Risk Management in Rosneft by ueu12593

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									The full note, with the table showing the best and worst blue chips year to date, is in the attached
word format file.


Still All About Oil
See separate Rosneft-BP comment and Stocks to Watch This Week later in this note.

Despite price weakness over the latter half of last week, the mood in global markets is still
generally positive. Markets are more likely to add further gains than to fall. That’s not to say that
volatility will not increase, i.e. as investors are very sensitive to newsflow. This week the main
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newsflow will come from the big Wall Street banks reporting 4 Qtr numbers (see This Week
below) and from the China-US summit that will take place in Washington. If the banks report
numbers as good as JP Morgan did on Friday and investors take the view that the threat of a
trade/currency stand-off is lessened, then all markets will finish this week higher.

Emerging market currencies are becoming a hot investment theme – at the expense of gold - as
Central Banks move to raise interest rates (Thailand and Korea did last week) in an effort to
combat inflation. The euro may also extend its recovery against the dollar this week as the
imminent threat of another debt crisis has waned. Portugal, Italy and Spain all sold new debt issues
last week and Japan joined China in declaring that it would buy more eurozone sovereign debt.

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The combination of reducing euro debt risk, positive 4 Qtr US earnings, increasing appetite for
developing economy currencies and with crude oil (Brent and Urals) near $100 p/bbl, creates a
near ideal backdrop for the Russian equity market and for the ruble. We should see further gains in
both again this week. The year to date gains have been dominated by the metals & mining sector
and the oils. This week, i.e. apart from a Rosneft “adjustment” early Monday, we should see the
banks taking more of a lead.

The main risk for all markets remains China and the effect on commodities demand from any
further actions it may take to curtail inflation. The main Russia specific risk is that the list of
companies looking to raise money via IPOs may grow too fast and sap available liquidity. Many
companies were hoping to raise money last year but waited too long and missed the favourable
window from January to mid April. This year they will be wary of waiting too long. KOKS Group is in
the process of raising $600 mln, EurosibEnergo $1.5 bln Hong Kong listed is expected soon and
Severstal’s gold division is expected to start marketing its $1 bln London IPO on Monday.

Since the start of 2011 trading, Russian equities have out-performed global peers. The RTS is up
5.6%, MICEX is 3.4% higher and the IOB Index of London traded GDRs is 6.5% better. The ruble
rally has affected prices on MICEX. That compares with a gain of only 0.8% for the MSCI Emerging
Markets Index over the same period. Amongst the MSCI dollar series indices, Russia is best with a
5% gain, China is 4.0% higher, Brazil is up 0.9% and India is down 9.3%. The MSCI Turkey index
is up 0.8%.

The MSCI All-World index is 2.3% better with gains in Japan and the US, where the S&P 500 is
2.8% higher since the start of the year, leading the way.

The ruble has rallied 1.7% against the dollar this year and closed MICEX trade on Friday at 29.99.
Against the euro the ruble lost 44 basis points on Friday but is still up 0.9% (to 40.137) this year.

The euro rallied strongly against the dollar on Friday as debt risk in the eurozone is seen to have
lessened after successful issues by countries including Portugal and Spain, a promise from Japan
and China to buy more bonds and progress towards a new deal to prevent a repeat of Ireland and
Greece’s problems. Having dipped below $1.30 over the past week, the dollar-euro rate finished
Friday at 1.3388, i.e. almost unchanged for the week.

The price of one-month Brent closed Friday at $98.38 p/bbl, up over $1 p/bbl for the session and
3.8% higher for the week. Urals last traded at $94.99 p/bbl and WTI ended at $91.54 p/bbl. $100
p/bbl will likely prove a technical resistance over the short term but several OPEC ministers said
over the weekend that they see no reason for extra production until Brent reaches $120 p/bbl.
Saudi’s reaction and, more importantly, its actions will be key.

Platinum and nickel have been the strongest metals since the start of this year, rising 4.5% and
4.2% respectively. That compares with a loss of 0.8% for copper and flat pricing for zinc and
aluminium. The outlook for copper is still very good as more industry observers forecast a big
supply deficit this year.

Gold fell 2% on Friday to bring the decline year to date to 4.3%. The metal finished Friday at
$1,360.5 per ounce. The eurozone debt risk is viewed as improving and, with rising interest rates
across many developing economies, investors see less need for haven assets such as gold and
silver. The price of silver is off 8.5% since the start of the year.

Most agriculture commodities were also weaker as traders are reluctant to push prices much higher
after last year’s strong gains. Wheat and sugar are off 2.6% and 3.8% year to date albeit corn is
3.1% better.

The weekly fund flows report from EPFR Global shows that investors continue to add new money
to emerging markets (EM) last week, albeit at a slower pace than in the week earlier. The major
new money flows are being directed to commodity theme country funds and almost all of that is via
more speculative ETF flows.

Brazil again dominated. In the latest week, these funds took in $613 mln of fresh money, just
slightly lower than the $677 mln attracted the previous week. Russia funds were next in the table,
taking in $196 mln and over double the previous week’s net inflow of $97 mln. (full note is below)



Rosneft-BP deal

Positive strategic move by Rosneft. The Rosneft-BP deal will dominate Moscow’s bourses
on Monday. BP will acquire a 10.8% equity stake in Rosneft (mainly the Treasury shares that
Rosneft bought from the Yukos receiver) and Rosneft acquires a 5% stake in BP. Both companies
will create a JV to explore a major block of Russia’s arctic shelf. From a strategic viewpoint the deal
is very positive for Rosneft as it creates a strong strategic alliance with one of the world’s oil
majors. BP has considerable expertise in offshore drilling and will bring that, plus capital, to the JV
in the arctic and, presumably, to other projects that undoubtedly both companies will be involved in.
Having BP as a strategic partner will also help further distance Rosneft from the Yukos legacy and
will make it easier for the new JV to attract other oil partners in the future.

The only risk is that Rosneft now has a clearly identifiable asset in the west, i.e. 5% of BP shares. If
the Menatep shareholders, currently suing the Russian state for $98 bln in the Court of Human
Rights in Strasburg, decide to go after Rosneft then they have a target for the first time.

Unclear long-term valuation impact. The short term impact on valuations, etc will be
reviewed by our oil team. See Russian Informer. From a longer term financial viewpoint, how
lucrative is this deal for both companies can only be calculated when the results of test drilling in
the arctic block are known in several years time. Currently, geologists and government agencies
cam only use best guesstimates. Those estimates range from 20 billion to 100 billion barrels of
recoverable oil and 5 to 30 trillion cubic meters of gas.

TNK? The BP-Rosneft deal will inevitably raise the question about BP’s future involvement with
TNK. Will it keep both, will it sell to, e.g. GazpromNeft, or will it look to eventually merge this asset
into Rosneft. Any number of combinations is possible and may introduce a speculative element that
boost TNK-BP’s share price. Meantime, as of last Friday’s close, the shares are yielding a relatively
strong 7.4% dividend yield.

Major gas deposit still available. The deal also raises the prospect that Rosneft may acquire
the Kovykta gas deposit in the Far East when it is auctioned off in mid February as part of the
bankruptcy of Russia Petroleum. BP is the operator of that deposit and a JV between the two to
further develop the project is very likely. That would then raise the question as to whether Rosneft
can steal the China gas export contract from Gazprom, further boosting and diversifying its
business base. China is known to prefer a dedicated gas reservoir and direct pipeline link (as it has
in Turkmenistan and Kazakhstan) rather than plugging into the Gazprom grid.

Game Changer? Yes for the arctic. It is now open for the oil business. Yes for Rosneft. It has
a strategic partnership that will allow it tap into experiences and technology. Partially for the oil
industry in general. The move towards such a deal has been clear for some time. No for the
general economy. The fact that there is another big deal in the oil industry makes little difference
to strategic investors in other sectors. Wall-Mart walking away from Russia is a more important –
and negative – event.

Note: I issued a note titled “Taking Modernization, Prioritizing Energy” one week ago. That note
covers the reasons why this deal happened and why more big energy deals are in the offing.



Stocks to watch this week

Rosneft (ROSN LI: Buy). See comment above. The deal will provide a boost to Rosneft shares. It
also serves to remind investors that, during this year when many state and state linked companies
are restructuring or expanding their business, there is a positive “event risk” with many of these
enterprises.

TNK-BP (TNBP RU: Hold). The BP-Rosneft deal will inevitably raise the question about BP’s
future involvement with TNK. Will it keep both, will it sell to, e.g. GazpromNeft, or will it look to
eventually merge this asset into Rosneft. Any number of combinations are possible and may
introduce a speculative element that boost TNK-BP’s share price. Meantime, as of last Friday’s
close, the shares are yielding a relatively strong 7.4% dividend yield.

LUKoil (LKOD LI: Buy). LUKoil’s share price is one of the best performing year to date as
investors hope that Conoco will confirm, with its results announcement later this month, that it has
sold its remaining shares. But the problem is that while investors can be relieved that the fact of
this action has removed the risk of an overhang, there is more reason to be wary as to the reason
for it. The Rosneft deal, and the recent Bashneft deal to acquire new oil deposits, shows that the
state companies are in the prime position to gain from new finances, etc.

Banks. The bank sector was one of the best performing global market sectors last week. Russian
bank shares have lagged the market rally year to date, e.g. Sberbank shares are up only 4.3%
while most oils and metals are up between 10% and 15%. The banks are the main beneficiaries of
higher budget oil revenues, i.e. because of the trickle-down effect to the economy, and to the
expected stronger ruble. With Brent now within $2 p/bbl of $100 p/bbl (Urals is at $95 p/bbl) the
bank sector shares should play catch-up this week. Especially if the other big Wall Street banks
report numbers as good as JP Morgan did last Friday. If this positive market backdrop continues
then Sberbank is very likely to proceed with its long awaited GDR issue sooner than later.
Sberbank (SBER03 RX: Buy), Vozrozhdenie (VZRZ RX), VTB (VTBR LI: Buy) and Bank St
Petersburg (BSPB Rx: Buy) in that order.

Vimpelcom (VIP US: Buy). Media reports say that Telenor is opposed to any new deal to acquire
Orascom and Wind assets and will try to block the deal. That uncertainty has already hit the shares
this year (up only 2%) and will continue to hang over the price until the situation is resolved.

Gold stocks. The price of gold fell 2.0% on Friday and is down 4.3% since the start of the year.
The eurozone debt risk is viewed as improving and, with rising interest rates across many
developing economies, investors see less need for haven assets such as gold and silver. Highland
Gold (HGM LN: Buy), Polymetal (PMTL LI: Buy), Polyus Gold (PLZL LI: Buy) and Petropavlovsk
(POG LN: Buy) are the worst performing Russian shares (in that order) year to date and are likely
to see more relative pressure this week. We do, however, like the gold sector and expect that
global debt and currency risks are far from resolved. Buy into dips is the advice, albeit there is no
hurry for now. Severstal’s gold division, Nord Gold, is expected to start marketing its $1 bln London
IPO on Monday and that will also temporarily cap demand for other gold stocks.

Reporting companies. Alliance Oil (AOIL SS: Buy), M.Video (N/R) and X Five (Five LI: U/R) are
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all scheduled to release 4 Qtr operating results this week.



This Week: Earnings Season Steps Up a Gear

Rosneft deal will dominate. Although Moscow’s bourses will be pre-occupied with the
Rosneft–BP deal on Monday, most other major markets will see a quiet start to the week because
of the holiday in the US. The visit by the Chinese President to Washington this week will
undoubtedly focus a lot of attention on global trade balances and the vexing issue of competitive
currency management. China has again tightened the reserve requirement for its banks and, on
Thursday morning, will release its December macro data. Inflation is expected to have grown by
5.7% last year and GDP by 10.2%.Developing economy currencies and commodity prices will be
sensitive to any agreements reached between the US and China and the trend in the Chinese
economy.

Wall Street banks to report. The US 4th Qtr earnings season steps up a gear with more of the
big blue chip names scheduled to report. After the better than expected JP Morgan numbers last
Friday, investors will hope that this trend will be repeated in Citigroup numbers (Tuesday), with
Goldman Sachs (Wednesday), Morgan Stanley (Thursday) and Bank of America (Friday). These
numbers will be printed before the market opens. Also listed to report this week, with numbers
typically coming out after the close of Wall Street, are Apple (Tuesday) and Google (Thursday).

US housing stats. Amongst the market sensitive economic numbers to be published this week is
the ZEW Survey of Economic Sentiment in Germany (Tuesday), the Empire Manufacturing update
in the US (Tuesday), the Leading Indicator of US economic trends (Thursday) and the Philadelphia
Fed survey (Friday). Several of the important monthly housing reports in the US will also be
published later this week,

Russian inflation report. In Russia, the weekly inflation report is attracting much more attention
than it used to. Investors are wary of the threat that rising inflation has to profit margins and to
interest rates. Rising inflation does, however, provide a prop to the ruble on the basis that it will
lead to either higher rates or Central Bank tolerance of a stronger ruble. Several Russian
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companies are scheduled to report 4 Qtr operating data this week, including Alliance Oil and
M.Video, both on Tuesday, and X Five on Wednesday.



Fund Flows: ETFs Dominate Positive Flows

Investor flows into EM remain positive. The weekly fund flows report from EPFR Global
shows that investors continue to add new money to emerging markets (EM) last week, albeit at a
slower pace than in the week earlier. The major new money flows are being directed to commodity
theme country funds and almost all of that is via more speculative ETF flows. These fund flows are
very sensitive to oil and other commodity price trends. That sustains a positive backdrop for Russia
and Brazil for now but increases the risk of greater market volatility when commodity prices
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stabilize or fall. For the week to January 12 , a total of $1,585 mln was invested into all EM funds
compared to $3,348 mln the week earlier. Of that, $606 mln was invested into EM Balanced funds,
$533 mln went into Asia funds, $369 mln was directed to LatAm funds and EMEA regional funds
attracted $401 mln.

Commodity themes dominate. Amongst the country specific funds, Brazil again dominated. In
the latest week, these funds took in $613 mln of fresh money, just slightly lower than the $677 mln
attracted the previous week. Russia funds were next in the table, taking in $196 mln and over
double the previous week’s net inflow of $97 mln. But, just as has been the case since late
November, most new money invested into the “commodity theme” funds, i.e. including Russia and
Brazil, was again via the Exchange Traded Funds (ETFs). ETF flows into Brazil topped $646 mln,
i.e. traditional funds suffered net redemptions of $33 mln, and of the $196 mln invested in Russia,
$174 mln was via ETFs.

Flows elsewhere are modest. Elsewhere amongst the country specific funds, China funds
reported net outflow of $30 mln and India funds took in $56 mln of new money. Turkey funds
reversed a long stretch of net redemptions with a net inflow of $8 mln. Few of the non-commodity
themed funds have experienced any big pick up in ETF flows



 Leaders & Laggards Year to Date*

                          Price*       Year to Date*
                          $ p/s           $ p/s

 IRC (HK$)               HK$1,85               30,3%
 Mail.Ru                  $43,11               19,8%
 Mostotrest                $9,35               16,6%
 Chelyabinsk Zinc          $4,99               14,0%
 Rostelecom                $5,40               13,7%
 Severstal                $19,04               13,0%
 Mechel                   $32,78               12,1%
 LUKoil                   $62,95               11,4%
 Surgutneftegaz           $11,78               11,1%
 TNK-BP                    $3,02               11,0%

 RTS                     1 870,09                5,6%
 MICEX                   1 744,74                3,4%
 IOB Index               1 062,43                6,5%

 Novatek                   120,70                1,0%
Sistema                   24,79    -0,6%
MTS                       20,65    -1,1%
Comstar                    6,60    -1,3%
Novolipetsk               47,07    -1,3%
RusAl (HK$)            HK$11,72    -1,7%
Petropavlovsk P         1122,00    -1,9%
Polyus                   $34,40    -5,6%
Polymetal                 17,19    -6,1%
Highland Gold P          169,25   -10,1%

Source: Bloomberg

* as at close January 14th

								
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