repaid, and Bashneft’s debit balance with the bank was RUB5.1bn. While Fitch does not currently constrain Bashneft’s ratings (which can be the case if related party transactions intensify and lead to material cash outflow), Bashneft cannot be rated more than two notches higher than Sistema under the agency’s criteria.

Rating sensitivities

Positive: Successful production launch and development at T&T in 2013–2015 coupled with solid operational and credit metrics, eg, stable brownfield production and refining volumes and FFO gross adjusted leverage below 2.5x and FFO interest cover above 8x on a sustained basis, may lead to a positive rating action.

Negative: Bashneft’s failure to maintain crude production or sustained deterioration of its credit metrics, including FFO gross adjusted leverage above 2.5x and FFO interest cover below 8x on a sustained basis owing to higher capex and dividends may lead to a negative rating action.

Liquidity and debt structure

Acceptable Liquidity

At end-2012, Bashneft had cash of RUB20.1bn and RUB33bn in committed credit facilities, which covered its short-term debt of RUB32bn. In February 2013, Bashneft issued RUB30bn 10-year bonds (with a half having a put option in 2018 and another half in 2020) and repaid most of the debt falling due in 2013. Fitch believes that Bashneft has good access to the domestic capital markets and would refinance its upcoming maturities if needed.

Balanced Debt Portfolio

At end-2012, Bashneft’s balance sheet debt of RUB110.2bn was made up of bank loans (RUB77.4bn), domestic bonds (RUB25.2bn) and pre-export finance facilities (RUB7.6bn). As most of its borrowings are RUB-denominated, its effective interest rate remained relatively high at 8.4%. This may reduce as Bashneft intends to increase the share of USD-denominated borrowings in its portfolio.

List of rating actions

Long-Term IDR: affirmed at 'BB', Outlook revised to Positive from Stable
Short-Term IDR: affirmed at 'B'
Local currency Long-Term IDR: affirmed at 'BB', Outlook revised to Positive from Stable
Local currency Short-Term IDR: affirmed at 'B'
National Long-Term Rating: affirmed at 'AA-(rus)', Outlook revised to Positive from Stable
Senior unsecured rating: affirmed at 'BB'