In 1987, Russia produced more oil than any other country in the world. At 11.5m barrels per day (...
In 1987, Russia produced more oil than any other country in the world. At 11.5m barrels per day (bpd), the then communist country's production far exceeded that of oil giant Saudi Arabia (4.6m bpd) and accounted for nearly 20% of the world's total.
By 1996, however, the industry had deteriorated and production had fallen to just over 6m bpd. Domestic consumption also fell during this period from 5m bpd to 2.6m bpd. This dramatic decline in production resulted from a combination of factors: a state-owned industry, with inefficient practices and mismanagement was operating in an environment of a strong currency and the legacies of central planning.
It took the Russian financial crisis of late 1998 and the associated collapse of the currency to shake the industry into recovery. The transformation of the sector was recently highlighted by BP's $7bn investment in Russian oil company TNK. The industry has gone from total state ownership to only 20% state ownership. Domestic and foreign investors now control the industry, a selection of multinational oil companies, including Shell and Exxon/ Mobil are all active.
Russia has vast oil and gas reserves. With the improved political environment and ongoing reform, investment risks are much diminished, resulting in the increased focus on Russian oil.
Not only is oil production growing rapidly, but there has also been scope for cost reduction through the application of industry best practice. This includes improved reservoir management, well stimulation and the application of horizontal drilling, resulting in more economic oil extraction.
In comparing the valuation of Russian oil companies with their international peers, the group looks extremely inexpensive on both asset and financial based measures. For example, the enterprise value per barrel of reserves for the Russian oil sector is $1.40 compared to $9.20 for the international majors.
However, this measure does not take into account the short-term profitability of the two groups. On a price to cash flow basis, the comparative numbers would be $4.3 for the Russian oils versus $8.1 for the majors in 2003 according to United Financial Group. Two companies in particular have been at the forefront of the drive to grow production and reduce costs: Yukos and Sibneft.
This has been reflected in improved valuations of these stocks versus their Russian peers. The two companies currently produce only two out of the 7m bpd of Russian oil, suggesting that the industry as a whole is still to see substantial efficiency improvement and therefore re rating.
Investor interest in the Russian oil and gas industry is growing. A placement of $1.75bn in bonds by the monopoly gas company, Gazprom, was record size for emerging market corporates.
Similarly, the Russian government was able to find ready buyers for part of its stake in Lukoil. Despite concerns over the unsustainability of current high oil prices, the Russian oil industry offers opportunity for portfolio investors.
Improvements in corporate governance.
Stocks undervalued compared to peers.
High production growth.
Putting the tech into protection
Square Mile’s series of informal interviews
Fallout from Haywood suspension
Launching later in 2019
£80bn funds under calculation