OREANDA-NEWS. Fitch Ratings has placed PJSOC Bashneft's ratings, including 'BB+' Issuer Default Rating (IDR), on Rating Watch Evolving (RWE) on the company's acquisition by PJSC Rosneft Oil Company. A complete list of rating actions is available below.

On 6 October 2016, the Russian government published a directive ordering state representatives on Rosneft's board to vote for buying the state's 50.075% interest in Bashneft for up to RUB330bn, and for instructing Rosneft's chief executive to sign a sale and purchase contract with the state by 15 October. On 10 October 2016 Russian Prime Minister Medvedev signed an order to sell the state's 50.075% stake in Bashneft to Rosneft for RUB329.7bn, to be paid for by 14 October 2016.

The RWE reflects uncertainty over Bashneft's credit position after the deal. It is not yet clear whether Bashneft will remain operationally independent, and whether its capex, dividend and funding policies will change significantly. Bashneft's rating direction will depend on its standalone credit profile, the credit profile of its new parent Rosneft, and our assessment of the legal, operational and strategic ties between Bashneft and its new parent.

We aim to resolve the Rating Watch as soon as there is more clarity on the credit consequences of the expected deal for Bashneft, which may take place after six months.

KEY RATING DRIVERS

'BB+' Standalone Profile

Bashneft's 'BB+' standalone credit profile takes into account its rising upstream production, high reserve life, diversification into downstream operations, and conservative leverage. At the same time, Bashneft's standalone rating is discounted by two notches to reflect Russia-specific risks, such as the risk of unexpected tax hikes in the oil and gas industry.

In 2015, Bashneft's oil production averaged 398 thousand barrels of oil per day (mbpd), close to that of OAO Tatneft (548mbpd; BBB-/Negative), Apache Corporation (558 mbpd; BBB/Stable) and Hess Corporation (375mbpd; BBB/Negative). We project that Bashneft's leverage, assuming no significant changes in operational and financial profiles, and no significant tax hikes, will remain conservative and much lower than that of its international peers, supported by the weak rouble and predominantly rouble-pegged debt portfolio.

Level of Integration Uncertain

We are not aware of Rosneft's plans with regards to Bashneft, but believe that there are two alternative scenarios. The first scenario assumes that Bashneft remains a relatively independent company with a separate management team, and its financial profile remains broadly unchanged. In this case, we are likely to keep rating Bashneft on a standalone basis.

The second scenario assumes that Bashneft is more closely integrated into Rosneft, which may require Rosneft's buy-out of the Bashkortostan Republic's (Bashkiria, BBB-/Negative) 25% blocking stake in Bashneft. Under that scenario, our assessment of Bashneft's credit profile would also take into account the credit standing of its parent, and legal, operational and strategic ties between the two entities. In this scenario, Bashneft may be required to pay higher dividends, it may significantly increase its debt load, and its standalone disclosures may weaken.

Higher Taxes a Risk

Russian oil and gas companies remain financially robust despite low oil prices, shielded by the weak rouble and a low cost of production. However, there is a risk that industry taxation will rise as the federal budget remains under pressure. The final tax rates for 2017 and beyond are currently being discussed and should be finalised by mid-October. Based on draft proposals by the Ministry of Finance we believe that the tax burden on the industry will remain manageable, and the final decision will be a compromise between the government and oil and gas companies. However, there is a risk of further tax hikes, especially if oil retreats to below USD40/bbl again. This risk is captured in the ratings through the standard two-notch discount we apply when rating Russian names, and through the ratings being capped by the sovereign rating.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuer include:

- Brent gradually recovering from USD42/bbl in 2016 to USD45/bbl in 2017, USD55/bbl in 2018 and USD65/bbl in the long term

- The US dollar/rouble exchange rate: at RUB69 in 2016, 68 in 2017, 62 in 2018 and 57 in the long term

- Crude production rising by 6.5% yoy in 2016, marginally rising thereafter

- Capex averaging 56% of EBITDA in 2016-20

- Dividends averaging around 40% of net income in 2016-20

RATING SENSITIVITIES

If Bashneft is more closely integrated with Rosneft, Bashneft's rating direction will reflect our assessment of Rosneft's consolidated credit profile and of the parent-subsidiary linkage.

Provided Bashneft remains operationally independent the following factors will be taken into account.

Future developments that may result in a rating affirmation:

- FFO adjusted net leverage below 2.5x through the cycle

- Moderately rising or stable oil production

- Moderate post-acquisition dividends (eg, not exceeding 50% of net profits)

- Adequate information transparency

Future developments that may result in a negative rating action include:

- Falling oil production

- FFO adjusted net leverage above 2.5x through the cycle

- High post-acquisition dividends (eg, exceeding 50% of net profits)

- Lower information transparency

Future developments that may result in a positive rating action include:

- FFO adjusted net leverage below 1.5x through the cycle

- Oil production sustainably above 500mbpd

- Commitment from the new owner that Bashneft will remain operationally independent

LIQUIDITY

Sufficient Standalone Liquidity: Bashneft's standalone liquidity is healthy. At 30 June 2016 its cash amounted to RUB58bn, compared to the short-term debt of RUB27bn, including prepayments. In addition, the company has available unutilised credit lines of RUB45bn.

Change of Control Provision: Some of Bashneft's loans may be subject to the change of control provisions that give lenders the right to demand an early repayment of the obligation if the company changes its owner. We believe Bashneft is likely to receive all necessary waivers, after it is acquired by Rosneft. In a worst-case scenario, Bashneft has the capacity to repay the instruments in question from its available liquidity.

FULL LIST OF RATING ACTIONS

Long-Term Foreign and Local Currency 'BB+' IDRs: Rating Watch Evolving On

Short-Term Foreign and Local Currency 'B' IDRs: Rating Watch Evolving On

National Long-Term 'AA(rus)' Rating: Rating Watch Evolving On

Senior Unsecured 'BB+' Rating: Rating Watch Evolving On

National Senior Unsecured 'AA(rus)' Rating: Watch Evolving On