OREANDA-NEWS. Fitch Ratings has affirmed Russia-based OAO Tatneft's (Tatneft) Long- and Short-term Issuer Default Ratings (IDR) at 'BBB-' and 'F3' respectively. The Outlook is Negative.

The ratings are capped by Russia's rating (BBB-/Negative), due to the company's asset concentration in the country and the influence the state exercises on the oil and gas sector through taxes and regulation.

The affirmation reflects Tatneft's sound business and financial profile following the commissioning and subsequent development of the OJSC Taneco (Taneco) refinery complex. The company's credit profile is supported by low leverage with funds from operations (FFO) adjusted gross leverage of 0.25x at end-2014, the lowest among Fitch-rated Russian oil and gas peers.

Fitch expects Tatneft will maintain stable oil production and favourable leverage metrics, in particular during the expected further expansion of Taneco's capacity to 14 million tonnes per annum (mtpa).

KEY RATING DRIVERS

Greater Vertical Integration
Tatneft continues to implement operational upgrades to the Taneco refinery, which was commissioned in December 2011. A new 2.9mtpa hydrocracking unit completed in 1Q14 will improve the depth of refining and raise the output of light products such as jet fuel and EURO 5 diesel fuel. In 2015 Tatneft expects to commission a delayed coker unit. Fitch views the improving refining complexity as positive for the company's credit profile.

Taneco's Further Development
Tatneft recently made the final investment decision to increase the capacity of Taneco to 14mtpa from the current 8.5 mtpa. Projected spending will total RUB190bn, while project implementation will take up to five years. In light of the currently less favourable tax treatment of dark fuel products, Tatneft plans to commission the expanded plant once completed rather than in stages as it did with the first phase of the refinery construction.

We view the capex manageable under our Brent oil price deck (USD55/bbl in 2015 gradually rising to USD80/bbl from 2018 onwards) without Tatneft compromising its credit metrics. The risk of breaching our negative rating guidance of FFO gross leverage above 1.5x in the medium term is limited as Tatneft will undertake the capex with a low financial gearing.

Russian complex refiners continue to be more profitable than their European peers due to favourable taxation and we expect this to continue at least up to 2018. Tatneft's increased vertical integration and refining cover will also reduce the risks of the 'crude quality bank', a project that has in discussion for a number of years.

Quality Bank
Tatneft currently benefits from blending its crude oil with higher sulphur content with better quality crude from other Russian producers in the domestic oil transportation system. The concept of separating lower and higher quality crude oil has been discussed in Russia for a number of years. Transneft, a Russian oil pipeline transportation company, is contemplating building a pipeline for export of crude oil with higher sulphur content through the Baltic port of Ust-Luga. Such a project will have negative financial consequences for Tatneft, but we currently do not incorporate it into our base case as no decisions have been made regarding its development.

Further expansion of Taneco resulting in higher output of fuel products versus crude oil will reduce the potential negative impact of separating crude oil, if such a pipeline is built in the future.

Lower Earnings Volatility
The earnings of Russian oil and gas companies (O&G), including Tatneft, are less volatile than those of most of their international peers, primarily due to progressive taxation on upstream activities and reasonable flexibility of the rouble exchange rate. These factors smoothed out Russian majors' EBITDA drop during the 2009 oil price collapse, and we expect the same factors to aid Russian O&G companies in 2015-2017, should oil prices remain depressed.
A possible revision of taxation aimed at increasing the government's stake in O&G revenues represents a risk, though we view this as unlikely at this stage.

Stable Production; Ample Financial Profile
Tatneft's credit profile is supported by stable and predictable oil production, a vast reserve base and favourable credit metrics. Proved reserves have been fairly flat over the past five years and amounted to 6.1 billion bbl as of 1 January 2015, implying an oil reserve life of 32 years - the longest among Russian peers. In 2012-2014 Tatneft repaid the majority of the debt it had raised for the construction of the first phase of Taneco, resulting in FFO adjusted gross leverage of 0.25x at end-2014, down from 0.8x in 2012.

Limited Impact from Sanctions
Tatneft is not subject to sanctions from the US and Europe. However, the political crisis over Ukraine has complicated Tatneft's access to western debt markets. Bond spreads have significantly increased and Russian companies have not issued major eurobonds since the Ukrainian crisis broke in spring 2014.

The company plans to procure equipment domestically for Taneco expansion. In our forecasts we assumed Tatneft will need additional external funding for the project no earlier than 2017. The ability to raise external debt is currently limited for Russian corporates, which adds to the completion risk inherent in Tatneft's investment project.

No Impact from Tax Manoeuvre
We assess the effect of the mineral extraction tax (MET) increase and simultaneous reduction in export duties on oil and certain oil products, which came into effect starting 1 January 2015, as broadly neutral for Tatneft. Among the factors that help Tatneft mitigate the surge in MET are tax benefits related to production from significantly depleted fields and fields with highly viscous oil reserves as well as a fairly large share of oil and oil products exports (around 55% of 1Q15 revenues after export duties).

The ultimate consequences of Russia's tax reform for Tatneft will depend on the evolution of domestic oil and fuel prices and the breakdown of the company's sales after the launch of Taneco's second-stage development.

Limited Production and Diversification
Tatneft's ratings are constrained by its production scale, mature oil reserves (hence higher lifting costs vs Russian peers) and concentrated production in the Republic of Tatarstan (BBB-/Negative).

RATING SENSITIVITIES

A revision of the Outlook on Russia to Stable from Negative will lead to a similar action for Tatneft's Outlook because the company's ratings are constrained by the sovereign. Headroom for further positive rating action is currently limited. Fitch would consider an upgrade if higher oil and gas production is accompanied by increased geographical diversification and FFO gross leverage remaining consistently below 1.0x.

Negative: Future developments that could lead to negative rating action include:
- FFO adjusted gross leverage above 1.5x on a sustained basis.
- FFO interest coverage below 10.0x (2014: 86.9x)

LIQUIDITY AND DEBT STRUCTURE

Adequate Liquidity, Higher Expected Leverage
At end-March 2015, Tatneft's short-term debt of RUB12.7bn was covered by its cash balance of RUB19.9bn. In addition, the company had short-term certificates of deposit totalling RUB42.5bn at 31 March 2015. Tatneft has a conservative capital structure, with FFO adjusted gross leverage of 0.25x at end-2014.

Fitch expects Tatneft to show moderately positive free cash flow (FCF) in 2015. The size of FCF in 2016-2018 will largely depend on the timing of investments in Taneco's expansion. According to our forecast, Tatneft's FFO adjusted gross leverage will increase but remain below 1.0x in 2015-2018 if the second stage of Taneco's development does not require more than RUB200bn of capex.

Cash Concentration
At end-March2015, Tatneft held approximately 50% of total cash at Bank Zenit (BB-/Negative) and AK BARS Bank (BB-/Negative), which Fitch considers as a constraint on the company's credit profile. We therefore place more emphasis on gross rather than net leverage ratios.

KEY ASSUMPTIONS

Fitch's key assumptions within our rating case for the issuers include:
- Stable oil and gas production.
- Improvement in refining complexity in 2015-2019.
- Brent oil price equal to USD55/bbl in 2015, USD65 in 2016, USD75 in 2017 and USD80 in 2018-2019.
- Average USD/RUB exchange rate of 60 in 2015, 55 in 2016, 50 in 2017 and 47.5 in 2018-2019.
- RUB200bn of capex to increase Taneco's capacity to 14 mtpa.
- Taneco's expansion completed in 2019.
- Dividend payout at 30% of net income.