OREANDA-NEWS. Fitch Ratings has affirmed Russia-based PJSC Tatneft's 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 AO Taneco refinery complex. The company's credit profile is supported by low leverage with funds from operations (FFO) adjusted gross leverage of 0.1x at end-2015, the lowest among Fitch-rated Russian oil and gas peers.

KEY RATING DRIVERS

Taneco Expansion

Tatneft is continuing the project to increase the capacity of Taneco to 14mtpa from the current 8.5 mtpa and improve the refinery's complexity. Projected spending will total RUB105bn in 2016-2019. 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. The company expects that initial processing units of the expanded plant will be technically completed in 2018, but production will likely commence later once Taneco's refining complexity allows for profitable production after additional investments are made. Our forecasts assume this will take place in 2020.

We view capex as manageable under our Brent oil price deck (USD35/bbl in 2016 gradually rising to USD65/bbl from 2019 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 due to Tatneft's strong balance sheet.

Acquisitions Rating Risk

Tatneft purchased shares in an investment fund holding land and made three acquisitions in late 2015 and 2016 for a total consideration of RUB46.5bn. The acquisitions have not caused us to reconsider Tatneft's ratings because of the company's low leverage. However, further material related party or non-core transactions having limited direct benefits for Tatneft's business or financial profile may lead to negative rating action.

We believe that the acquisition of 24.99% shares of PJSC Nizhnekamskneftekhim (NKNK) has the potential for limited synergies with Taneco. Increasing its shareholding in Taneco to 100% does not provide Tatneft with significant benefits because the company already had full control over the business. The transactions to purchase the investment fund investing in land from AK BARS Bank (BB-/Negative) and Bank Zenit (BB-/Negative) stake are non-core to Tatneft's oil and gas operations. We further conservatively estimate that Tatneft will provide RUB4bn of support to Bank Zenit annually in 2016-2019.

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. Net proved reserves have been fairly flat over the past five years and amounted to 5.8 billion bbl as of 1 January 2016, implying an oil reserve life of 32 years - the longest among Russian peers. In 2012-2015 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 0.1x at end-2015, down from 0.7x in 2012.We assume Tatneft will maintain capex of around RUB90bn-RUB100bn over the rating horizon and has headroom to increase dividends compared with payments made in 2012-2016. Nevertheless, we expect that Tatneft's gross leverage will remain close to zero.

Taxation Increase May Lower Profitability

The earnings of Russian oil and gas companies are less volatile than those of most international peers, primarily due to progressive revenue-based upstream taxation in Russia and a flexible rouble-dollar exchange rate. In 2015, the Russian government announced a minor tax hike that may cost Russian oil companies 3%-7% of their USD-denominated EBITDA in 2016. Further tax increases cannot be excluded, especially if oil prices of around USD45/bbl are not sustained. The risk of such an outcome on Tatneft's credit profile would likely be limited because of the company's ample leverage headroom.

Asset Base Constrains Ratings

The ratings are constrained by the characteristics of Tatneft's asset base: mature oil reserves with high sulphur content, lifting costs higher than the average for Russian peers and concentration of production in a relatively small number of areas in Russia.

Standalone Rating

Tatneft's ratings are based on its standalone profile. Tatneft is 36% (indirectly) owned by the Republic of Tatarstan (BBB-/Negative). The overall legal, operational and strategic) links with the republic are relatively modest. Tatarstan's ability to direct financial support from the republic's banking sector to Tatneft is limited, while the republic's dependence on Tatneft is high. The Tatarstan government initiated privatisation of its 4.3% stake in Tatneft. An ownership change would be rating neutral, including a scenario where Tatneft decides to buy back the stake valued at around RUB30bn.

KEY ASSUMPTIONS

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

- Stable oil and gas production in 2016-2019.

- Improvement in refining complexity in 2016-2019.

- Brent oil price equal to USD35/bbl in 2016, USD45 in 2017, USD55 in 2018 and thereafter.

- Average USD/RUB exchange rate of 75 in 2016, 68 in 2017, 62 in 2018, 57 in 2019 and 58 in 2020.

- Capex including potential acquisitions averaging RUB97bn per year in 2016-2020.

- Taneco's expansion completed in 2020.

- Dividend payout at 30% of net income.

RATING SENSITIVITIES

A revision of the Outlook on Russia to Stable from Negative would lead to a similar action on 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 (2015: 131.9x).

LIQUIDITY

At end-2015, Tatneft's RUB5.3bn short-term debt was covered by its cash balance of RUB24.6bn. According to Fitch's projections, Tatneft will generate RUB11.1bn of free cash flow in 2015. Tatneft held a significant share of total cash and cash equivalents at Bank Zenit and AK BARS Bank as of 31 December 2015, and we expect this share to increase after the acquisition of additional stake in Bank Zenit. Fitch considers this as a constraint on the company's credit profile. We therefore place more emphasis on gross rather than net leverage ratios.