OREANDA-NEWS. Fitch Ratings has affirmed Russia-based Joint Stock Oil Company Bashneft's (Bashneft) Long-Term foreign currency Issuer Default Rating (IDR) at 'BB' with a Positive Outlook. The rating action follows Bashneft's acquisition of Western Siberia's Burneftegaz (BNG), a small oil producer with significant oil resources for USD1bn (RUB35.6bn), including debt.

Bashneft is a second-tier Russian oil producer that accounts for 3% of oil production and 8% of oil refining output in the country, with assets located mainly in the Republic of Bashkiria. Its ratings reflect concentrated reserves, increasing leverage, high capex and generous dividends but also stable upstream and downstream operations and solid operating cash flows.

The Positive Outlook reflects Bashneft's progress with the development of the Trebs and Titov (T&T) oilfields in the north of Russia and our expectation that T&T will start generating positive free cash flows after 2017-2018. Bashneft's ratings include a two-notch discount to reflect Russia-specific and regulatory risks, in line with our approach to Russian issuers.

Acquisition Drives Leverage Higher
In 2013, BNG produced 6 thousand barrels of oil per day (mbbl/d), or 2% of Bashneft's total. It has 390 million barrels of C1+C2 reserves and resources under the Russian standards. While the BNG acquisition improves Bashneft's upstream operations we conservatively expect it to be cash-neutral in the medium term due to incremental development capex required to boost production.

Stable Brownfield Production
In 2013 Bashneft's crude production reached 321 mbbl/d, up 4% yoy, compared with the Russian average growth of 1%. Production from Bashkiria, the company's stronghold, contributed one half of this increase. We recognise Bashneft's efforts in boosting upstream output by applying the latest oil recovery techniques, but believe that it has limited potential to further increase oil output from Bashkiria's brownfields.

Competitive Reserves and Costs
Bashneft's proved reserves of 2 billion barrels of oil at end-2013 imply a 17.5-year reserve life, in line with that of its Russian peers. In 9M13 its lifting costs were USD7.9 per barrel of oil (bbl), below that of most international peers but above that of the Russian majors, due to Bashneft's smaller, more mature oilfields. We expect that company's operational metrics will remain sound in the medium term.

Strong Downstream and Retail
Bashneft is the fourth-largest refiner in Russia; its three Bashkiria-based refineries have 480mbbl/d total primary capacity and a Nelson index of 8.65. In 9M13, refining and marketing contributed around 35% to the company's EBITDA. The company's 9M13 EBITDA per barrel of oil produced of USD28/bbl is one of the highest among Russian peers, partially due to its downstream volumes being 35% larger than upstream volumes in 9M13.

In 2015, the Russian government plans to increase export duty on dark oil products, eg, fuel oil and vacuum gasoil. This will have a negative effect on Bashneft's downstream profits, which should not exceed 15%-20% of its EBITDA, in our view. Bashneft's planned refinery upgrades should improve its refining complexity, increase light product yield and partially offset the negative effect of higher duties.

Uncapped Standalone Ratings
We rate Bashneft on a standalone basis and assess its linkage with its majority shareholder Sistema Joint Stock Financial Corp. (Sistema; BB-/Positive) as moderate. Bashneft remains a key asset for Sistema, along with OJSC Mobile TeleSystems (BB+/Positive). Although Bashneft's ratings are not constrained, they cannot be more than two notches above Sistema's under Fitch's criteria.

Corporate Governance and Dividends
Bashneft continues to improve its transparency. In December 2013 it announced that it would eliminate cross ownership with ZAO Sistema Invest, a subsidiary of Sistema. This would moderately increase Bashneft's leverage, because it has an obligation to buy back its own shares for up to RUB18bn, as per Russian law. Bashneft also has related-party transactions, which we view as a low-to-moderate risk, as the scale of these transactions is diminishing.

In 2013, Bashneft paid RUB51bn in dividends, including 2012 full-year dividends and 9M13 interim dividends but not taking into account the amounts subsequently returned by Sistema Invest. The gross dividends paid out in 2013 corresponded to 97% of Bashneft's 2012 profits, up from 37% in the year before. In our rating case we assume an average dividend payout of 30% in the medium term, for leverage to remain within Bashneft's internal guidance.