OREANDA-NEWS. Major Russian oil and gas companies have broadly balanced their cash flows in 1H16 despite low oil prices and a recent tax hike, Fitch Ratings says. We expect a similar performance for the whole year as cash flows are shielded by progressive taxation, a weak rouble and limited access to international funding, which results in better spending discipline.

All Fitch-rated Russian oil producers (Gazprom, Lukoil, Gazprom Neft, Novatek, Tatneft and Bashneft) reported lower dollar operating earnings in 1H16 due to weaker oil prices. On average, their 1H16 per barrel EBITDA decreased by 23% year on year, outperforming the average Brent price fall of 29% from USD58/bbl in 1H15 to USD41/bbl in 1H16. In addition, 1H16 results were hit by the tax hike announced in October 2015. These negative factors were partially offset by the weaker rouble, which resulted in lower costs on a dollar basis, and by progressive oil taxes that fall as a share of revenue as oil prices fall.

Dollar-denominated capex and dividends sharply decreased, mainly as a result of the weaker rouble, which helped Russian oil and gas producers to report decent free cash flows even at the bottom of the cycle. In 1H16 free cash flows of Russian Fitch-rated oil and gas majors averaged USD2/bbl on a pre-dividend basis and minus USD0.5/bbl post-dividend.

Based on these two metrics, Tatneft was the best performer (USD3.7/bbl and USD1.9/bbl, respectively), while Gazprom Neft reported a negative pre-dividend free cash flow of minus USD1.4/bbl because of its intensive capex programme. But even this figure is still significantly better than the average cash flows reported by European oil majors (minus USD5/bbl pre-dividend and minus USD11/bbl post-dividend, excluding working capital movements).

Russian oil and gas producers should remain free cash flow neutral, provided taxation is unchanged and the rouble broadly follows oil prices. Based on our conservative 2017 Brent price assumption of USD45/bbl, Russian majors on average may report post-dividend FCFs of minus USD1/bbl, ranging from Novatek's USD1/bbl to Lukoil's minus USD1.5/bbl. This should not be a problem for credit profiles as Russian oil and gas players are only moderately leveraged.

The risk of further tax hikes is the key challenge for the Russian oil and gas producers. Our base case is that the taxes will remain at the 2016 level; however, further tax increases cannot be excluded, especially if oil retreats below USD40 again. This risk is taken into account in our ratings. Constrained access to international capital, especially for entities sanctioned by the US and EU, could also become a problem if it harmed their ability to make necessary investment and hence affected long-term production. But for now liquidity in the sector remains adequate, with Russian banks being supportive of large corporate borrowers.