o&g 2008 outlook

Oil & Gas 2008 Outlook

Alexander Burgansky +7 (495) 258 7904 [email protected] Adam Landes +44 (20) 7367 7777 [email protected] Elena Savchik +7 (495) 725 5265 [email protected] Roman Elagin +7 (495) 258 7763 [email protected] Irina Elinevskaya +7 (495) 783 5662 [email protected]

Sector update Equity Research

13 December 2007

Oil & Gas Russia, Central Asia and Ukraine

Report date: 13 December 2007 Total sector MktCap, $mn 645,507 Target MktCap, $mn 844,956 Weight In MSCI, % 61.4 RenCap Index High 3,532 RenCap Index Low 2,396 Average sector P/E 12.5 Average sector EV/EBITDA 8.0

Higher oil price forecasts. A tighter supply/demand outlook and rising production costs globally cause us to revise our long-term Brent price outlook to $60/bbl (from $50bbl). Our 2008 forecasts went up to $75/bbl (from $65/bbl). This resulted in an average 20% upgrade in our target prices.

Policy watch. Following crucial developments in the Russian gas sector in 2006-2007, we believe 2008 could see greater clarity in the long-term tax regulations of the oils sector in both Russia and Central Asia. Likely changes to gas taxation in Russia are also of great interest.

Corporate activity will be high, resulting in an even greater role played by state-controlled companies in Russia and Kazakhstan, in our view. Key stocks to watch are TNK-BP, Gazprom Neft, Surgutneftegas and KazMunaiGaz.

Gazprom remains our top pick with a 27% higher target price of $19/share, as a result of its dual exposure to strong gas price gains in Russia and Europe. A high oil price and strong refining margins make LUKOIL ever more attractive. KazMunaiGaz should strengthen its consolidator role in Kazakhstan, while CAToil is our preferred exposure to the oil field services sector.

Figure 1: Price performance – 52 weeks Figure 2: Sector stock performance – 3 months

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120Sector Relative to MSREN M SREN

-60 -40 -20 0 20 40 60

Big Sky EnergyVictoria Oil & Gas

Max PetroleumCaspian Holdings

CAToilUrals Energy

Caspian EnergyCanargo Energy

West Siberian ResourcesIntegra

RosneftLUKOILTatneft

KazMunaiGazGazpromNovatek

Dragon OilBurren Energy

Imperial EnergyGazprom Neft

Source: MSCI, Bloomberg Source: MSCI, Bloomberg

Summary of key sector ratings

Ticker Company Current price, $

Target price, $ Rating Upside MktCap, $mn EV, $mn ADR since

GAZP Gazprom 13 19 Buy 41% 316,898 335,054 1996 SIBN Gazprom Neft 5.75 4.99 Hold -13% 27,262 23,119 1998 LKOH LUKOIL 88 112 Buy 27% 73,406 76,324 1995 NVTK Novatek 7.08 6.00 Hold -15% 21,482 21,395 2005 ROSN Rosneft 9.42 9.60 Hold 2% 92,352 111,294 2006 SNGS Surgutneftegas 1.23 2.11 Buy 72% 16,751 12,192 1996 TATN Tatneft 6.20 6.90 Hold 11% 12,742 10,811 1996 TNBP TNK-BP Holding 2.17 3.33 Buy 54% 35,184 42,372 TRNFP Transneft (pref) 1,945 3,300 Buy 70% 13,004 16,889 KMG Kazmunaigas 27.6 36.1 Buy 31% 12,744 12,100 2006 UNAF Ukrnafta 75 83 Hold 11% 4,070 4,044 2000 O2C CAToil 15.4 28.1 Buy 83% 1,042 759 INTE Integra 14.8 22.3 Buy 51% 2,164 2,426

Source: RTS, Bloomberg, Renaissance Capital estimates

Important disclosures begin on page 53. This research material is released by Renaissance Securities (Cyprus) Limited. Regulated by the Cyprus Securities & Exchange Commission (License No: KEPEY 053/04).

13 December 2007 Oil & gas: 2008 Outlook Renaissance Capital

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Executive summary 3 Oil price: fundamentals stronger… 16

Technical snapshot 17 Supply/demand balance 18 OPEC watch 20 Inventories falling 21 Refining: The new scare 22 New paradigm 23

Fundamentals watch 28 Crude production 28 Investment-led growth 29 Crude netback parity 32

Policy watch 34 Oil taxation in Russia 34 Gas taxation in Russia 34 Amendments to Russia’s Subsoil Use law 34 Hydrocarbon taxation in Central Asia and Ukraine 35

Corporate actions 36 Performance and earnings 38

A special word on preferred shares 41 Company views 45

Russian vertically integrated oil companies 45 Russian gas 46 Oil & Gas infrastructure 48 Foreign-listed independents 48 Oil field services 49 Central Asia/Caspian 50 Ukraine 52

Important disclosures 53

Contents

Renaissance Capital Oil & gas: 2008 Outlook 13 December 2007

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Revised oil price forecasts

We still believe that we are in the midst of an extended oil cycle, although we accept that it will see considerably higher prices than previously anticipated and that the long-term oil price needed to deliver marginal supply has increased very significantly over recent years. Our 2008 Brent forecast rises to $75/bbl from $65/bbl. We then foresee price declines of $5/bbl in each of the next four years. Given the state of the futures market, this continues to look conservative. Our long-term Brent model input (meaning from 2011 onward) rises to $60/bbl from $50/bbl (both in nominal terms).

Policy watch: Oil taxes

Following crucial developments in the Russian gas sector in 2006-2007, we believe 2008 could see greater clarity in the Russian oils long-term tax regulations under the new government. Of equal importance are likely changes to the fiscal regime in Central Asian countries, a key source of crude production growth in the FSU. Likely changes to gas taxation in Russia are also of great interest.

Corporate activity to accelerate

We expect corporate activity will be at a high level, after an already eventful 2007. This should result in an even greater role played by state-controlled companies in Russia and Kazakhstan, in our view. Key stocks to watch are TNK-BP, Gazprom Neft, Surgutneftegas, Dragon Oil, Urals Energy and Bashkir oil assets on the sell-side, and Gazprom, Rosneft and KazMunaiGaz on the buy-side.

Our top picks

We believe the FSU oil and gas sector is attractively valued, and see plenty of potential upside throughout (our weighted-average estimated upside potential is 30%, following a 20% average increase in our target prices).

1. Russian gas through Gazprom (GAZP, BUY, target price $19.0 from $15.0). GAZP remains our top pick in the sector because of its higher, and more visible EPS growth, than for the oils stocks (we estimate Gazprom will deliver a three-year 2007-2010E EPS CAGR of 13% vs 2% for LUKOIL), amid broadly similar valuations. We see 41% potential upside for Gazprom over the next 12 months, through its unrivalled exposure to the liberalisation of the domestic gas market, strong gas prices in Europe and restructuring potential. We also believe that the recent changes to its regulatory framework have created new incentives for Gazprom to cut costs and increase gas production, which we expect will be followed by better operational performance, and improved management and organisational structures.

2. Russian oil through LUKOIL (LKOH, BUY, target price $112.0 from $92.0). Although the long-term visibility of the Russian oil sector is hindered by a lack of fiscal incentives, we believe this structural issue will have to be addressed by the new Russian government after its appointment in spring 2008. In the meantime, we see the short-term catalysts for the Russian vertically integrated oil companies (VIC) as positive, as a result of historically high refining margins (helped by the oil-price-linked subsidy on the export of oil products), flattening rouble and attractive relative

Executive summary


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valuations. LKOH trades at a 19% discount to its international peers in terms of 2008E P/E multiples, based on consensus estimates, and we believe this gap should close by the end of next year, as regulation becomes clearer and LKOH’s production growth accelerates.

3. Central Asian oil through KazMunaiGas E&P (KMG, BUY, target price $36.12 from $29.62). We believe this state-controlled Kazakh company is likely to see its role as a state consolidator of all the best onshore assets grow in 2008 with likely acquisitions of its parent’s stakes in MangistauMunaiGas, Kazturkmunai and Kazakhoil-Actobe. At the same time we anticipate the effect of possible tax changes on Kazmunaigas E&P will be mitigated (given its links to the state) through off-setting benefits of asset contributions or tax privileges.

We also see considerable value in less liquid oil field services (OFS) and infrastructure companies. Our preferred exposure to the OFS segment is via CAToil (O2C, BUY, target price EUR28.1), where we see positive earnings momentum as a result of its recent acceleration in organic growth and diversification into new higher-end services. Although our pricing assumptions for its pressure pumping business recently became more conservative, we estimate it will still double its EPS next year.

Transneft’s (TRNFP, BUY, target price $3,300) share price performance has been less than impressive for the past two years, while the fundamental value of the company (and our target price) has been growing. We believe this could reverse under the new management team which, we believe, should bring the level of corporate governance and investor relations at least up to the level of other state-owned companies. We also see positive fundamental newsflow, including our expectations of strong financial results and greater regulatory visibility.

We expect 2008 will see consolidation of the gas distribution infrastructure (the so-called ‘oblgazes’) into Gazprom and believe that locally-listed Lipetskoblgaz (LPOG, BUY, target price $829) and Oreloblgaz (ORGZ, BUY, target price $973) offer the best exposure to this theme.

Finally, we see strong production growth and substantial valuation upside in junior E&P companies with our top three picks being West Siberian Resources (WSIB, BUY, target price SEK15.7 from SEK13.8) as a result of its balanced development portfolio and substantial undervaluation, Imperial Energy (IEC, BUY, target price GBP25.7 from GBP19.4) on low execution risk and significant resource potential, and Tethys Petroleum (TPL, BUY, target price CAD4.41 from CAD3.93) giving an exposure to an attractive gas sector in Central Asia.

Our changes to ratings and target prices

We have updated all our financial models for the sector, with new price targets and ratings shown in Figure 3. On average, we have increased our price targets for the FSU oil and gas companies by 20%, with the three changes in rating being Tatneft, which we have downgraded to HOLD (from Buy), Burren Energy (HOLD from Buy) and Canargo Energy (HOLD from Sell). Aside from the upgrade to our oil price forecasts, we have revised all of our financial models to take account of new macroeconomic forecasts, recent financial results and changes to the companies’ guidance.


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Figure 3: Ratings and target price changes Old New TP/Rating Δ Upside

Ticker Stock TP Rating TP % Chg. Rating /(Downside) GAZP Gazprom 15.0 Buy 19.0 27% Buy +/= 41% NVTK Novatek 5.50 Hold 6.00 9% Hold +/= -15% SIBN Gazprom Neft 4.10 Hold 4.99 22% Hold +/= -13% LKOH LUKOIL 92.0 Buy 112.0 22% Buy +/= 27% ROSN Rosneft 8.75 Hold 9.60 10% Hold +/= 2% SNGS Surgutneftegas (common) 1.90 Buy 2.11 11% Buy +/= 72% SNGSP Surgutneftegas (preferred) 1.14 Buy 1.27 11% Buy +/= 90% TATN Tatneft (common) 5.80 Buy 6.90 19% Hold +/- 11% TATNP Tatneft (preferred) 3.11 Buy 3.59 15% Hold +/- 11% TNBP TNK-BP Holding (common) 2.88 Buy 3.33 16% Buy +/= 54% TNBPP TNK-BP Holding (preferred) 2.44 Buy 2.94 20% Buy +/= 54% TRNFP Transneft (preferred) 3,300 Buy 3,300 0% Buy =/= 70% IEC Imperial Energy £19.4 Buy £25.7 32% Buy +/= 91% SBE Sibr Energy £5.44 Hold £5.85 8% Hold +/= 13% UEN Urals Energy £6.37 Hold £4.71 -26% Hold -/= 124% VOG Victoria Oil & Gas £0.88 Hold £0.81 -8% Hold -/= 501% VGAS Volga Gas £3.75 Buy £4.17 11% Buy +/= 35% WSIB West Siberian Resources SEK 13.8 Buy SEK 15.7 14% Buy +/= 224% ABG Arawak Energy CAD 3.51 Buy CAD 3.63 3% Buy +/= 36% BSKO Big Sky Energy 0.22 Hold 0.13 -40% Hold -/= 51% KAZ BMB Munai 10.0 Buy 10.2 2% Buy +/= 79% BUR Burren Energy £12.65 Buy £12.76 1% Hold +/- 3% CNR Canargo Energy 0.49 Sell 0.50 1% Hold +/+ -26% CEK Caspian Energy CAD 0.77 Buy CAD 0.79 2% Buy +/= 102% CSH Caspian Holdings £0.06 Hold £0.06 0% Hold -/= 59% DGO Dragon Oil £3.69 Buy £4.36 18% Buy +/= 34% FRR Frontera Resources £1.41 Buy £1.37 -3% Buy -/= 142% KMG KazMunaiGas 29.62 Buy 36.12 22% Buy +/= 31% MXP Max Petroleum £1.22 Hold £1.07 -12% Hold -/= 44% RXP Roxy Petroleum £0.42 Hold £0.43 4% Hold +/= 13% TPL Tethys Petroleum CAD 3.93 Buy CAD 4.41 12% Buy +/= 52% TMY Transmeridian 1.57 Sell 1.71 9% Sell +/= -4% UNAF Ukrnafta 77 Hold 83 8% Hold +/= 11% O2C CAToil € 28.1 Buy € 28.1 0% Buy =/= 83% INTE Integra 22.3 Buy 22.3 0% Buy =/= 51%

Source: Renaissance Capital estimates

Sensitivity analysis of earnings to the oil price

The Russian oil industry’s punitive taxation makes pure upstream Russian oil producers (such as Tatneft) less sensitive to oil price assumptions than their international peers. However, vertically integrated companies benefit from higher oil prices disproportionately, as the Russian refining margin is directly linked to the oil price (via the tax subsidy on the export of oil products). Our analysis in Figure 4 suggests that Gazprom is the least sensitive to the oil price in terms of its 2008 EPS estimates (due to the lag effect on the gas price in Europe, and secular growth in domestic gas tariffs); while Surgutneftegas (SNGS, BUY, target price $2.11 from $1.90) is the most sensitive (because of its high operating leverage). We calculate that a $5/bbl drop in the oil price forecast reduces our 2008E EPS estimates for the Russian stocks 6% (for the gas producers), and 12% for the oil producers, on average. The same statistics for KazMunaiGaz E&P is 11%.


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Figure 4: Earnings sensitivity analysis to oil price assumptions Changes to 2008E EPS

$/bbl –10 –5 5 10 Gazprom -13% -6% 6% 13% Novatek -14% -7% 5% 8% Gazprom Neft -25% -13% 13% 25% LUKOIL -21% -10% 10% 21% Rosneft -26% -13% 13% 26% Surgutneftegas (comm) -33% -17% 17% 33% Tatneft (common) -17% -8% 8% 17% TNK–BP Holding (comm)

-19% -9% 9% 19% Kazmunaigas -21% -11% 11% 21%


Valuations

The relative performance of the Russian and Central Asian major oil and gas stocks has started to improve recently, with Gazprom, for example, outperforming the Russian equity market and the Bloomberg World Oil and Gas index by 15% and 6%, respectively over the past three months. Although oil stocks have continued to underperform the Russian equity market (by 7% in the past three months), they outperformed their global peers by 2% over the same period. Over the past 12 months; however, both Gazprom and the oils have underperformed the Bloomberg World Oil and Gas Index by 9% and 22%, respectively.

We estimate that the Russian oil and gas stocks will continue to look attractive on the basis of their relative valuations (see Figure 5):

Based on average 2008E consensus P/E multiples, the Russian oil sector trades at a 6% discount to the super-majors, and a 60% discount to GEM alternatives (the same statistics for Gazprom are a 4% premium and a 55% discount, respectively). Excluding Rosneft (ROSN, HOLD, target price $9.60 from $8.75) and Petrochina, these turn into 25% and 39% discounts, respectively. The biggest difference between our estimates and consensus estimates continues to be the case of Surgutneftegas, but this is likely explained by the different share count used. Excluding Surgutneftegas, Gazprom Neft (SIBN, HOLD, target price $4.99 from $4.10) is trading at the lowest 2008E P/E multiple, based on our estimates, driven by the estimated decline in both production and unit earnings, in our view.

Based on average 2008E consensus EV/EBITDA multiples, the Russian oil sector trades at an 11% discount to Gazprom and at a 17% premium to the super-majors, but at a 56% discount to GEM alternatives. Excluding Rosneft and Petrochina, these turn into 29%, 6% and 33% discounts, respectively. LUKOIL, TNK-BP and Tatneft appear to trade more or less in line with the international peer group, with Rosneft trading at a substantial premium, but Surgutneftegas and Gazprom Neft showing significant discounts.

KazMunaiGas trades at a 2008E consensus P/E multiple of 8.8x, and a 2008E consensus EV/EBITDA estimate of 4.4x, a discount of 13% and 28% to the Russian average, and 19% and 16% to the international oil majors, respectively.


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Another way of showing the relative valuations of the FSU oil and gas companies vs international benchmarks is by comparing their unit valuations (market capitalisation per unit of output) with unit profitability (net income per unit of output), as shown in Figure 5. As is evident from this analysis, Russian oil companies have much lower unit valuations as a result of much lower unit net income. Most of the Russian companies seem to be positioned on, or below, the trend line, with the notable exception of Rosneft. KazMunaiGas enjoys a higher unit net income, and a higher unit valuation.

Figure 5: Price/Earnings ratio: relative valuation of Russian oil companies

Kazmunaigas

Gazprom

ConocoPhillips

Chevron

Petrobras

ONGCBP

Gazprom NeftLukoil

TNK-BP Holding

Tatneft

Surgutneftegas

Rosneft

RoyalDutchShell

Petrochina

CNOOC

Total

Sinopec ExxonM obil

Novatek

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Source: Thomson Datastream, Renaissance Capital estimates


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Figure 6: Summary valuation for oil and gas companies we cover in Russia Current

price MktCap P/E NI CAGR (%) EV/EBITDA Div. yield (%) FCF yield (%) EV/proved reserves, EV/production,

Reuters ticker Rating Currency Target

price 7-Dec-07

Upside potential $mn 2007E 2008E 2009E 2007E-09E 2007E 2008E 2009E 2007E 2008E 2007E 2008E $/boe, 2006 $/boe, 2006

Russian gas producers Gazprom (RC estimates) GAZP.RTS Buy USD 19 13.5 41% 316,898 14.0 10.5 9.8 13 9.1 6.4 5.9 0.9 1.1 2.7 5.4 2.8 91.1 Gazprom (consensus estimates) 13.3 11.3 9.9 17 8.7 7.1 6.0 0.8 1.0 2.8 89.9 Novatek (RC estimates) NVTK.RTS Hold USD 6.0 7.08 -15% 21,482 27.4 22.5 20.4 27 17.3 14.3 13.0 1.4 1.7 0.7 1.9 4.6 115.5 Novatek (consensus estimates) 28.0 21.4 18.5 27 17.8 13.7 12.5 1.1 1.3 4.6 115.5 Cap-weighted average 14.9 11.2 10.5 14 9.6 6.9 6.4 0.9 1.2 2.6 5.2 3.0 92.7 Russian oil producers Rosneft (RC estimates) ROSN.RTS Hold USD 9.6 9.42 2% 92,352 6.9 13.8 14.4 22 7.9 8.3 8.1 0.6 0.7 -6.3 -0.7 5.5 168.0 Rosneft (consensus estimates) 18.9 15.1 15.9 10 10.8 9.1 8.5 0.6 0.8 5.7 173.2 LUKOIL (RC estimates) LKOH.RTS Buy USD 112 88 27% 73,406 7.6 8.2 9.1 2 5.1 5.3 5.6 1.8 2.0 5.1 3.8 3.9 97.7 LUKOIL (consensus estimates) 8.9 8.8 10.2 -2 5.7 5.6 6.0 2.0 2.1 3.9 98.7 TNK-BP Holding (RC estimates) TNBP.RTS Buy USD 3.33 2.17 54% 35,184 8.3 9.0 10.5 -17 5.6 5.8 6.2 9.3 9.1 7.3 8.2 4.3 69.0 TNK-BP Holding(RC estimates) TNBPP.RTS Buy USD 2.94 1.91 54% TNK-BP Holding (consensus estimates) 7.0 7.7 8.5 -11 4.8 5.3 5.3 7.0 6.2 3.9 62.1 Surgutneftegas (RC estimates) SNGS.RTS Buy USD 2.11 1.23 72% 16,751 4.8 7.5 7.5 -8 1.5 2.3 2.1 2.8 1.8 20.1 6.7 0.9 21.6 Surgutneftegas (RC estimates) SNGSP.RTS Buy USD 1.27 0.67 90% Surgutneftegas (consensus estimates) 4.0 4.5 4.9 -6 0.9 0.9 0.7 2.0 1.7 0.6 13.2 Gazprom Neft (RC estimates) SIBN.RTS Hold USD 4.99 5.75 -13% 27,262 7.2 6.7 6.7 3 5.2 4.4 4.0 4.7 5.1 11.1 13.1 3.7 67.7 Gazprom Neft (consensus estimates) 7.3 7.8 8.3 0 4.4 4.3 4.2 4.9 4.4 3.8 68.9 Tatneft (RC estimates) TATN.RTS Hold USD 6.90 6.20 11% 12,742 8.8 9.3 9.3 8 4.4 4.6 4.3 1.2 1.5 5.1 11.8 1.8 56.3 Tatneft (RC estimates) TATNP.RTS Hold USD 3.59 3.23 11% Tatneft (consensus estimates) 9.6 10.7 9.6 6 5.4 6.3 5.5 3.1 2.8 2.0 60.8 Cap-weighted average 7.3 10.2 10.9 6 5.9 6.1 6.1 2.8 2.8 2.9 4.3 4.2 108.8 Alternatives -11% Imperial Energy (RC estimates) IEC.L Buy GBP 25.65 13.44 91% 1,394 n/a 37.0 18.4 n/a n/a 21.3 11.8 0.0 0.0 -19.1 -16.5 9.8 12,321.6 Imperial Energy (consensus estimates) n/a 27.5 16.0 n/a n/a 19.7 10.5 0.0 0.0 9.7 12,148.7 Sibir Energy (RC estimates) SBE.L Hold GBP 5.85 5.17 13% 4,052 23.4 10.3 8.8 75 9.5 6.0 5.6 2.7 4.6 -21.3 3.7 11.4 410.0 Sibir Energy (consensus estimates) 18.0 11.0 10.1 59 12.0 7.9 6.3 1.4 5.9 11.0 397.6 Urals Energy (RC estimates)* UEN.L Hold GBP 4.71 2.10 124% 509 n/a n/a 3.9 56 68.9 17.7 4.2 0.0 0.0 -141.8 -47.9 4.2 284.0 Urals Energy (consensus estimates) 58.3 17.1 4.3 102 13.5 6.9 3.0 0.1 0.5 2.5 165.8 West Siberian Resources (RC estimates) WSIB.SG Buy SEK 15.70 4.84 224% 898 19.5 14.4 10.5 41 9.7 5.2 4.1 0.0 0.0 -9.6 1.5 10.3 142.4 West Siberian Resources (consensus estimates) 20.3 9.5 7.3 50 9.1 5.8 4.1 0.0 0.0 10.8 148.4 Victoria Oil & Gas (RC estimates)** VOG.L Hold GBP 0.81 0.14 501% 32 n/a 5.5 2.3 n/a n/a 4.6 2.3 0.0 0.0 -44.5 -46.7 2.9 1,367.3 Victoria Oil & Gas (consensus estimates) n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a Volga Gas (RC estimates) VGAS.L Buy GBP 4.17 3.09 35% 335 116.8 17.3 5.3 n/a n/a 12.8 2.9 0.0 0.0 -12.3 -15.9 15.6 n/a Volga Gas (consensus estimates) n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a Cap-weighted average 21.0 15.5 10.3 51 11.4 10.0 6.3 1.5 2.6 -27.6 -5.3 10.6 2,653.5 Oil field services CAToil (RC estimates) O2C.DE Buy EUR 28.1 15.39 83% 1,042 26.1 12.1 10.5 40 13.5 7.1 5.8 0.0 0.0 0.0 0.0 n/a n/a CAToil (consensus estimates) 24.3 13.7 9.1 43 12.9 7.8 5.3 0.4 0.7 n/a n/a Integra (RC estimates) INTEq.L Buy USD 22.3 14.81 51% 2,164 201.9 25.3 16.6 n/a 10.6 7.1 5.2 0.0 0.0 0.0 0.0 n/a n/a Integra (consensus estimates) 30.7 17.7 15.4 n/a 11.8 8.2 6.1 0.0 0.0 n/a n/a


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Figure 6: Summary valuation for oil and gas companies we cover in Russia Current

price MktCap P/E NI CAGR (%) EV/EBITDA Div. yield (%) FCF yield (%) EV/proved reserves, EV/production,

Reuters ticker Rating Currency Target

price 7-Dec-07

Upside potential $mn 2007E 2008E 2009E 2007E-09E 2007E 2008E 2009E 2007E 2008E 2007E 2008E $/boe, 2006 $/boe, 2006

Cap-weighted average 144.7 21.0 14.6 13 11.5 7.1 5.4 0.0 0.0 0.0 0.0 Transneft (RC estimates) TRNFP.RTS Buy USD 3,300 1,945 70% 13,004 5.8 4.8 4.6 14 3.6 3.2 2.7 0.51 0.61 -13.3 -13.1 n/a n/a Transneft (consensus estimates) 5.2 5.1 4.6 8 3.9 4.0 3.5 0.4 0.4 n/a n/a Transneft (disc)/prem to Russian oil producers -21% -53% -58% 8% -39% -48% -55% -2% -2% -16% -17% Russian gas producers average (disc)/prem to Russian oil producers 104% 11% -3% 7% 63% 13% 4% -2% -2% 0% 1% -30% -15%

Russian oil producers average (disc)/prem to alternatives -65% -35% 5% -45% -48% -39% -4% 1% 0% 31% 10% -60% -96% Reserve ratios for the Russian companies are calculated using SPE measures. Those for other companies are on an SEC basis. * Our model has not been yet adjusted for the acquisition of 35.3% interest in OOO Taas-Yuriakh Neftegazodobycha and the additional share issue. ** Our model has not been yet adjusted for FY07 UK GAAP results (year-end 31 May).

Source: Company data, Thomson financial and Renaissance Capital for estimates


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Figure 7: Summary valuation for oil and gas companies we cover in other FSU countries Reuters Rating Currency Target Current

price Upside MktCap, P/E NI CAGR (%) EV/EBITDA Div. yield

(%) FCF yield

(%) EV/proved reserves, EV/production,

ticker price 7-Dec-07 potential $mn 2007E 2008E 2009E 2007E-09E 2007E 2008E 2009E 2007E 2008E 2007E 2008E $/boe, 2006 $/boe, 2006 Kazakhstan Arawak Energy (RC estimates) ABG.C Buy CAD 3.63 2.67 36% 479 24.3 9.3 10.2 56 5.0 2.8 2.4 n/a n/a 0.4 5.1 15.3 160 Arawak Energy (consensus estimates) 21.7 9.1 11.4 26 6.4 3.3 2.6 n/a n/a 17.3 181 Big Sky Energy (RC estimates) BSKO.US Hold USD 0.13 0.085 51% 14 3.6 0.8 0.8 n/a 5.3 0.9 0.3 n/a n/a -7 56 4.3 115.3 Big Sky Energy (consensus estimates) n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a BMB Munai (RC estimates) KAZ.US Buy USD 10.2 5.70 79% 256 7.9 5.1 4.4 283 5.3 3.7 3.1 n/a n/a -17 -9 19.1 892 BMB Munai (consensus estimates) n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a Caspian Energy (RC estimates) CEK.C Buy CAD 0.79 0.39 102% 40 n/a 3.1 3.2 n/a 417 3.1 1.5 n/a n/a -59 -9 33.6 416 Caspian Energy (consensus estimates) n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a Caspian Holdings (RC estimates) CSH.L Hold BPN 5.98 3.75 59% 7 n/a 10.9 2.7 n/a n/a 3.5 2.3 n/a n/a -64 -86 1.0 222 Caspian Holdings (consensus estimates) n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a KazMunaiGas (RC estimates) KMG.L Buy USD 36.1 27.6 31% 12,744 8.9 8.3 9.9 10 4.7 4.5 5.3 1.5 1.4 6 4 17.7 176 KazMunaiGas (consensus estimates) 12.2 8.8 8.2 31 5.8 4.4 4.4 0.6 0.6 18.3 182 Max Petroleum (RC estimates) MXP.L Hold BPN 107 74 44% 513 48.7 14.4 11.2 n/a 30.1 11.3 9.0 n/a n/a -1 5 198 17,110 Max Petroleum (consensus estimates) n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a Roxy Petroleum (RC estimates) RXP.L Hold BPN 43 38.5 13% 132 493.4 18.7 8.8 n/a 345.4 7.3 4.2 n/a n/a -24 0 n/a n/a Roxy Petroleum (consensus estimates) n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a Tethys Petroleum (RC estimates) TPL.C Buy CAD 4.41 2.90 52% 135 n/a 18.2 17.4 n/a n/a 15.0 14.3 n/a n/a -2 0 n/a n/a Tethys Petroleum (consensus estimates) n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a Transmeridian (RC estimates) TMY.US Sell USD 1.71 1.78 -4% 181 n/a n/a n/a n/a 19.8 6.3 4.8 n/a n/a -36 -15 6.3 559 Transmeridian (consensus estimates) n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a Cap-weighted average 15.0 8.5 9.8 15 10.0 4.8 5.4 1.3 1.2 3.9 3.5 24.0 803.5 Georgia Canargo Energy (RC estimates) CNR.US Hold USD 0.50 0.67 -26% 344 266.6 25.3 50.1 n/a 65.4 11.5 12.7 n/a n/a 5.0 4.9 97.9 2,085 Canargo Energy (consensus estimates) n/a 28.6 20.2 78 n/a 9.3 7.3 n/a n/a 92.5 1,969 Frontera Resources (RC estimates) FRR.L Buy BPN 137 57 142% 72 n/a n/a n/a n/a n/a 6.5 8.3 n/a n/a -20.8 -2.6 n/a 2,263.4 Frontera Resources (consensus estimates) n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a Cap-weighted average 220.3 20.9 41.4 - 54.0 10.6 14.4 0.0 0.0 0.5 3.6 97.9 2,116.4 Turkmenistan Burren Energy (RC estimates) BUR.L Hold BPN 1,276 1,245 3% 3,601 10.5 11.0 11.1 9 6.5 6.8 6.4 1.1 0.9 5.6 5.9 36.3 213 Burren Energy (consensus estimates) 12.1 11.4 11.4 6 8.4 7.9 7.6 n/a n/a 40.9 240 Dragon Oil (RC estimates) DGO.L Buy BPN 436 326 34% 3,414 12.8 8.2 7.5 36 7.7 4.9 3.9 0.0 0.0 -3.4 4.6 21.5 421.3 Dragon Oil (consensus estimates) 10.2 6.4 6.9 41 7.3 4.8 3.5 n/a n/a 21.5 421 Cap-weighted average 11.6 9.7 9.4 22 7.1 5.9 5.2 0.6 0.5 1.2 5.3 29.1 314.5 Ukraine Ukrnafta (RC estimates) UNAF.PFT Hold USD 83 75 11% 4,070 18.8 20.7 22.8 -25 7.8 8.7 9.5 2.1 1.9 4.5 3.4 7.6 94 Ukrnafta (consensus estimates) 10.2 9.2 12.4 -10 n/a n/a n/a 4.7 4.8 8.1 100 Central Asia cap-weighted average 17.9 9.1 10.2 17.3 9.9 5.3 5.5 1.1 1.0 3.0 4.1 27.1 669.1 FSU cap-weighted average 18.0 11.0 12.3 10.6 9.6 5.8 6.1 1.2 1.1 3.2 4.0 24.0 577.4



11

Figure 8: Comparable multiples analysis for oil companies

Reuters Price MktCap, P/E NI CAGR (%) EV/EBITDA Div. yield (%) EV/proved

reserves, EV/production,

Country

ticker Currency

7-Dec-07 $mn 2007E 2008E 2009E 2007E-09E 2007E 2008E 2009E 2007E 2008E $/boe, 2006 $/boe, 2006 Russian oil companies Rosneft (RC estimates) Russia ROSN.RTS USD 9.42 92,352 6.9 13.8 14.4 22 7.9 8.3 8.1 0.6 0.7 5.5 168.0 Rosneft (consensus estimates) 18.9 15.1 15.9 10 10.8 9.1 8.5 0.6 0.8 5.7 173.2 LUKOIL (RC estimates) Russia LKOH.RTS USD 88 73,406 7.6 8.2 9.1 2 5.1 5.3 5.6 1.8 2.0 3.9 97.7 LUKOIL (consensus estimates) 8.9 8.8 10.2 -2 5.7 5.6 6.0 2.0 2.1 3.9 98.7 TNK-BP Holding (RC estimates) Russia TNBP.RTS USD 2.17 35,184 8.3 9.0 10.5 -17 5.6 5.8 6.2 9.3 9.1 4.3 69.0 TNK-BP Holding (consensus estimates) 7.0 7.7 8.5 -11 4.8 5.3 5.3 7.0 6.2 3.9 62.1 Surgutneftegas (RC estimates) Russia SNGS.RTS USD 1.23 16,751 4.8 7.5 7.5 -8 1.5 2.3 2.1 2.8 1.8 0.9 21.6 Surgutneftegas (consensus estimates) 4.0 4.5 4.9 -6 0.9 0.9 0.7 2.0 1.7 0.6 13.2 Gazprom Neft (RC estimates) Russia SIBN.RTS USD 5.75 27,262 7.2 6.7 6.7 3 5.2 4.4 4.0 4.7 5.1 3.7 67.7 Gazprom Neft (consensus estimates) 7.3 7.8 8.3 0 4.4 4.3 4.2 4.9 4.4 3.8 68.9 Tatneft (RC estimates) Russia TATN.RTS USD 6.20 12,742 8.8 9.3 9.3 8 4.4 4.6 4.3 1.2 1.5 1.8 56.3 Tatneft (consensus estimates) 9.6 10.7 9.6 6 5.4 6.3 5.5 3.1 2.8 2.0 60.8 Cap-weighted average 7.3 10.2 10.9 6 5.9 6.1 6.1 2.8 2.8 4.2 108.8 Other FSU oil companies KazMunaiGas (RC estimates) Kazakhstan KMG.L USD 28 12,744 8.9 8.3 9.9 10 4.7 4.5 5.3 1.5 1.4 17.7 175.6 KazMunaiGas (consensus estimates) 12.2 8.8 8.2 -12 5.8 4.4 4.4 0.6 0.6 18.3 181.7 Ukrnafta (RC estimates) Ukraine UNAF.PFT USD 75 4,070 18.8 20.7 22.8 -25 7.8 8.7 9.5 2.1 1.9 7.6 94.2 Ukrnafta (consensus estimates) 10.2 9.2 12.4 -10 n/a n/a n/a 4.7 4.8 8.1 100.4 Cap-weighted average 11.3 11.3 13.0 1 5.4 5.5 6.3 1.7 1.5 15.2 155.9 Other GEM Petrochina China 601857.SS RMB 31 774,063 37.8 32.8 31.3 4 20.6 18.0 17.2 1.2 1.3 36.8 709.4 Petrobras Brazil PETR4.BR BRL 80 198,515 14.0 12.3 12.2 2 7.3 6.9 6.5 2.1 2.2 14.5 267.0 Sinopec China 386.HK CNY 11.75 137,619 16.2 13.8 12.9 17 8.7 7.8 7.4 1.5 1.7 42.0 482.8 ONGC India ONGC.IN INR 1,190 64,461 11.8 11.6 11.1 6 5.5 5.3 5.4 3.1 3.3 8.3 165.9 CNOOC China 883.HK CNY 13.15 78,284 19.0 16.2 14.3 10 11.3 9.7 8.5 1.9 2.2 30.6 463.5 Cap-weighted average 29.1 25.3 24.2 5 15.8 14.0 13.2 1.5 1.7 32.0 571.1 International oil companies ExxonMobil USA XOM.US USD 92 499,922 13.0 12.3 11.7 -1 5.8 5.8 5.7 1.5 1.7 22.0 371.3 BP UK BP/.GB USD 12.6 237,837 12.4 10.7 10.8 -1 6.4 5.7 6.0 3.4 3.7 15.7 275.4 Royal Dutch Shell Holland/UK RDSB.GB USD 40 261,864 10.0 10.5 10.9 -3 5.0 5.2 5.2 3.5 3.6 24.6 285.0 Total France FP.FR EUR 56 197,278 10.3 10.0 10.0 0 5.2 5.0 5.0 3.7 4.0 18.2 308.0 Chevron USA CVX.US USD 91 192,057 11.0 10.2 9.7 2 4.5 4.4 4.0 2.4 2.7 16.2 220.4 ConocoPhillips USA COP.US USD 83 133,243 9.2 8.5 8.1 -2 4.2 4.2 4.1 2.0 2.1 16.3 217.2 Cap-weighted average 11.5 10.8 10.6 -1 5.4 5.2 5.2 2.6 2.8 19.8 300.7 Russian oil average (disc)/prem to other FSU -36% -10% -17% 5% 8% 11% -3% 1.1% 1.3% -72% -30%

Russian oil average (disc)/prem to GEM -75% -60% -55% 1% -63% -56% -54% 1.2% 1.2% -87% -81% Russian oil average (disc)/prem to international oil companies -36% -6% 2% 7% 10% 17% 17% 0.2% 0.0% -79% -64% Reserve ratios for the Russian companies are calculated using SPE measures. Those for other companies are on an SEC basis.



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Figure 9: Comparable multiples analysis for gas companies Reuters Price MktCap, P/E NI CAGR (%) EV/EBITDA Div. yield (%) EV/proved reserves, EV/production, Country ticker Currency 7-Dec-07 $mn 2007E 2008E 2009E 2007E-09E 2007E 2008E 2009E 2007E 2008E $/boe, 2006 $/boe, 2006 Russian gas companies Gazprom (RC estimates) Russia GAZP.RTS USD 13.5 316,898 14.0 10.5 9.8 13 9.1 6.4 5.9 0.9 1.1 2.8 91.1 Gazprom (consensus estimates) 13.3 11.3 10 17 8.7 7.1 6.0 0.8 1.0 2.8 89.9 Novatek (RC estimates) Russia NVTK.RTS USD 7.1 21,482 27.4 22.5 20.4 27 17.3 14.3 13.0 1.4 1.7 4.6 115.5 Novatek (consensus estimates) 28.0 21.4 18.5 27 17.8 13.7 12.5 1.1 1.3 4.6 115.5 Cap-weighted average 14.9 11.2 10.5 14 9.6 6.9 6.4 0.9 1.2 3.0 92.7 International gas companies Ouicksilver Resources USA KWK.US USD 53 4,195 35.4 29.1 22.7 28 14.3 12.6 8.3 0.0 0.0 18.4 472.3 Murphy Oil USA MUR.US USD 75 14,280 18.7 12.6 10.6 30 8.6 5.8 4.4 0.9 0.9 40.2 425.6 Devon Energy USA DVN.US USD 88 39,143 14.0 11.9 10.9 8 5.9 5.1 4.0 0.6 0.7 18.5 205.0 Chesapeake Energy USA CHK.US USD 38 18,185 12.6 11.8 11.4 3 6.0 5.1 4.7 0.7 0.7 18.2 282.7 Encana Canada ECA.CA USD 67 50,160 12.8 14.3 17.3 n/a 6.1 6.2 n/a 1.2 1.2 17.3 206.5 Pioneer Natural Resources USA PXD.US USD 47 5,584 21.0 17.4 12.9 28 7.2 6.1 5.0 0.6 0.6 8.7 172.1 Apache USA APA.US USD 99 33,078 12.9 11.0 9.7 14 5.3 4.7 3.9 0.6 0.6 16.1 204.0 Anadarko Petroleum USA APC.US USD 61 28,653 17.3 18.4 17.5 -16 5.9 5.6 5.0 0.7 0.7 13.8 213.8 XTO Energy USA XTO.US USD 65 25,067 14.8 15.1 14.3 6 7.6 6.7 5.6 0.6 0.6 20.5 314.6 BG Group UK BG/.GB GBP 10.3 70,309 19.8 16.9 17.2 4 9.4 7.9 7.8 0.8 0.9 33.5 328.4 Cap-weighted average 16.1 14.7 14.6 5 7.2 6.3 4.6 0.8 0.8 22.2 264.7 Russian gas average (disc)/prem to international gas companies -7% -24% -28% 8% 35% 10% 38% 0.1% 0.3% -87% -65% Reserve ratios for the Russian companies are calculated using SPE measures. Those for other companies are on an SEC basis.



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Figure 10: Comparable multiples analysis for alternative oil and gas companies Country Reuters Current price MktCap, P/E EV/EBITDA EV/production EV/reserves (2P), EV/resources, ticker Currency 7-Dec-07 $mn 2007E 2010E 2007E 2010E 2007E 2010E $/boe $/boe Russia Imperial Energy Russia IEC.L GBP 13.44 1,394 n/a 10.2 n/a 7.2 1,104.4 102.9 1.95 1.07 Sibir Energy Russia SBE.L GBP 5.17 4,052 23.4 7.6 9.5 5.5 209.4 106.0 6.76 4.91 Urals Energy* Russia UEN.L GBP 2.10 509 n/a 4.6 68.9 3.1 283.4 64.8 1.71 1.04 West Siberian Resources Russia WSIB.SG SEK 4.84 898 19.5 7.2 9.7 2.7 103.2 33.9 3.72 2.41 Victoria Oil & Gas** Russia VOG.L GBP 0.14 32 n/a 2.4 n/a 1.5 341.8 32.6 0.71 0.08 Volga Gas Russia VGAS.L GBP 3.09 335 116.8 4.7 n/a 1.7 n/a 32.5 4.25 1.21 Cap-weighted average 21.0 7.7 11.4 5.1 365.1 89.8 4.96 3.39 Central Asia Arawak Energy Kazakhstan ABG.C CAD 2.67 479 24.3 12.6 5.0 2.3 124 53.2 6.32 2.87 Big Sky Energy Kazakhstan BSKO.US USD 0.09 14 3.6 1.2 5.3 -0.2 48 -3.0 4.33 4.33 BMB Munai Kazakhstan KAZ.US USD 5.70 256 7.9 4.9 5.3 3.1 243 108.8 2.15 1.12 Burren Energy Turkmenistan BUR.L BPN 1,245 3,601 10.5 11.5 6.5 6.0 185 128.5 13.78 7.61 Canargo Energy Georgia CNR.US USD 0.67 344 n/a n/a n/a n/a n/a n/a n/a 4.35 Caspian Energy Kazakhstan CEK.C CAD 0.39 40 n/a n/a 416.8 1.2 192 22.8 12.9 0.84 Caspian Holdings Kazakhstan CSH.L BPN 3.75 7 n/a n/a n/a 1.9 114 51.7 0.71 0.44 Dragon Oil Turkmenistan DGO.L BPN 326 3,414 12.8 7.3 7.7 3.1 275 87.1 4.91 4.36 Frontera Resources Georgia FRR.L BPN 56.50 72 n/a n/a n/a n/a n/a n/a n/a 0.35 Max Petroleum Kazakhstan MXP.L BPN 74.25 513 48.7 n/a 30.1 n/a n/a n/a n/a 0.74 Roxy Petroleum Kazakhstan RXP.L BPN 38.50 132 n/a n/a n/a 3.9 n/a 111 24.82 9.78 Tethys Petroleum Kazakhstan TPL.C CAD 2.90 135 n/a 21.7 n/a 15.2 n/a 584 14.83 2.07 Transmeridian Kazakhstan TMY.US USD 1.78 181 n/a n/a 19.8 1.5 281 31.5 1.60 1.60 Cap-weighted average 9,187 14.5 9.7 10.5 4.5 224 111 9.21 5.20 Russian (disc)/prem to Central Asia 44% -20% 8% 14% 63% -19% -46% -35% * Our model has not been yet adjusted for the acquisition of 35.3% interest in OOO Taas-Yuriakh Neftegazodobycha and the additional share issue. ** Our model has not been yet adjusted for FY07 UK GAAP results (year-end 31 May).

Source: Company data, Thomson financial, Renaissance Capital estimates


14

Figure 11: Comparable multiples analysis for oil field service companies Reuters Price MktCap, P/E NI CAGR (%) EV/EBITDA Div. yield (%) Country ticker Currency 7-Dec-07 $mn 2007E 2008E 2009E 2007E-09E 2007E 2008E 2009E 2007E 2008E Russian OFS companies CAToil (RC estimates) Russia O2C.DE EUR 15.4 1,042 26.1 12.1 10.5 40 13.5 7.1 5.8 0.0 0.0 CAToil (consensus estimates) 24.3 13.7 9.1 43 12.9 7.8 5.3 0.4 0.7 Integra (RC estimates) Russia INTEq.L USD 14.8 2,164 201.9 25.3 16.6 n/a 10.6 7.1 5.2 0.0 0.0 Integra (consensus estimates) 30.7 17.7 15.4 n/a 11.8 8.2 6.1 0.0 0.0 Cap-weighted average 144.7 21.0 14.6 40 11.5 7.1 5.4 0.0 0.0 North American OFS companies Baker Hughes Inc USA BHI.US USD 83.450 26,553 17.5 14.7 12.2 15 9.5 7.9 6.5 0.6 0.6 BJ Services Co USA BJS.US USD 24.850 7,277 8.8 8.8 n/a n/a 4.8 4.8 n/a 0.9 0.9 Calfrac Well Services Ltd Canada CFW.CA CAD 19.000 697 13.8 12.7 n/a n/a 6.7 5.2 n/a 0.5 0.5 Halliburton Co USA HAL.US USD 37.550 33,087 15.2 12.6 10.5 11 8.4 7.4 6.2 0.9 1.0 Transocean Inc USA RIG.US USD 135.070 37,720 16.2 10.3 8.4 74 14.4 7.2 5.3 0.0 0.0 Schlumberger Ltd USA SLB.US USD 97.190 116,226 23.1 19.2 16.0 27 13.7 11.3 9.4 0.7 0.8 Trican Well Service Ltd Canada TCW.CA CAD 17.180 2,075 16.1 12.4 10.3 n/a 9.2 6.0 n/a 0.6 0.6 Weatherford International Ltd USA WFT.US USD 65.650 22,143 20.0 15.2 12.1 28 11.1 9.1 7.5 0.0 0.0 Cap-weighted average 19.6 15.7 12.8 30 12.1 9.3 7.5 0.6 0.6 European OFS companies Abbot Group PLC UK ABG.GB GBP 3.348 1,575 21.8 15.6 14.0 40 11.1 9.3 5.2 1.8 2.0 Aker Kvaerner ASA Norway AKVER.NO NOK 151.750 7,575 17.1 14.6 12.1 24 9.5 8.2 6.6 2.1 2.5 Fugro NV Holland FUGR.NL EUR 53.990 5,390 17.7 14.4 12.8 30 9.9 8.1 7.1 2.1 2.6 Cie Generale de Geophysique-Veritas France GA.FR EUR 203.860 8,175 20.5 14.9 12.5 37 6.8 5.5 4.7 0.0 0.2 Petrofac Ltd UK PFC.GB USD 10.229 3,534 20.9 18.4 16.9 22 10.9 9.6 8.5 1.3 1.5 Petroleum Geo-Services ASA Norway PGS.NO USD 27.662 4,979 11.5 9.8 8.6 25 6.5 5.0 4.3 0.0 0.0 SeaDrill Ltd Norway SDRL.NO NOK 119.000 7,872 27.1 14.6 7.1 83 18.0 11.8 5.9 0.0 1.1 Saipem SpA Italy SPM.IT EUR 27.390 17,671 22.2 17.8 14.7 32 12.5 10.4 8.7 1.6 1.8 John Wood Group PLC UK WG/.GB USD 7.756 4,067 22.0 18.0 15.3 30 12.4 10.1 8.6 0.8 0.9 Cap-weighted average 20.6 15.6 12.6 37 11.2 8.9 6.9 1.1 1.4 Russian OFS average (disc)/prem to North American OFS companies 638% 34% 14% 10% -4% -24% -28% -0.6% -0.6%

Russian OFS average (disc)/prem to European OFS companies 603% 35% 16% 3% 3% -20% -22% -1.1% -1.4%

Source: Company data, Thomson financial, Renaissance Capital estimates


15

Figure 12: Comparable multiples analysis for Transneft Company Reuters ticker Share price MktCap EV/IC Pre-tax ROIC (%) EV/EBITDA P/E Dividend yield (%) Country Currency 7-Dec-07 $mn 2006 2006 2007E 2008E 2009E 2007E 2008E 2009E 2007E 2008E Russian comparable companies Transneft (RC estimates) Russia TRNFP.RTS USD 1,945 13,004 0.86 15 3.6 3.2 2.7 5.8 4.8 4.6 0.51 0.61 Transneft (consensus estimates) 3.9 4.0 3.5 5.2 5.1 4.6 0.4 0.4 Gazprom (RC estimates) Russia GAZP.RTS USD 13.5 316,898 2.37 20 (7*) 9.1 6.4 5.9 14.0 10.5 9.8 0.9 1.1 Gazprom (consensus estimates) 8.7 7.1 6.0 13.3 11.3 9.9 0.8 1.0 Cap-weighted average 2.31 20 8.9 6.3 5.8 13.7 10.2 9.6 0.9 1.1 International peer group Elia Belgium ELI.BR EUR 27.9 1,963 1.19 6 12.3 11.8 11.3 19.7 17.9 16.6 4.6 4.8 Red Electrica Spain REE.MC EUR 43.5 8,611 2.37 9 12.2 11.3 10.6 24.6 21.0 18.8 2.4 2.8 Terna Italy TRN.MI EUR 2.72 7,948 2.13 15 9.0 9.3 9.2 17.9 18.5 18.2 5.2 5.4 Transelectrica Romania TSEL.BX RON 36.7 902 1.34 12 9.3 n/a n/a 20.1 15.7 n/a n/a n/a Cap-weighted average 2.11 12 10.7 10.0 9.6 21.1 19.4 17.4 3.6 3.9 Transneft (disc)/prem to international peer group -59% 4% -67% -68% -72% -73% -75% -74% -3% -3% * gas transportation only

Source: Company Data, Thomson Financial, Renaissance Capital estimates


16

Why $100/bbl oil? We see many reasons why the crude markets have rallied this year, as supply and demand conditions have tightened. First, global economic growth has remained robust, and so has crude demand. Second, non-OPEC crude supply has been disappointing, making OPEC supply restraint dominant. Third, OECD inventories have seen severe unseasonal declines, and the trend looks decidedly downward. Fourth, worldwide refining bottlenecks, limited global (OPEC, mainly) spare production capacity and ongoing geopolitical risks have continued to seed doubts about supply availability.

What has not contributed? Rather importantly, activity in the futures markets does not seem to have played a major part in the August-December crude rally, although it was a significant contributor after the near-$50/bbl recent low episode that was seen in Jan 2007. Since August, commercial net long positions are flat while speculative net long interest has more than halved. On the other hand, we are uncertain as to whether the weaker US dollar is the cause or the effect of higher crude prices, but there is no denying that the directional correlation has been strong and OPEC, for better or for worse, has seemed more preoccupied with the exchange rate than with the crude price.

New paradigm Although inventories are falling, OECD crude inventories are adequate and days of forward cover reasonable. Crude prices remain unusually high given these conditions, signalling that there is still a large supply risk premium built into prices. Yet we see no reason for this to dissipate any time soon. Demand from developing economies remains robust, and will go on for quite some time. There are plenty of resources, but these are in the wrong (ie risky) locations. The call on OPEC thus grows over time. While we believe the cartel is focused on adding capacity, this is a slow process. Moreover, outside of OPEC, service cost inflation and the shift to unconventional supplies is forcing development costs upward.

Revised forecasts We still believe that we are in the midst of an extended oil cycle, although we accept that it will see considerably higher prices than previously anticipated and that the long-term oil price needed to deliver marginal supply has increased very significantly over recent years. Thus, our 2007 Brent forecast rises from $70 to $73/bbl (roughly the YtD average plus the price inferred from the futures strip). We are raising our 2008 forecast from $65/bbl to $75/bbl, and then foresee price declines of $5/bbl in each of the next three years. Given the state of the futures market, this continues to look conservative. Our long-term Brent model input (meaning from 2011 onward) rises from $50/bbl to $60/bbl, in nominal terms.

What are the risks? We think that crude prices could easily surpass $100/bbl on any threat to supplies. However, crude markets look equally vulnerable to a number of factors. First, slowing demand growth would certainly get OPEC’s attention. Signs point to slowing demand, surely the effect of the high prices. Second, financial interest remains net long while the scale of the current backwardation presages a sizeable price fall. Third, a reduction in geopolitical tensions would also hurt oil. Iraq has been quieter, and its crude output rising, while Israel and the Palestinian Authority are back in talking mode.

Oil price: fundamentals stronger…


17

Figure 13: Brent futures, $/bbl

0

10

20

30

40

50

60

70

80

90

100

2003 2004 2005 2006 2007 2008 2009 2010 2011

Source: ICE, Bloomberg

Figure 14: Futures open interest, ‘000 contracts

-100,000

-50,000

0

50,000

100,000

150,000

2000 2001 2002 2003 2004 2005 2006 2007

Speculative Commercial

Source: CFTC, Bloomberg

Figure 15: Contango or backwardation, $/bbl

0102030405060708090

100

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

-10-8-6-4-20246810

One-year contango/(backwardation) (RHS) Brent (LHS)

Source: ICE, Bloomberg, Renaissance Capital estimates

Technical snapshot

North of $85/bbl as far as we can see, but forward curve is now in backwardation

After the liquidity bubble burst in August, net long positions are much reduced

Backwardation has been rare of late and on this scale has tended to presage price falls

It likely discounts that OPEC restraint is behind limited current supplies and that demand may be at some risk


18

Forecasts for crude demand in 2007 from the International Energy Agency (IEA), the US Department of Energy’s Energy Information Administration (EIA) and OPEC now foresee 1.3% growth (1.113mn bpd), somewhat lower than in September after upward reviews to 1H07 demand offset by lower expectations for 2H07. Growth of 1.9% (1.587mn bpd) is now foreseen for 2008. This larger growth mainly reflects the expectation of average winter weather conditions in contrast to the very mild ones experienced the last time around. We continue to believe that the 2008 forecasts are vulnerable to any global growth setback brought about by the financial market turmoil and demand destruction by high crude prices.

Non-OPEC supply growth estimates have remained stable over recent months, after expectations were lowered during the summer months. This leaves demand growth expectations amply exceeding forecast non-OPEC supply growth, in rather sharp contrast to the expectations in late 2006, although Angola joining OPEC earlier this year explains some of this phenomenon.

Current non-OPEC supply growth expectations are for 1.3% (0.667mn bpd) this year and 2.1% (1.037mn bpd) next year. FSU supply growth represents a huge 79% of the expected growth in 2007, meaning an optimistic 0.523mn bpd, in our opinion. Although the ratio is a more modest 49% of total non-OPEC supply growth in 2008, this still represents 0.503mn bpd, which seems a real stretch given trends in Russia and growing resource nationalism in the likes of Kazakhstan.

Taking the above demand and non-OPEC supply forecasts at face value, as well as IEA, EIA and OPEC forecasts of 4.1% (0.180mn bpd) growth in OPEC NGLs supply this year, and a striking, and therefore suspect, 10.2% (0.467mn bpd) in 2008, balanced markets require 0.9% (0.267mn bpd) more OPEC crude (and stock draws) in 2007 than in 2006, and a further 0.3% (0.083mn bpd) in 2008.

We note (from Figure 17) that OPEC’s own view of the market is less sanguine. Specifically, the cartel’s own numbers foresee a 0.3% (0.100mn bpd) higher call on OPEC and stocks in 2007 and 1.0% (0.300mn bpd) less in 2008, perhaps explaining its reluctance to increase production.

In summary, we believe that crude markets have tightened further over recent months and are now considerably more in OPEC’s control. End-2006 estimates of non-OPEC supply growth had set the stage for price weakness in 2007, but these conditions faded as the year advanced. OPEC looks in as much control in 2008, in spite of the wave of investment going into the global industry right now.

This is a very important issue, as shown in Figure 16. Arguably insufficient non-OPEC supply growth has been behind the price strength that has been seen over the past three years. These conditions are now expected to continue at least until 3Q08, assuming, of course, that bullish non-OPEC supply growth estimates for the second half of 2008 actually hold.

Supply/demand balance

19


Figure 16: Non-OPEC supply growth fails to meet demand growth, mn bpd

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-1

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4

1Q04 3Q04 1Q05 3Q05 1Q06 3Q06 1Q07 3Q07 1Q08E 3Q08E

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Demand (mnbpd, LHS)Non-OPEC supply (mnbpd, LHS)Brent, $/bbl higher YoY (RHS)

Note: Non-OPEC production includes OPEC NGLs.

Source: IEA Monthly Oil Report, US DOE EIA’s Short Term Energy Outlook, OPEC Monthly Oil Market Report, Renaissance Capital estimates

Figure 17: World oil supply/demand balance, mn bpd 2006 2007E 2008E FY 1Q 2Q 3Q 4QE FYE 1QE 2QE 3QE 4QE FY Demand 84.6 85.7 84.6 85.4 87.2 85.7 87.7 86.0 86.8 88.7 87.3 IEA 84.7 85.8 84.7 85.3 87.1 85.7 88.2 86.5 87.2 88.9 87.7 US DOE 84.7 85.6 84.5 85.6 87.5 85.8 87.7 86.0 86.9 88.5 87.3 OPEC 84.5 85.8 84.6 85.4 87.0 85.7 87.3 85.6 86.4 88.6 87.0 Supply 84.7 84.7 84.7 84.8 86.2 85.0 87.3 87.3 87.9 92.2 87.8 Non-OPEC 49.4 50.1 50.0 49.7 50.5 50.1 51.0 50.8 50.9 55.0 51.1 IEA 49.5 50.4 50.1 49.6 50.4 50.1 51.4 51.0 50.9 61.5 51.2 US DOE 49.3 49.7 49.9 49.7 50.3 49.9 50.2 50.6 51.1 51.4 50.8 OPEC 49.4 50.3 50.0 49.8 50.8 50.2 51.3 50.8 50.8 52.1 51.3 Of which FSU 12.1 12.6 12.6 12.6 12.8 12.6 12.9 13.0 13.2 13.1 13.1 IEA 12.2 12.7 12.7 12.7 12.8 12.7 13.0 13.2 13.3 12.5 13.3 US DOE 12.2 12.6 12.6 12.5 12.8 12.6 12.8 12.9 13.2 13.3 13.0 OPEC 12.0 12.5 12.4 12.5 12.8 12.6 12.9 13.0 13.1 13.4 13.1 OPEC NGLs 4.4 4.5 4.5 4.6 4.7 4.6 4.8 4.9 5.1 5.3 5.0 IEA 4.6 4.8 4.8 4.8 5.0 4.8 5.1 5.3 5.5 5.8 5.4 US DOE 4.5 4.6 4.5 4.5 4.6 4.5 4.7 4.7 4.9 5.0 4.8 OPEC 4.1 4.2 4.3 4.4 4.6 4.4 4.7 4.8 4.9 5.1 4.9 OPEC crude 30.8 31.1 30.1 31.2 32.0 31.1 31.9 30.3 30.8 28.3 31.2 IEA 30.6 30.6 29.8 30.9 31.7 30.8 31.7 30.2 30.8 21.6 31.1 US DOE 30.9 31.4 30.1 31.4 32.6 31.4 32.8 30.7 30.9 32.0 31.6 OPEC 31.0 31.3 30.3 31.2 31.6 31.1 31.3 30.0 30.7 31.4 30.8 Call on OPEC crude and stocks 30.9 30.0 30.1 30.5 31.0 30.4 31.5 31.5 31.8 31.9 31.7 IEA 31.1 30.2 30.2 30.6 - - - - - - - US DOE 30.8 29.9 30.1 30.4 31.0 30.4 31.5 31.5 31.8 31.9 31.7 OPEC 30.9 30.0 30.1 30.5 - - - - - - - Stock-build/(draw) 0.1 (1.1) 0.1 (0.7) (1.6) (1.0) (1.3) 0.8 0.9 (0.1) 0.1 IEA 0.5 (0.4) 0.4 (0.3) - - - - - - - US DOE (0.1) (1.4) (0.0) (1.0) (1.6) (1.0) (1.3) 0.8 0.9 (0.1) 0.1 OPEC (0.1) (1.3) (0.2) (0.7) - - - - - - - Notes: The IEA and OPEC numbers do not project OPEC crude supply. Processing volumetric gains, losses and biofuels are included in non-OPEC supply.

Source: IEA Monthly Oil Report, US DOE EIA’s Short Term Energy Outlook and OPEC Monthly Oil Market Report, all from Nov 2007

Non-OPEC cannot meet demand growth.

Prices rise!

Non-OPEC cannot meet demand growth.

Prices rise!


20

OPEC’s compliance (Figure 18) slipped somewhat following the Oct 2006 and Feb 2007 production ceiling (quota) reductions, but it has remained very good by historical standards. OPEC has been highly disciplined of late, in our opinion.

Figure 18: OPEC output, mn bpd

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30

35

2000 2001 2002 2003 2004 2005 2006 2007

Non-compliance OPEC Ex -Iraq and ex -Angola Quota

Source: Bloomberg, Renaissance Capital estimates

Meanwhile, the supply/demand balance portrayed in Figure 17 indicates that OPEC’s production would have to increase fairly substantially from 3Q07 levels in order to keep crude markets in balance in 4Q07 and 1Q08, when there is a seasonal upswing in demand due to the onset of winter in the northern hemisphere. The call on OPEC crude (and stocks) is anticipated to rise by 0.8mn bpd between 3Q07 and 4Q07. Normally, this is partly met with a stock-draw offsetting-inventory build in 2Q and 3Q of the year. This time around, however, 3Q closed with a large and unseasonal stock draw of around 0.7mn bpd, according to forecasts from the IEA, EIA and OPEC.

Against this background, OPEC convened in Vienna on 11 Sep 2007 and agreed to increase the production ceiling (excluding Iraqi and Angolan output) by 0.5mn bpd from 1 Nov 2007. OPEC explained the move by the higher needs in the winter season. OPEC also alluded to the shift of the forward market into backwardation around that time, which would imply a further reduction in stocks, and that higher supplies would alleviate this.

However, OPEC observed in its September communiqué that output increases in prior years had led to comfortable inventory levels, especially of crude. We tend to concur with this view. In addition, OPEC noted the ongoing tightness in the US products market and acknowledged that this continued to affect the level of product stocks and prices. The cartel’s view on this is long established. Basically, the failure of customers (and implicitly their governments) to encourage downstream investment is not the cartel’s problem to fix. Many in the market judged the September quota increase to be insufficient and crude markets rallied in the aftermath.

More recently, as crude prices retreated from near $100/bbl, hurt by worries about global growth, OPEC's decision to leave output unchanged at its 5 Dec 2007 meeting in Abu Dhabi provided strong short-term support for oil prices‚ in our view.

OPEC watch

21


Crude markets came off the boil in the latter stages of 2006, and they started 2007 on a rather weak note. We think these price setbacks were a delayed response to faltering demand as well as lower geopolitical tensions.

We actually believe that the principal driver was a rise in oil inventories. Both US inventories, which are regularly reported and tracked, and OECD ones (shown in Figure 19 and Figure 20, respectively) trended upward from early 2003 through mid-2006.

Since then, however, inventories have contracted due to the upswing in demand into the winter season, non-OPEC supply growth faltering and OPEC restraining supply. This trend will continue through 1Q08, at the very least.

Figure 19: US inventories and total product supply

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850

1990 1992 1994 1996 1998 2000 2002 2004 2006

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16

17

18

19

20

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22

Inventories (LHS, mn bbls) Supply (RHS, mn bpd)

Source: US Department of Energy’s EIA, Renaissance Capital estimates

Figure 20: OECD stocks and forward demand cover

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1990 1992 1994 1996 1998 2000 2002 2004 2006

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OECD stocks (LHS, mn bbls) Days of forward cover (RHS)


Inventories falling


22

Refining capacity, or rather the lack of it, has become a hot topic in the oil market1. We believe Figure 21 illustrates the nature of the problem. Counter intuitively, US crack spreads (the difference between the value of refined products and crude) have widened to almost unprecedented levels (bar for the brief spike after Hurricane Katrina in 2005) while US refinery capacity utilisation has been declining.

Figure 21: US refinery capacity utilisation vs crack spreads

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1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007

75

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85

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US crack spread, $/bbl (LHS) US refinery capacity utilisation, % (RHS)

Source: US DOE’s EIA, Bloomberg, Renaissance Capital estimates

Under normal circumstances, one would expect lower capacity utilisation to signal loose market conditions and to weaken prices. That this is not happening merely reflects that the US refinery stock has suffered from so much chronic underinvestment that high utilisation rates are no longer considered achievable.

By way of example, investors should note that whereas US gasoline consumption has risen by around 45% over the past 30 years, not a single new refinery has been built in the period. This is explained by poor profitability for much of this period and environmental rules that have made it nearly impossible to build refineries close to residential populations, in turn driven by widespread nimbyism.

It is against this background that persistent refinery outages are attracting attention. There is no quick fix to this problem. The worldwide system has little slack at present, particularly in the US and Europe, and most additional capacity is being built, but only slowly, in OPEC’s backyard. This, of course, shifts the balance of power from rich countries that consume the products to nations that hold significant oil reserves. Indonesia, Kuwait, Saudi Arabia, Nigeria, and Qatar are now directing billions of dollars worth of investment into refining or gas-to-liquids (GTL) projects.

This trend is slowly handing control over refined product pricing, as well as that of crude, to OPEC and other reserve-rich countries, including Russia, which also has a policy of promoting domestic refining, often at the expense of crude exports.

1 On paper, limited refinery capacity means there is nowhere else to sell crude, leading to a surplus and, in theory, lower prices. Sadly, only crude and refined product prices regulate demand. Hence, limited refinery capacity actually translates into higher crude prices to destroy demand. Such a move, in turn, would lower demand for fuels at the pump, lowering demand for crude and eventually crude oil prices. The reverse transmission mechanism works too. For example, after hurricane Katrina, the EIA and the US released crude stocks to dampen the effect at the pump from knocked-out refining capacity.

Refining: The new scare

23


While crude threatened to break below $50/bbl in Jan 2007, it has spent much of the remainder of the year on a firm uptrend. Brent is currently trading near an all-time nominal high. While it is undeniable that the crude market has tightened over the past year or so, as evidenced by the downward trend of inventories, crude prices remain very high relative to the actual level of inventory, as shown in Figure 22.

Figure 22: The new paradigm

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0 10 20 30 40 50 60 70 80 90 100

Crude (US import price), $/bbl

OECD

sock

s, da

ys of

forw

ard co

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Now


This merely tells us that history appears to have little to do with current, and we believe future, crude price formation. We shall be exploring some of the reasons behind this below, but the first point to note is that crude prices have only recently approached a high point in real terms (Figure 23). Moreover, with the benefit of hindsight, the rise in crude over recent years has been neither as inflationary nor as hurtful to growth as feared, although there may be a limit to this phenomenon.

Figure 23: US crude import price – real and nominal terms, $/bbl

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1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006

Nominal Real


New paradigm


24

Demand is rising, fuelled by developing economies

Figure 24 through Figure 26 show the inexorable rise of crude demand from developing economies. This phenomenon will continue for a considerable period of time, we believe.

Figure 24: Demand, mn bpd

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1965 1970 1975 1980 1985 1990 1995 2000 2005

Non-OECD OECD

Source: US Department of Energy’s EIA

Figure 25: Share of demand, %

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1965 1970 1975 1980 1985 1990 1995 2000 2005

Non-OECD OECD


Figure 26: Demand growth, % YoY

-8-6-4-202468

1012

1965 1970 1975 1980 1985 1990 1995 2000 2005

Non-OECD OECD


Global production capacity is limited

OPEC, which holds the world’s entire spare crude production capacity, has been operating at 90%-plus utilisation rates since 2003. This leaves very little room for error should non-OPEC supply falter through project delays or accidents, or OPEC supply be disrupted or held back due to internal strife (eg Nigeria), policy malaise (eg Venezuela or Iran) or geopolitical risks (eg affecting the whole of the Middle East, we would say). While spare capacity is forecast to rise this year and next, it will remain low in absolute terms. This calls for a continuing risk premium in crude markets.

Figure 27: OPEC capacity utilisation

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85%

90%

95%

100%

2000 2001 2002 2003 2004 2005 2006 2007

Source: Bloomberg

Figure 28: Global spare crude production capacity, mn bpd

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1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007E2008E


25


Resources overall are adequate, but in the wrong kind of place

We do not have much time for Malthusian peak-oil theories. Any focus on discoveries vs demand can lead to such concerns, but these views disregard the effect of economics and technology on reserves. Bearing these two factors in mind, which Figure 29 does, the world’s reserve-to-production ratio has undoubtedly kept up with the relentless rise in demand.

Figure 29: Global reserve additions (bn bbls) and R/P ratio (years)

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1980 1985 1990 1995 2000 2005

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Reserve additions Production R/P ratio (RHS)

Source: BP Statistical Review of World Energy, June 2007, US Department of Energy’s EIA, Renaissance Capital estimates

Having said the above, the lion’s share of global reserves is held by OPEC, with most (55%) concentrated in the Middle East. To many, this is a source of systemic supply risk. Moreover, while the economic ‘proving’ of Canada’s oil sands boosted the non-OPEC share, these resources are costly to develop and slow to produce.

Figure 30: Reserves location, %

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20%

40%

60%

80%

100%

1980 1985 1990 1995 2000 2005

OPEC Non-OPEC



26

Given this resource picture, much of the future rise in demand needs to be met by OPEC, as shown in Figure 31. Under these circumstances, OPEC’s grip over the market can only grow. The EIA expects OPEC’s share (including unconventional supplies) to climb from around 40% currently to approximately 50% by 2030. This means OPEC adding over 20mn bpd of output, and presumably more to its capacity. This is such a huge absolute sum that it raises a number of concerns in its own right.

Figure 31: Long-term production sources, %

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1980 1985 1990 1995 2000 2005 2010E 2015E 2020E 2025E 2030E

Non-OPEC conventional Non-OPEC unconventional OPEC conventional OPEC unconventional


OPEC often states its commitment to sound supply fundamentals and an adequate level of spare capacity. Planned investments by members suggest that this is the case, as portrayed in Figure 32 and Figure 33. The cartel plans nearly $130bn in upstream investment in coming years, reportedly to boost conventional crude capacity by some 5mn bpd by 2010, and spare capacity by just over 3mn bpd.

Figure 32: OPEC upstream capex

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Capex ($ bn) Projects (units)

Source: OPEC

Figure 33: OPEC capacity forecast, mn bpd

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2000 2001 2002 2003 2004 2005 2006 2007E 2008E 2009E 2010E

Crude capacity Crude + NGL capacity Call on OPEC crude

Source: OPEC

27

Renaissance Capital Oil & Gas 13 December 2007

Cost of adding production is rising

The rising cost of development is a source of great concern. Capital costs, alongside taxes, are among the most significant expenses borne by the industry. Figure 34 portrays three-year averages for unit finding and development costs (F&DC, measured in dollars of capital spent to prove a barrel of oil equivalent). For the super-majors, they more than quadrupled between 2000 and 2006.

Figure 34: Three-year finding and development cost, $/boe

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2000 2001 2002 2003 2004 2005 2006

Super-majors Russian companies Other GEM oils

Source: Companies’ US GAAP SFAS No. 69 disclosures, Renaissance Capital estimates

High service price inflation is mainly to blame for rising F&DC, although ever-more challenging geology is a factor too. In addition, the growing role of unconventional oil is also adding to the cost of replacing production. Figure 35 shows this. It excludes deep offshore plays as nowadays these are considered a conventional source.

Figure 35: Growing non-conventional supply, mn bpd

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1980 1990 2000 2004 2010E 2015E 2020E 2025E 2030E

Canadian oil sands Ultra-heavy crudes Biofuels Coal-to-liquids Gas-to-liquids Other



28

Crude production

Russia’s crude production turned very disappointing in 2007, with our growth forecasts having been cut twice to the current level of 2.3% (from 3.7% at the start of the year). This was mainly driven by a delayed drilling campaign in 1Q07, when unusually warm weather held back winter-road building, pad construction and rig mobilisation. We had hoped for performance to catch up subsequent to this, but the renewed vigour of development-drilling metrics, up 22% YoY through September (last reported), appears to have had little visible effect on output from Russia’s core producing basins. Excluding the Sakhalin projects and Rosneft’s upstream assets, the daily crude output growth from the remaining VICs was fairly insignificant or even negative YoY since May. Preliminary output figures for November indicated further deterioration of the YoY growth rate which shrank to merely 0.9%, while December is normally a modest down month as Sakhalin-2 closes for winter. For 2007 as a whole, we forecast Russia will produce 491.4mnt (or 9.828mn bpd), representing 0.4% YoY growth from Russia’s core producers, with the ramp-up of production at Sakhalin-1 earlier in the year contributing the rest.

We do not expect the reverse of this trend in 2008. Spending remains focused on greenfield projects, which should take some time to contribute. On current trends we expect Russia to be producing flat to less crude YoY through Apr 2008, with some seasonal recovery thereafter. However, as we expect no growth at all for the core producers next year, we forecast Russia’s overall crude output growth in 2008 of just 0.5% YoY, measured in tonnes, and 0.2% YoY in bpd terms, once adjusted for leap year effects. We believe this Russian supply outturn is considerably weaker than current market thinking.

Figure 36: Russian crude production growth, % YoY

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2002 2003 2004 2005 2006 2007 2008 2009 2010

Source: InfoTEK, Reuters, Renaissance Capital estimates

The Central Asian and Caspian region has been outperforming Russia in terms of production growth over 2005-2006. In our view, 2007 will not be an exception with estimated production growth of 12.4% to 125.6mnt (2.5mn bpd), accelerating further by 16.5% in 2008 to 146.3mnt.

Fundamentals watch

29


Azerbaijan has been the largest single contributor to this growth with the 2007 increase forecast at 30% fuelled by Azerbaijan International Operating Company (AIOC) and its largest project Azeri-Chirag-Guneshli. Kazakhstan lagged behind with just 3.9%, 5.5% and 5.1% production growth in 2005, 2006 and 2007, respectively. From 2008, however, we expect production in Kazakhstan to start growing with double-digit rates mainly due to the ramp-up of the Tengiz and Karachaganak fields. Kashagan is to contribute from 2010 only, in our view.

Turkmenistan has been a marginal producer until recently but promises to catch up quickly, reaching a 2.5x increase over the next decade. The major hopes rest on offshore development, the Yeloten group of fields, and the implementation of enhanced recovery methods, still quite underutilised in the country. Uzbekistan is unlikely, in our view, to demonstrate any liquids production growth in the next 10 years, given its traditional focus on gas resources and limited liquids opportunities.

Ukraine remains a marginal producer with future growth rates likely to fall given an unfriendly taxation regime, in our view.

Figure 37: Central Asia crude production, mnt

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1996 1999 2002 2005 2008 2011 2014

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Kazakhstan, RHS Turkmenistan, RHS Azerbaijan, RHS

Uzbekistan, RHS growth % , LRS


Figure 38: Ukraine crude production, mnt

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1996 1998 2000 2002 2004 2006 2008 2010 2012 2014

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Ukraine, RHS growth % , LHS


Investment-led growth

Figure 36 provides a clear indication that Russia’s so-called brownfield miracle has been exhausted. This means that the ratio of mature and highly depleted reserves is increasing, as is the ratio of hard-to-recover reserves. While crude and gas production from brownfield assets will continue to be the largest contributor to overall production for the foreseeable future, the transition from brownfield to greenfield is evidently happening.

These newer developments incorporate much improved capital inputs, entailing higher capital spending by producers, while the growing maturity of the brownfields


30

sites, as well as regulatory pressure to lower the idle well stock, also call for increased capital costs associated with maintaining production.

Figure 39: Upstream capital spending by Russian VICs, $mn

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12,000

2005 2006 9m 2007

Drilling capex Other capex

Source: NGV, Neftyanaya Torgovlya, Renaissance Capital estimates

The capex spend of Russia’s main VICs expanded 37% in the first nine months of 2007, following the growth of some 45% in the whole of last year. This translated to around $1.2bn/month of upstream capital spending, including $0.5bn/month of drilling capex. Although this is partially driven by firmer pricing, there is also a strong volume pick-up. Specifically, development drilling footage for VICs rose 22% in first nine month of 2007, while exploration drilling increased 26% in the same period (vs 26% and 17% FY06 growth, respectively).

Figure 40: Exploration and development drilling volumes by Russian VICS, km

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2005 2006 9m 2007

Development drilling Ex ploration drilling

Source: NGV, Neftyanaya Torgovlya, Renaissance Capital estimates

31


We expect this trend for accelerated capital spending to continue in 2008, in part fuelled by high commodity prices, but also administrative support for the development of the new frontier regions (such as East Siberia) via fiscal incentives.

We also see development drilling growth all over the Central Asia/Caspian region and Ukraine. In Kazakhstan the trend is not as strong as in Turkmenistan (where a significant part of drilling is for gas rather than oil). Aggressive drilling growth in Turkmenistan, we believe, will help to deliver sizable growth in the near future, while Kazakhstan and Azerbaijan are switching towards productivity improvement rather than pure expansion. In exploration drilling, the story looks different with Ukraine lacking the incentives to invest and Azerbaijan focusing on production growth but not reserves replacement.

Figure 41: Drilling (km) and production in Kazakhstan

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Source: RPI, InfoTEK, NGV

Figure 12: Drilling (km) and production in Ukraine

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Figure 43: Drilling (km) and production in Azerbaijan

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Figure 44: Drilling (km) and production in Turkmenistan

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32

Crude netback parity

Following the fiscal incentive to refine that was introduced in Russia in Aug 2004, when crude export duties shot up, the traditional crude export premium has disappeared. In fact, crude export margins (vs wellhead sales) have been negative for most of 2006, but have since grown significantly (reaching nearly $10/bbl last month). We associate this recent strength with the time-lag on export duties, which has a temporary positive effect on export margin when the oil price is rising, and we do not think this will be sustained. Domestic refining margins remain very strong with both diesel and gasoline trading at 5-20% premiums to export netbacks, as is the export margin on fuel oil (Figure 45), increasing the attractiveness of local refining vs crude exports. This is an area of some concern, as either market forces (more products staying at home) or political interference (either via coercion or raising product export duties) could adversely affect these rather benign trading conditions.

Figure 45: Russia: Oil products netbacks

(35)

(30)

(25)

(20)

(15)

(10)

(5)

0

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Apr-05 Jul-05 Oct-05 Jan-06 Apr-06 Jul-06 Oct-06 Jan-07 Apr-07 Jul-07 Oct-07

Gasoline Diesel Fuel o il


None of the Central Asia/Caspian crude-long countries has a domestic market for crude oil. Domestic product prices are normally regulated, and state-controlled companies are burdened with the duty to supply local refineries at prices, which are significantly below international netbacks. We do not envisage this will change any time soon.

Ukraine, however, is different with regular crude oil auctions allowing Ukrainian producers to sell oil at unregulated domestic prices. For most of 2005, this was trading at a premium to the price that Ukrainian refineries paid for Russian crude (see Figure 46). From Nov 2005, however, this started to change as a result of decreased demand from local refineries, some of which closed for modernisation or signed direct crude delivery contracts with Central Asian producers.

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Figure 46: Ukrainian domestic crude market trends, $/bbl

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Source: Petroleum Argus, UKRSE, UICE, Renaissance Capital estimates


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Oil taxation in Russia

The lacklustre performance of the Russian oil stocks over the past 12 months – which saw the oil price growing 42% and the Bloomberg World Oil and Gas Index appreciating 21% – is widely attributed to the specifics of the Russian oil taxation system, which makes pure upstream producers fairly insensitive to the oil price. We estimate that at $100/bbl oil, marginal tax amounts to 90% (split as 22% UNRPT, 65% export duty and 3% income tax), significantly reducing the incentives for incremental investments upstream. However, vertically integrated companies benefit from higher oil prices disproportionately, as the Russian refining margin is directly linked to the oil price (via the tax subsidy on the export of oil products). We estimate that the average gross refining margin in Russia will be $16.4/bbl in 2008 (using a $75/bbl Brent), and that it would go up to $19.3/bbl under the $85/bbl oil price assumption. Most of this growth is related to the tax subsidy on the export of fuel oil, thus reducing the incentives for the oil companies to increase the refining depth.

This dual lack of incentives to invest either upstream or downstream is a structural problem for the Russian oil sector and will need to be addressed by the government, in our view. The existing tax regime was put in place in 2005, when it was targeting different costs and a dissimilar oil price environment. Although the absolute level of industry taxation seems reasonable to us, we believe significant changes are required to make marginal investments more attractive, both upstream and downstream. While there has been a lot of smoke on this subject coming from the industry, government officials and the financial community, the substance is still lacking. It seems that the current government is not willing or able to address this rather important issue this side of the political cycle, and that we need to wait for the appointment of the new government in Mar 2008 to get things moving. There is no shortage of investment opportunities in Russia – both upstream and downstream – and any visibility towards possible improvements to the tax structure will be taken enthusiastically by the market, in our view.

Gas taxation in Russia

While the marginal taxation of the oil industry is likely to go down, the story in the gas sector is opposite – although, no less uncertain. The current UNRPT flat-rate tax for gas is low (RUB147/mcm) and, although fixed for 2008, is likely to go up in the future, at least in line with the growth in domestic gas tariffs, in our view. Original proposals by the Ministry of Finance for a significant (up to six-fold) increase in the tax rate by 2011 were dismissed by the government earlier this year, which is instead trying to find a balance between increasing the taxation of the windfall profits arising from the growth in domestic gas tariffs for industrial users, and maintaining the incentives for the development of new production provinces (such as Yamal, the Arctic shelf and East Siberia). Preliminary proposals from Gazprom – which we believe will be used as the basis for future tax regime – call for a higher base rate, which, however, will be accompanied by the introduction of differentiated taxation via tax breaks on mature fields, new production provinces and such others. We expect that new tax rules for the gas producers could be agreed upon during 2008, and introduced from 2009.

Amendments to Russia’s Subsoil Use law

Of some significance for the sector is the long-awaited introduction of amendments to Subsoil Use Law, regulating, among other things, access to ‘strategic’ resources.

Policy watch

35


At this stage, little in the proposed legislation is actually unknown, with new amendments designed to enhance the state companies’ positions relative to private investors, and endorse into law fairly blatant resource nationalism. Therefore, it should not prove market-moving. In spite of this, we would still welcome approval of the new legislation as it would lead to strategic fields being auctioned, thereby helping the market to understand the impact of the new rules.

Hydrocarbon taxation in Central Asia and Ukraine

Russia seems unique in that we expect its oils taxation burden to decline. Most of the other major oil producers in the world are heading in the opposite direction, with taxation increasing or stable. Central Asia is no exception. Kazakhstan is leading this trend with recent and proposed changes to the legislation tightening the grip around the oil producers. In early 2007, the Kazakh government introduced a two-year ban on the re-sale of oil producing assets (to stimulate investments), and later in the year, embarked on a major offensive spree against the members of the Kashagan consortium. This included new powers given to the government to unilaterally amend existing PSAs, as well as more recent suggestions that all PSAs could be abolished and associated tax rules changed (i.e., increased).

In this regard, the Finance Ministry of Kazakhstan recently proposed replacing existing export rent tax with a new mineral extraction tax, with more details expected to be announced in 1Q08. The change, should it be approved, will be introduced from 2009, and should lead to a significant increase in overall tax receipts for the government, mainly through higher taxation of domestic volumes and PSAs. We anticipate that the effect of such changes on Kazmunaigas E&P will be mitigated (given its links to the state) through off-setting the benefits of asset contributions or tax privileges.

Unlike Kazakhstan, Azerbaijan does not believe any of its PSA terms need to be amended. However, it has announced a hike in its export windfall tax rate to 30% in 2008 (from 25% previously). The tax is applied to the difference between international and domestic crude oil price, with the latter determined by the state, but moving towards liberalisation. The country also seeks tougher ecological compliance requirements.

We expect little change in Turkmenistan next year given that the country is trying to attract new investors. At the same time, some positive action is possible in Tajikistan and Ukraine, where both taxation and licensing regimes are less than friendly (royalty tax has gone up five times in Ukraine over the past three years). However, political instability in both countries makes the likelihood of these changes less than certain, in our view.


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The year 2007 proved very busy from an M&A stand-point, but we believe it will be overshadowed by the amount of corporate activity next year. The main highlight of 2007 was, of course, the series of YUKOS auctions, but there were also many more deals including Transneft’s merger with Transnefteprodukt, Gazprom’s acquisition of a 62.8% stake in RUSIA Petroleum, Kazmunaigas E&P’s acquisition of Kazgermunai and CITIC Canada Energy, ENI’s acquisition of Burren Energy, Ural Energy’s acquisition of a 35.3% stake in Taas-Yuriakh Neftegazodobycha, as well as a number of initial and secondary offerings and private placements. We believe the following possible transactions could have a material impact on the share prices of listed companies next year:

The next big deal to look out for should be the Russian partners’ exit from TNK-BP. While they deny such a course of action, we believe this in itself is a telling sign. There are many other signs too, including TNK-BP selling assets and the Russian partners’ investment efforts elsewhere. Both Gazprom and Rosneft have shown an early interest, and usually, if interested, they get what they want. While this will be an off-market transaction, i.e. not one directly involving TNK-BP Holding’s shares, we would expect the sellers to try to maximise proceeds.

Improving corporate governance for the listed unit would help to lower the risk premium and create a reliable valuation benchmark for any future deal. We believe the market now foresees Gazprom landing this asset, in large part because Gazprom and TNK-BP bump into each other in so many different areas (Slavneft, the pending gas JV, etc.). However, Rosneft has a deepening relationship with BP, and we are convinced the latter would relish the prospect of partnering Gazprom in gas and Rosneft in oil. Hence, a grand-bargain split of the assets should not be ruled out, in our view. Either way, we like TNK-BP Holding due to this foreseeable corporate action as well as its value proposition after substantial underperformance over the past two years.

Another potential deal to look out for in 2008 centres on the Bashkir assets (including Bashneft plus the three Ufa-based refineries). These are currently controlled by the Russian government and Sistema. We believe this collection of assets is of significant interest to both Rosneft and Gazprom Neft, which are both crude-long and have the political clout to pull the deal at attractive terms with the government. This suggests that the Bashkir units may not be the best way to play this story.

There is continuing speculation in the press that Surgutneftegas will also end up in the hands of one of the state-owned companies, with Rosneft most often cited in this context. While we see some logic behind these rumours, Surgutneftegas is not a willing seller and the company’s unusual business model has been praised by President Putin. We therefore think Surgutneftegas is ’protected’ during this political cycle, but the future looks more uncertain. This points towards a possibility that the current ambiguous ownership structure could be clarified before the presidential elections; however, if it isn’t, investors should brace themselves for a long, and potentially indefinite, wait, in our view.

Finally among the large-caps, we believe Gazprom is keen to buy a 20% stake in Gazprom Neft (currently owned by ENI), and, potentially, mop up

Corporate actions

37


the remaining 5% freefloat from the market. The expectation of what it will pay, however, does not exactly provide grounds for encouragement for minority shareholders in the unit.

We expect continuing corporate activity from smaller E&P companies across the FSU, including acquisitions, disposals and equity offerings. Urals Energy is a key one to watch in Russia, which has said it will start the asset rationalisation process following the recent acquisition of a substantial property in East Siberia. Victoria Oil & Gas is also likely to be transformed next year given recent production setbacks, funding issues and pending management changes.

In Ukraine, we believe the sector will consolidate given the unfavourable taxation regime and believe that Regal Energy, in particular, is vulnerable following the last-minute break-up of its deal with RoyalDutchShell.

Among Central Asian companies we expect Kazmunaigas E&P to acquire stakes in MangistauMunaiGas, Kazturkmunai and Kazakhoil-Actobe from its parent. We also believe that Max Petroleum, Caspian Energy and Tethys Petroleum will all announce farm-out partners for their respective prospects next year, while the improving investor climate in Turkmenistan will likely increase the chances of a corporate deal for Dragon Oil.


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During the past year the share-price performance of Russian major oil and gas stocks has significantly lagged that of its FSU and developed markets peers, and the Russian equity market in general. In Figure 47 we calculate that the Russian major oil stocks have underperformed the Bloomberg World Oil and Gas Index by 21.9%, the MSCI Renaissance Index by 24.1% and its peers from Central Asia (KazMunaiGas) and Ukraine (Ukrnafta) by 49.6% and 21%, respectively. The underperformance of Russian gas stocks relative to the Bloomberg World Oil and Gas Index and the MSCI Renaissance Index was 9.5% and 11.7%, respectively. While the underperformance relative to the Russian equity market can be explained by the strengthening rouble (as shown below), such significant underperformance of oils stocks relative to international peers is historically unusual, particularly during a period of a strengthening oil price.

We show in Figure 48 that in 2005 Russian oil and gas stocks were generally outperforming their peers from developed countries (as measured by the FTSE All World Developed Oil and Gas Producers) in line with Central Asian oil companies and Ukrnafta, but then the performance diverged: while Ukrnafta continued its impetuous growth (which we associate primarily with the political reasons, namely: the rapid development of the Ukrainian stock market following the ‘orange revolution’ in Dec 2004 and President Yushenko’s decision to veto the ban for Ukrnafta’s privatisation in Jan 2006), the performance of Russian and Central Asian peers slowed down, generally in line with the temporary weakness in the Brent price. In 2007, however, both Russian and Central Asian oil and gas stocks have underperformed the Brent price by 43% and 32%, respectively. Ukrnafta has also headed south since late spring 2007 when the management of the company warned the investors that FY07 net income may decline four times YoY due to tax hikes.

We associate some of the relative underperformance of Russian gas stocks in the early part of this year to growing concerns about a possible hike in the gas MET rate, as well as uncertainty about the government’s commitment to proceeding with the liberalisation of the domestic gas price for industrial users. Both concerns are now firmly behind us. Russian oils stocks also saw a difficult start to the year as a result of an unfavourable export duty which has lagged the decline in the oil price during 2H06 and 1Q07. This situation reversed in 2Q07, and is now looking equally favourable for 4Q07, given the continuing strength of the oil price (Figure 49).

Performance and earnings

Figure 47: Relative performance of oil companies, last year Rebased to 100

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Figure 48: Relative performance of oil companies, last three years Rebased to 100

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Source: Thomson Datastream, Bloomberg

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It is widely believed that the sensitivity of Russian oil stocks to the oil price is lower than that of their international peers, as a result of rather punitive taxation on the upstream side. In Figure 51 we compare the upstream taxation regimes in Russia and Kazakhstan and conclude that Kazakh companies earn better netbacks than the Russian ones from all export contracts (irrespective of their terms or export routes) if the oil price exceeds $60/bbl. Although various sources recently reported that Kazakhstan’s Ministry of Finance had proposed a significant hike in the taxation burden, the final decision is yet to be made.

While punitive crude taxation seriously affects pure upstream producers, VICs significantly benefit from the so-called tax subsidy on the export of oil products, the size of which is strongly correlated with the oil price (Figure 52). We show in Figure 50 that this subsidy has now reached historically high levels of $17/bbl, on average, which should further help the financial performance of Russian VICs (LUKOIL, Rosneft, Surgutneftegas, Gazprom Neft, TNK-BP) over the period of a rising oil price, in our view.

Figure 49: Tax subsidy on the export of oil products, $/bbl

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Figure 50: Relative performance of Russian oils vs global oils vs tax subsidy on the export of oil products

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Figure 51: Sensitivity of export netback to oil prices, $/bbl

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Given oil and gas companies are often large exporters, national currency/dollar exchange rates impact their relative performance on the domestic stock markets. On average, oils outperform the domestic market index when the national currency depreciates (and export revenues increase) and underperform the index when the national currency appreciates (thereby causing export revenues to decline), other things being equal (Figures 53-55).

While the tendency is evident for Russian and Kazakh companies, Ukrnafta’s performance does not exhibit a statistically significant correlation (despite the fact that Ukrnafta is not a direct exporter, the oil prices it receives at the domestic auctions correlate with Urals (Ukraine)), which we explain by the lack of other liquid plays for investors who desire Ukrainian exposure.

Over the past three years the currency impact has been the strongest on the Russian market. We believe the rouble appreciation is coming to an end, being hindered by the recent outflow of short-term foreign investments from the money market, the gradual reduction of the current account surplus and massive long-term investments abroad by Russian companies. Any weakness in the rouble should be supportive for the relative performance of the Russian oil and gas sector, in our view.

Figure 53: Russian oils vs currency dynamics

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In the context of individual stock performance, our key observations are as follows:

Despite relatively high consensus estimates of earnings growth (which were recently revised upwards) both Gazprom and Novatek underperformed their international peers over the past year. We see 41% upside for Gazprom over the next 12 months, through its unrivalled exposure to the liberalisation of the domestic gas market, strong gas prices in Europe and restructuring potential.

Gazprom Neft and Tatneft were the best performers among the Russian major oils YtD (up 22.4% and 20.2%, respectively), while Surgutneftegas was the worst performer (down 14.5%). Rosneft was flat. LUKOIL and TNK-BP were both weak (down 4.1% and 11.1%, respectively), as well as Transneft (down 21.3%). We associate Surgutneftegas’s weak performance with the lack of clarity on its ownership and balance sheet structure and that of TNK-BP with the negative sentiment resulting from the

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loss of the Kovykta licence by TNK-BP’s parent company earlier this year. This however, had no effect on the fundamental valuation of the listed entity. We do not believe that either issue will hold in 2008.

Share price performance of the independents was very volatile, ranging from Imperial Energy (up 100.7%) and Dragon Oil (up 83.1%) to Victoria Oil & Gas (down 81.8%) and Big Sky Energy (down 83.3%). The consensus estimates for their earnings growth (when available) are high, but also subject to significant revisions due to high execution, financing or resource quality risks. Going forward, we believe the risks and performance will be equally diverse, as the fate of these companies is almost entirely dependent on meeting their individual milestones, rather than general sector trends.

Both CAToil and Integra were weak YtD (down 9.3% YoY and 25% since the start of trading, respectively). Both companies are at a transitional stage, actively diversifying into new market segments and geographical regions, which makes their fundamental analysis extremely challenging and adds volatility towards their share price performance. In the case of CAToil, this is further impacted by its low liquidity. We expect the negative share performance trends to reverse in 2008.

A special word on preferred shares

Surgutneftegas and Tatneft’s ordinary and preferred shares are traded with significant discounts (43% and 47% at present, respectively), while those of TNK-BP rarely diverge by more than 10-15%, with discounts even turning negative before the dividend announcements (due to high dividend payouts). Last month Surgutneftegas’s preferred shares reached a multi-year high level of discount of 55%, but it since narrowed to Tatneft’s level. We expect Surgutneftegas and Tatneft’s discounts to shrink further in 2008, following the improvement in corporate governance standards in the case of Tatneft and clarification of the ownership and balance sheet structures in the case of Surgutneftegas.

Figure 56: Preferred share price discount to the ordinary

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Figure 57: Consensus earnings growth vs price performance for gas producers, %

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Figure 58: Consensus earnings growth vs price performance for major oil producers, %

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Figure 60: Consensus earnings growth vs price performance for oil field service companies, %*

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Source: Thomson Financial


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Figure 61: Price performance of Russian oil and gas companies Current

price 52 weeks Share price performance (abs.)*,

% Share price performance

(rel. to Bloomberg World Oil and Gas Index), % Share price performance (rel. to MSREN Index), %

Share price performance (rel. to MSCI EM Index), %

Reuters ticker Currency

3-Dec-07 High Low 1W 1M 3M 12M 1W 1M 3M 12M 1W 1M 3M 12M 1W 1M 3M 12M Russian gas producers Gazprom GAZP.RTS USD 13.1 13.4 9.1 2.7 3.7 26.4 12.4 0.4 7.9 15.0 -9.0 0.7 1.9 6.1 -11.2 -1.9 8.8 12.4 -29.0 Novatek NVTK.RTS USD 6.49 6.65 4.70 6.3 15.1 29.1 3.0 4.0 19.2 17.7 -18.3 4.3 13.3 8.8 -20.5 1.7 20.2 15.1 -38.4 Cap-weighted average 2.9 4.4 26.6 11.8 0.6 8.6 15.2 -9.5 0.9 2.6 6.3 -11.7 -1.7 9.5 12.6 -29.6 Russian oil producers Rosneft ROSN.RTS USD 8.94 9.60 7.85 1.6 2.8 8.5 -1.2 -0.7 7.0 -2.9 -22.6 -0.3 1.0 -11.8 -24.8 -3.0 7.9 -5.5 -42.6 LUKOIL LKOH.RTS USD 85 96 71 -2.4 -6.9 14.0 -6.0 -4.7 -2.8 2.6 -27.3 -4.3 -8.8 -6.3 -29.5 -7.0 -1.8 0.1 -47.4 TNK-BP Holding TNBP.RTS USD 2.16 2.58 2.47 -0.7 -5.3 10.7 -11.7 -3.0 -1.1 -0.7 -33.0 -2.7 -7.1 -9.6 -35.2 -5.4 -0.2 -3.2 -53.0 TNK-BP Holding TNBPP.RTS USD 1.92 2.30 2.19 -0.6 -3.9 12.9 -13.4 -2.9 0.3 1.5 -34.7 -2.6 -5.7 -7.4 -37.0 -5.3 1.2 -1.1 -54.8 Surgutneftegas SNGS.RTS USD 1.16 1.51 1.07 -2.4 -9.8 -8.1 -16.1 -4.8 -5.6 -19.5 -37.4 -4.4 -11.6 -28.4 -39.6 -7.1 -4.7 -22.1 -57.4 Surgutneftegas SNGSP.RTS USD 0.65 1.07 0.60 1.6 -4.1 0.4 -32.3 -0.7 0.1 -11.0 -53.6 -0.4 -5.9 -19.9 -55.8 -3.1 1.1 -13.6 -73.7 Gazprom Neft SIBN.RTS USD 5.55 5.30 3.70 10.2 12.7 44.2 33.1 7.9 16.8 32.8 11.8 8.2 10.9 23.9 9.5 5.6 17.8 30.2 -8.3 Tatneft TATN.RTS USD 5.91 6.30 3.85 1.0 -3.4 18.0 21.9 -1.3 0.7 6.6 0.5 -1.0 -5.2 -2.3 -1.7 -3.6 1.7 4.0 -19.5 Tatneft TATNP.RTS USD 3.21 3.30 2.55 2.5 -0.4 16.8 8.9 0.2 3.8 5.4 -12.4 0.5 -2.2 -3.5 -14.7 -2.2 4.7 2.9 -32.5 Cap-weighted average 0.9 -1.1 13.7 -0.5 -1.4 3.1 2.4 -21.9 -1.1 -2.9 -6.5 -24.1 -3.8 4.0 -0.2 -41.9 Alternatives Imperial Energy IEC.L GBP 13.80 15.26 6.11 0.2 -6.9 41.6 86.2 -2.1 -2.7 30.2 64.9 -1.7 -8.7 21.3 62.6 -4.4 -1.7 27.6 44.8 Sibir Energy SBE.L GBP 5.51 5.68 4.02 -1.4 -1.6 5.4 34.7 -3.7 2.5 -6.0 13.3 -3.4 -3.4 -14.9 11.1 -6.1 3.5 -8.6 -6.7 Urals Energy UEN.L GBP 2.39 4.45 2.20 -6.0 -14.8 -8.1 -30.0 -8.3 -10.7 -19.4 -51.3 -7.9 -16.6 -28.4 -53.6 -10.6 -9.7 -22.0 -71.4 West Siberian Resources WSIB.SG SEK 4.78 7.80 4.53 3.1 -12.3 -16.8 -41.5 0.8 -8.1 -28.1 -62.9 1.2 -14.1 -37.1 -65.1 -1.5 -7.2 -30.7 -82.9 Victoria Oil & Gas VOG.L GBP 0.13 0.73 0.12 -0.1 -23.2 -60.0 -82.6 -2.4 -19.1 -71.4 -104.0 -2.1 -25.0 -80.3 -106.2 -4.7 -18.1 -74.0 -124.0 Volga Gas VGAS.L GBP 3.26 3.85 2.88 -3.6 -1.8 15.7 n/a -5.9 2.3 4.3 n/a -5.6 -3.6 -4.6 n/a -8.3 3.3 1.7 n/a Cap-weighted average -1.0 -4.9 8.8 28.6 -3.3 -0.8 -2.5 8.3 -3.0 -6.8 -11.4 6.2 -5.7 0.2 -5.1 -10.8 Oilfield services CAToil O2C.DE EUR 15.42 25.56 15.15 -7.3 -18.2 -20.2 -12.2 -9.6 -14.0 -31.6 -33.5 -9.3 -20.0 -40.5 -35.7 -11.9 -13.0 -34.2 -53.6 Integra INTEq.L USD 14.71 21.55 13.55 3.4 -5.2 -8.7 n/a 1.1 -1.0 -20.1 n/a 1.5 -7.0 -29.0 n/a -1.2 0.0 -22.7 n/a Cap-weighted average 0.0 -9.4 -12.4 -3.9 -2.3 -5.2 -23.8 -10.8 -2.0 -11.2 -32.7 -11.5 -4.7 -4.2 -26.4 -17.3 Transneft TRNFP.RTS USD 1,880 2,505 1,400 -0.5 -3.1 24.5 -22.7 -2.8 1.0 13.1 -44.0 -2.5 -4.9 4.2 -46.2 -5.1 2.0 10.5 -64.0 Russia cap-weighted average 1.9 1.8 20.7 6.1 -0.4 5.9 9.4 -15.2 -0.1 0.0 0.5 -17.4 -2.7 6.9 6.8 -35.1 Bloomberg World Oil and Gas Index 2.3 -4.1 11.4 21.3 - - - - 0.3 -5.9 -8.9 -2.2 -2.3 1.0 -2.6 -20.0

MSCI Renaissance Index 2.0 1.8 20.3 23.6 -0.3 5.9 8.9 2.2 - - - - -2.7 6.9 6.3 -17.8 MSCI EM Index 4.7 -5.1 14.0 41.4 2.3 -1.0 2.6 20.0 2.7 -6.9 -6.3 17.8 - - - - * calculated on USD basis

Source: RTS, Bloomberg


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Figure 62: Price performance of oil and gas companies from other FSU countries

Reuters ticker Currency Current

price 52 weeks Share price performance (abs.)*, % Share price performance

(rel. to Bloomberg World Oil and Gas Index), %

Share price performance (rel. to MSREN Index), %

Share price performance (rel. to MSCI EM Index), %

3-Dec-07 High Low 1W 1M 3M 12M 1W 1M 3M 12M 1W 1M 3M 12M 1W 1M 3M 12M Kazakhstan Arawak Energy ABG.C CAD 2.69 3.20 2.27 -6.2 -4.0 6.7 25.2 -8.5 0.1 -4.7 3.9 -8.2 -5.8 -13.6 1.6 -10.9 1.1 -7.3 -16.2 Big Sky Energy BSKO.US USD 0.090 0.79 0.05 0.0 12.5 -60.0 -83.3 -2.3 16.6 -71.4 -104.7 -2.0 10.7 -80.3 -106.9 -4.7 17.6 -74.0 -124.7 BMB Munai KAZ.US USD 5.60 6.96 4.59 -4.3 1.8 -3.6 12.0 -6.6 6.0 -15.0 -9.3 -6.3 0.0 -23.9 -11.6 -8.9 6.9 -17.6 -29.4 Caspian Energy CEK.C CAD 0.37 1.36 0.34 -5.7 -36.2 -13.9 -65.1 -8.0 -32.1 -25.3 -86.5 -7.7 -38.0 -34.2 -88.7 -10.4 -31.1 -27.9 -106.5 Caspian Holdings CSH.L BPN 3.75 9.75 3.63 -6.3 -27.4 -26.8 -57.7 -8.6 -23.3 -38.2 -79.1 -8.3 -29.2 -47.1 -81.3 -11.0 -22.3 -40.8 -99.1 KazMunaiGas KMG.L USD 26.7 29.7 18.2 -3.7 -2.5 25.7 49.1 -6.0 1.6 14.3 27.8 -5.7 -4.3 5.4 25.6 -8.4 2.6 11.7 7.7 Max Petroleum MXP.L BPN 83 210 43.5 15.1 -13.6 -24.8 -7.6 12.8 -9.4 -36.1 -29.0 13.1 -15.4 -45.1 -31.2 10.5 -8.4 -38.7 -49.0 Roxy Petroleum RXP.L BPN 38.5 74 38 n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a n/a Tethys Petroleum TPL.C CAD 3.93 4.0 2.4 -3.1 -16.6 20.6 n/a -5.4 -12.4 9.2 n/a -5.1 -18.4 0.3 n/a -7.8 -11.5 6.6 n/a Transmeridian TMY.US USD 1.76 4.1 1.1 -0.7 -13.7 -13.2 -49.6 -3.0 -9.6 -24.6 -70.9 -2.7 -15.5 -33.5 -73.1 -5.3 -8.6 -27.2 -91.0 Cap-weighted average -3.0 -3.3 21.4 42.5 -5.2 0.8 10.1 21.6 -4.9 -5.1 1.3 19.4 -7.6 1.8 7.5 1.9 Georgia Canargo Energy CNR.US USD 0.42 1.66 0.35 -8.5 -33.8 -45.6 -64.8 -10.8 -29.7 -56.9 -86.1 -10.5 -35.7 -65.9 -88.3 -13.1 -28.7 -59.5 -106.1 Frontera Resources FRR.L BPN 56.5 87.5 43.5 5.1 4.4 -0.4 67.1 2.8 8.5 -11.7 45.7 3.2 2.5 -20.7 43.5 0.5 9.5 -14.3 25.7 Cap-weighted average -5.1 -24.3 -34.2 -31.7 -7.4 -20.1 -45.6 -53.0 -7.1 -26.1 -54.5 -55.2 -9.7 -19.1 -48.2 -73.0 Turkmenistan Burren Energy BUR.L BPN 1,234 1,249 725 15.6 2.1 51.7 41.6 13.3 6.2 40.4 20.2 13.6 0.2 31.4 18.0 10.9 7.2 37.8 0.2 Dragon Oil DGO.L BPN 316 323 158 13.4 -1.9 41.6 83.1 11.1 2.2 30.3 61.8 11.4 -3.7 21.3 59.6 8.7 3.2 27.7 41.8 Cap-weighted average 14.5 0.1 46.9 61.5 12.2 4.3 35.5 40.2 12.5 -1.7 26.6 38.0 9.9 5.3 32.9 20.2 Ukraine Ukrnafta UNAF.PFT USD 75.1 99.6 59.4 1.7 -9.1 -6.5 20.5 -0.6 -5.0 -17.8 -0.9 -0.3 -11.0 -26.7 -3.1 -3.0 -4.0 -20.4 -20.9 FSU cap-weighted average 2.5 -3.5 23.2 43.3 0.2 0.6 11.9 22.2 0.5 -5.3 3.0 20.0 -2.1 1.5 9.3 2.4 Bloomberg World Oil and Gas Index 2.3 -4.1 11.4 21.3 - - - - 0.3 -5.9 -8.9 -2.2 -2.3 1.0 -2.6 -20.0 MSCI Renaissance Index 2.0 1.8 20.3 23.6 -0.3 5.9 8.9 2.2 - - - - -2.7 6.9 6.3 -17.8 MSCI EM Index 4.7 -5.1 14.0 41.4 2.3 -1.0 2.6 20.0 2.7 -6.9 -6.3 17.8 - - - - * calculated on USD basis

Source: Bloomberg, Thomson Financial

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Our coverage universe has expanded substantially over the past 12 months, following recent initiations of coverage on Oil Field Services companies, Central Asian E&P and Russian gas distributors (oblgazes), and now includes 60 stocks. We highlight our main investment themes for each of these below.

Russian vertically integrated oil companies

This sub-sector (down 0.5%, on average, over the past 12 months), has massively underperformed its international peers with the exception of Tatneft (up 21.9%) and Gazprom Neft (up 33.1%). The market sentiment towards the sector has been heavily influenced by concerns over the rising costs and unfavourable taxation regime, which significantly reduces the marginal benefits of a higher oil price to Russian upstream producers. The refining margin, however, does have a positive correlation with the oil price via a tax incentive on the export of oil products, benefiting the most vertically integrated producers, such as LUKOIL and Rosneft. In fact, as we stated earlier, we estimate that at the current level of the oil price they are now more sensitive to changes in the oil price, than international oil majors.

While long-term visibility on the possible changes to oil taxation rules in Russia does not exist, we believe this structural problem could be addressed by the new government after its appointment in Mar 2008. In the meanwhile, however, we are left to focus on the short-term catalysts, which, on balance, appear positive for the next two quarters, in our view. First, and contrary to 2H06, the taxation cycle is positive with the export duty on crude lagging the recent growth in the oil price by two to three months, and the tax subsidy on oil products exports hitting all-time highs. Secondl, our house view on the Russian rouble has changed recently towards an expectation of a flattening rouble/dollar exchange rate in 2008 because of the changing dynamics in trade and capital flows. This should prove very positive for the relative performance of the Russian oil companies, relative to the RTS (as shown in Figure 53). Third, recent significant underperformance has resulted in attractive relative valuations, with the sector trading at a 2008E P/E multiple of 8.1 (excluding Rosneft), a 25% discount to the international oil majors, and a 2008E EV/EBITDA multiple of 4.9, a discount of 6%.

We believe LUKOIL (LKOH, BUY, target price $112.0 from $92.0) offers the best exposure to these three trends, and expect that it could close the existing 19% valuation gap (based on the 2008E P/E multiple) with its peers over the next few months. As the most vertically integrated of the Russian oil companies, it should be the key beneficiary of historically high refining margins in Russia, helped by the oil-price-linked subsidy on the export of oil products. We estimate that the company’s unit upstream capex has already reached the plateau level (unlike some of the other Russian producers), and its production growth could start picking up from 2H08 and into 2009-2010 with the planned launch of production from the new oil fields in Timano-Pechora and the Caspian sea.

Rosneft (ROSN, HOLD, target price $9.60 from $8.75) offers equally attractive exposure to the positive taxation cycle and what looks like the best upcoming quarter in the history of the Russian oils industry (4Q07). However, it suffers from a lack of visibility on the growth prospects of the recently acquired YUKOS assets amid relatively high valuations (it trades at a 72% premium to LUKOIL in terms of consensus 2008E P/E multiple) and high financial leverage. We believe that this

Company views


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visibility could improve substantially after the much-awaited and long overdue strategic update (now expected in Jan 2008). However, we believe our current forecast already assumes a significant improvement in production rates and operational performance, and therefore do not anticipate any substantial upgrades.

We continue to like Surgutneftegas (SNGS, BUY, target price $2.11 from $1.90) and TNK-BP (TNBP, BUY, target price $3.33 from $2.88) as consolidation plays. We associate Surgutneftegas’ likely corporate activity with the change in the political cycle, and that of TNK-BP with the expiration of the shareholder agreement between BP and its Russian partners. The TNK-BP transaction looks more certain to us and also offers fundamental value through above-average unit cash flows and exposure to vast East Siberian resources.

We believe that the share price of Tatneft (TATN, HOLD from Buy, target price $6.90 from $5.80) will consolidate at these levels following the strong 22% growth in its share price over the past 12 months following visibly better corporate governance and improved prospects of its bitumen opportunity. Better clarity on the economics of this project, as well as positive progress with its refinery construction is crucial for the further stock appreciation, in our view.

Future share price performance of Gazprom Neft (SIBN, HOLD, target price $4.99 from $4.10) is largely at the will of Gazprom, its 75% shareholder. The company’s production is in decline, and could be reversed either through an acquisition or by operating Gazprom’s untapped oil reserves, in our view. The economics of both scenarios are unknown, but do not look overly promising to us, given our understanding of Gazprom’s intentions to consolidate the remaining 25% of the company. The expectation of what it will pay, however, does not provide grounds for encouragement for minority shareholders in the unit.

Russian gas producers

Gazprom (GAZP, BUY, target price $19.0 from $15.0) remains our top pick in the sector despite the 26% increase in the share price over the past three months. The visibility of growth in domestic profitability improved significantly this month with the regulator’s approval of a 25% increase in the 2008 gas tariff for industrial users and a 19% growth in the transportation tariff for the third parties. Gazprom is the most leveraged play on the oil price of all hydrocarbon producers in Russia (through the oil-link to its contract gas prices in Europe), which should result in at least 20% growth in its realised price in Europe in 2008, on our estimates, all in all leading to our estimated EPS growth rate of 28% in 2008. Finally, we expect the company will embark on a restructuring programme in the next few months, which could include the disposal/sale of four assets (Gazprombank, Sibur, Gazprom Media and electricity assets). This could refocus investors’ attention to the sum-of-the-parts valuation of the company, which currently stands at $23.3/share, on our estimates.

We are more cautious on Novatek (NVTK, HOLD, target price $6.00 from $5.50), especially after the 15% rebound in its share price over the last month. Its current valuation (2008E P/E multiple of 21.4, an 89% premium to Gazprom, based on consensus forecasts) could only be justified by assuming significant growth in both gas production volumes and ex-field prices, on our estimates. While Novatek undoubtedly boasts a very attractive asset base and has the potential to increase its

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output, so do many other independent gas producers and oil companies. This may lead to market pressures on both volumes and pricing growth, in our view. Much of this uncertainty could be clarified next year. Volume-wise, we expect firmer indications from Novatek’s competitors on their ultimate production ambitions (Itera said that it is planning an IPO, Rospan is likely to be folded into a JV with Gazprom, Enineftegas should become more vocal ahead of the expiration of the Gazprom call option, Rosneft could strike a deal with Gazprom over its Kharampur field, and Gazprom itself will start properly competing in the non-regulated segment of the market in 2008). Price-wise, we anticipate wellhead prices charged by the independents to start converging next year from the current very-wide range of between $25/mcm for Rosneft and $40/mm for LUKOIL (with Novatek’s $30/mcm somewhere in between), with the outcome of this process heavily influenced by increased competitiveness in the sector, in our view.

With an estimated 41% DCF-derived upside potential for Gazprom (vs -15% for Novatek) and more visible earnings growth and performance catalysts, we believe Gazprom will continue to outperform Novatek in 2008. As the only gas producer in Russia with regulated tariffs, Gazprom offers the best exposure to the trend of domestic gas price liberalisation, as well as bringing the benefits of high leverage to the oil price and restructuring potential.

Importantly, our understanding of the domestic gas price dynamics in Russia after the promised liberalisation in 2011 continues to evolve. Although netback parity has been promised by the Russian government, it was based on a rather conservative oil price outlook of $40-50/bbl. With evidently higher oil prices (and, as a result, much higher than previously expected gas prices in Europe) we believe there is a risk that the netback parity will not be achieved in 2011. This scenario would be highly positive for Gazprom anyway, as the company is highly leveraged to the gas price in Europe, but means that other Russian gas producers may not see as high a price growth as would have been implied by direct netback calculation using a higher oil price assumption. Our new domestic gas price assumptions, shown in Figure 63 below, have not changed much in absolute terms, but do imply that the export netback parity will not be reached before 2015.

Figure 63: Russian domestic gas price forecasts $/mcm at the wellhead

-

40

80

120

160

2004 2005 2006 2007E 2008E 2009E 2010E 2011E 2012E 2013E 2014E 2015E

Gazprom's from sales to Europe Gazprom's from sales to FSU

Gazprom's from domestic sales Gazprom's w eighted av erage netback to the w ellhead

Nov atek's ex -field selling price Lukoil's ex -field selling price to Gazprom

Source: Company Data, Renaissance Capital estimates


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Oil & Gas infrastructure plays

Transneft’s (TRNFP, BUY, target price $3,025) share price performance has been less than impressive for the past two years, while the fundamental value of the company (and our target price) has been growing. We believe our $3,000/share valuation is conservative, as it assumes that the company’s ROIC will decline to 9.0% in 2008, compared to 2006 actual of 12.1%. We estimate the company’s IC will grow to $36.4 mn in 2010E, signalling an 108% upside potential to the company’s share price over the three-year period, and this does not include the 26.9mnt oil inventory, valued at $7.7 bn at the current domestic price of $39.4/bbl.

We believe the fundamental newsflow is also likely to be supportive of the share price, including strong financial results from the recent merger with Transnefteprodukt and what looks like a higher than expected likely tariff growth in 2008 (20.1% requested by the company recently). We believe the regulatory visibility is also likely to improve with the expected approval of the government decree regulating the tariff-setting principles for the company. The only uncertainty to the investment story comes from the recently appointed new management team, in our view. We believe the market needs to see significant improvements in corporate governance and investor relations, at least to the level of other state-owned companies, before this substantial share price upside could be realised.

Russian gas distributors (the so-called oblgazes) were a hot sector in 2007, with share prices of some companies increasing three to four times. We believe many companies remain significantly undervalued and expect further strong sector performance in 2008 driven by more industry consolidation under Gazprom's control, with the government finally transferring its blocking stakes in gas distributors to Gazpromregiongaz. This should bring Gazprom's stakes in several oblgazes to 50-75% or higher, providing a good exit option for the existing minority shareholders subject to a voluntary or compulsory (depending on the final Gazrpom's stake) buy-out offering. We expect that first and foremost Gazprom will push for the consolidation of government stakes in those gas distributors in which it does not hold the controlling stake yet. Thus, we believe that investors should pay special attention to the shares of Lipetskoblgaz (LPOG, BUY, target price $829) and Oreloblgaz (ORGZ, BUY, target price $973), which also offer attractive fundamental upside potentials, in our view, although being rather illiquid.

Foreign-listed independents

Unlike Russian oil majors, this subsector offers significant production growth with estimated average 2007E-2010E output CAGR of 48% for the six companies under our coverage. This growth, however, is far from guaranteed. Asset quality, funding and execution are the three primary risks that haunt this subsector, in our view. These were vividly demonstrable over the past 12 months, with three out of six companies cutting their production forecasts (UEN, WSIB, VOG), two almost completely changing management teams (VOG, UEN; the same two also facing funding constraints); and three companies facing enquiries by the Ministry of Natural Resources (IEC, WSIB, UEN). This has resulted in very diverse and volatile group share price performance, with the best performing stock - Imperial Energy, up 86%, and the worst performer – Victoria Oil & Gas, down 83% over the past 12 months.

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Going forward, we believe the risks and performance will be equally diverse, as the fate of these companies is almost entirely dependent on them meeting their individual milestones, rather than general sector trends.

We believe West Siberian Resources (WSIB, BUY, target price SEK15.7 from SEK13.8) offers the most balanced risk-return trade-off in this space because of its highly visible development portfolio, the presence of a strategic shareholder, and attractive valuations. Unlike some of its peers, WSIB growth is expected to come from a diverse range of assets (Sev-Kharyaga, Lekh- Kharyaga, Kolvinskoye and SANECO), which we believe mitigates some of the execution risk. We estimate that the successful development of existing 2P reserves provides 115% upside potential for the stock, with resource potential adding another 17%. A strong balance sheet and a track record of successful acquisitions provides further upside potential and supports our BUY rating on the stock, in our view.

Our two other BUY-rated stocks are Imperial Energy (IEC, BUY, target price GBP25.7 from GBP19.4) and Volga Gas (VGAS, BUY, target price GBP4.17 from GBP3.75), each offering substantial upside potential, and specific risks. Our principle attraction to IEC is low execution risk, following significant recent investments in surface infrastructure and a sizeable resource base. Volga Gas, on the other hand, is an early-stage exploration and development play, where most of the risks are associated with the commercial development of the Vostochny Makarovsky licence area, which is set to move into production by the end of 2008.

We rate three other companies in our universe HOLD (Sibir Energy (SBE, HOLD, target price GBP5.85 from GBP5.44), Urals Energy (UEN, HOLD, target price GBP4.71 from GBP6.37) and Victoria Oil & Gas (VOG, HOLD, target price GBP0.81 from GBP0.88). We view SBE as a low risk/low return opportunity, where the upside beyond the DCF valuation is mostly related to the possibility of a corporate deal with Gazprom Neft that would resolve two existing disputes over Moscow Refinery and Sibneft-Yugra. Unlike SBE, UEN offers significant upside potential, based on DCF, but it is conditional on the company's meeting production and funding milestones. Finally, VOG offers significant upside potential, if things go right, but recent drilling mishaps, funding constraints and management uncertainty do not allow sufficient visibility into its production profile to justify anything more than a HOLD rating at this stage, in our view.

Oil field services

Performance of the Russian OFS sector was very weak in 2007 with both CAToil and Integra down 9% and 25% YtD, respectively. Given highly attractive industry fundamentals, we believe this performance will reverse in 2008. Upstream capex trends remain robust, fuelled by high commodity prices, and evident transition of Russia’s oil and gas output from Soviet brownfield production areas to post-Soviet greenfield opportunities.

The growing maturity of Russia’s brownfield sites is also leading to demand for high-end services such as sidetracking, directional drilling and coil tubing – all of which are currently undersupplied. This simply mirrors the shortage observed in more conventional services, such as drilling, formation evaluation and seismic. In addition,


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regulatory pressure to lower the idle well stock calls for more remedial workovers involving ever more sophisticated technology solutions to support production.

The ongoing consolidation of the OFS sector and diversification efforts among its largest players demands better management and higher efficiencies. The opportunity to acquire large OFS assets on the cheap is now behind us, as burgeoning demand, and more interest from other would-be buyers, has boosted valuations. Thus, focus on the organic growth delivery, through rationalisation, optimising and restructuring of the existing asset portfolio will be prioritised for OFS providers going forward, in our view.

We view Integra (INTE, BUY, target price $22.3) as a restructuring play and turnaround story in a highly attractive OFS market. With the financial community being sceptical about the management’s ability to improve the performance of such a complex business, its share price is very leveraged to any visible progress on execution and profitability improvement, in our view. This is likely to come from the rationalisation and optimisation of the existing asset portfolio, as well as the broadening of its high-end service offering by entering the coil-tubing and sidetracking/directional drilling services during 2007-2008. We believe these efforts will result in a tangible improvement in the company’s financial performance around 2Q/3Q next year.

We see stronger short-term earnings momentum in CAToil (O2C, BUY, target price EUR28.1) as a result of its recent acceleration in organic growth and rapid diversification into new service segments. CAToil is rapidly transforming from niche-player, pressure-pumping specialist into a fully diversified OFS provider via the aggressive addition of new capacity into high-end services (sidetracking/directional drilling and coil tubing), entering new service segments (geotechnical services and seismic) and broader geographical market presence. This means that our even more conservative pricing assumptions for its fracturing business for 2009 will not derail the company from doubling its EPS next year. Over time, we expect that sales contributions from the fracturing business will decline from the current 80% to roughly 45% at the end of the decade. This broadens CAToil’s revenue base, and, therefore, decreases its exposure to pricing risk in the fracturing segment.

Central Asia/Caspian E&P opportunities

We believe the share price performance of Central Asian and Caspian oil and gas producers will be diverse in 2008, affected by three principle themes. First, we expect worsening investor sentiment towards Kazakhstan following the recent message from the government that the country wants to increase control over its hydrocarbons and increase the tax burden. Contrary to this, we believe interest in Turkmenistan will grow, given the country’s efforts to attract foreign investments to boost its hydrocarbon production. Finally, we believe key to the investment story of many Central Asian E&P plays will be their host countries’ ability to renegotiate gas contracts with Russia.

Against these themes, we believe three companies offer the best exposure to the Central Asian story in 2008. Kazmunaigas E&P (KMG, BUY, target price $36.12 from $29.62) is a state-controlled Kazakh company, which is likely to see its role of a state consolidator of all the best onshore assets grow in 2008 with the likely

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acquisitions of its parent’s stakes in MangistauMunaiGas, Kazturkmunai and Kazakhoil-Actobe. At the same time we anticipate the effect of possible tax changes on Kazmunaigas E&P will be mitigated (given its links to the state) through off-setting the benefits of asset contributions or other tax privileges.

Dragon Oil (DGO, BUY, target price GBP4.36 from GBP3.69) offers an exposure to an attractive Turkmen story and potential liberalisation of the gas price in Central Asia. Despite strong performance in 2007, the company is still one of the cheapest in our universe, valued at only about $5/boe. Its performance also lags behind its closest peer, Burren Energy, which benefited from a series of bids from ENI. This suggests that Dragon Oil could become an acquisition target by an oils major, given the scarcity of listed oil and gas companies in Turkmenistan and an improving investor climate.

Tethys Petroleum (TPL, BUY, target price CAD4.41 from CAD3.93) is our favourite small-cap name in this region, offering investors exposure to the regional gas theme. The company is about to start its first production and expects to see reserves (and probably resources) updated at the end of 1Q08. Tethys recently agreed to sell a significant part of its production at a price linked to the price at the Uzbek-Kazakhstan border, minimising the future price risk. We also believe that, as a gas play, the company is less sensitive to proposed tax changes in Kazakhstan.

Our other BUY-rated stocks in the region include Arawak Energy (ABG, BUY, target price CAD3.63 from CAD3.51), BMB Munai (KAZ, BUY, target price $10.2 from $10.0), Caspian Energy (CEK, BUY, target price CAD0.79 from CAD0.77) and Frontera Resources (FRR, BUY, target price GBP1.37 from GBP1.41). The first two companies offer attractive reserves to resources ratios and have already moved into production with estimated output growth of over 40% in 2008. The other two stocks are more risky exploration plays, the success of which depends on their ability to monetise their exploration potential. We expect Caspian Energy to succeed in finding a partner for the deep sub-salt hydrocarbons potential and Frontera Resources to move to its first commercial production during 2008.

Other companies in the region have a much lower visibility of success, in our view. Big Sky (BSKO US, HOLD, target price $0.13 from $0.22) is entangled into a host of financial, operating and legal problems, which, however, seem to be reflected in its share price. Canargo Energy (CNR US, HOLD from Sell, target price $0.50 from $0.49) needs to find a technological solution for the development of its extremely challenging resource-base in Georgia. Caspian Holdings (CSH LN, HOLD, target price GBP0.06) needs to extend its licence area, while Max Petroleum (MXP LN, HOLD, target price GBP1.07 from GBP1.22), has lost investor confidence following the unfortunate scandal with the company’s management over share option grants. Uncertainty around the details or recent acquisitions and current share trading suspension in Roxi Petroleum (RXP LN, HOLD, target price GBP0.43 from GBP0.42) should be resolved at the beginning of 2008, which, we believe, may cause the share price to rebound.

Finally, we rate Transmeridian Exploration as SELL (TMY US, SELL, target price $1.71 from $1.57). To be able to service its enormous debt, Transmeridian needs to demonstrate significant production growth, which is unlikely in our view. The company failed to sell its key asset South Alibek in 2007, and is unlikely, in our view, to find a buyer next year.


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Ukraine oil & gas producers

We remain cautious on Ukrnafta (UNAF, HOLD, target price $83.0 from $77.0) because of the uncertain company strategy and low upside potential amid shareholder gridlock and the unfavourable taxation regime in Ukraine. This has also been an issue for listed refineries in Ukraine, that were negatively affected following the introduction of differentiated excise tax for diesel this spring, forcing them to pay an additional tax of €15/tonne for high-sulphur content. Therefore, we believe the share price performance of both the Galitchina (HANZ, SELL, target price $0.18) and Nadvirna (NAFP, BUY, target price $8.25) refineries in 2008 will be highly sensitive to the progress of their modernisation. Finally, following recent changes to the corporate and ownership structure of the Kherson refinery (HNPK, UR) we expect 2008 will see clarification of new partners' investment plans and the modernisation schedule for the refinery, which should become important catalysts for the stock, in our view.

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Analysts certification and disclaimer

This research report has been prepared by the research analyst(s), whose name(s) appear(s) on the front page of this document, to provide background information about the company or companies (collectively, the “Company”) and securities which are the subject matter of this report. Each research analyst hereby certifies that with respect to each of the Company and such securities, all the views expressed in this document accurately reflect his or her personal views about any and all of such securities or the Company.

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Important disclosures

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Investment ratings

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Renaissance Capital Research

Head of Research Roland Nash + 7 (495) 258 7916 [email protected]

Head of Equity Research Alexander Burgansky + 7 (495) 258 7904 [email protected] Deputy Head of Equity Research Natasha Zagvozdina + 7 (495) 258 7753 [email protected]

Head of Fixed Income Research Alexei Moisseev + 7 (495) 258 7946 [email protected]

Head of Africa Equity Research Matthew Pearson + 44 (207) 367 7734 [email protected] Head of Africa Fixed Income Research Gordon Smith + 44 (207) 367 7781 [email protected]

Automotive & Transport + 7 (495) 258 7747 Eduard Faritov [email protected] Banking + 7 (495) 258 7748 David Nangle [email protected] Svetlana Kovalskaya Chemicals & Engineering +7 (495) 783 5653 Marina Alexeenkova [email protected] Rinat Kirdan Consumer/Retail + 7 (495) 258 7753 Natasha Zagvozdina [email protected] Ivan Nikolaev Victor Dima Ulyana Tipsina Equity Strategy + 7 (495) 258 7916 Roland Nash [email protected] Tom Mundy Ovanes Oganisian Metals & Mining + 7 (495) 258 7743 Rob Edwards [email protected] Yury Vlasov

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Fixed Income + 7 (495) 258 7946 Alexei Moisseev [email protected] Nikolai Podguzov Petr Grishin Alexey Bulgakov Maxim Raskosnov Valentina Krylova Anastasiya Golovach (Ukraine) Nargiz Sadykhova Olesya Cherdantseva Economics + 7 (495) 258 7703 Katya Malofeeva [email protected] Elena Sharipova Olesya Cherdantseva Igor Lebedinets

Macro & Strategy + 44 (207) 367 7781 Gordon Smith [email protected] Samir Gadio Viriya Tim Credit Analysis +44 (207) 367 7931 John Bates [email protected] Technology/ Media/ Telecoms + 44 (207) 367 7734 Matthew Pearson [email protected] Financials + 44 (207) 367 7754 Sruti Patel [email protected] Metals & Mining + 44 (20) 7367 7777 Mark Smith [email protected] East Africa + 254 (203) 60 1822 Robert Bunyi [email protected] Mbithe Muema Southern Africa + 263 11 634 463 Dzika Danha [email protected] West Africa + 234 1271 9132 7 Oluyemisi Lanre-Philips [email protected] Adedapo Temitayo Orekoya Esili Eigbe

o&g 2008 outlook

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