Executive summary
Gazprom remains our top pick because we believe that it is the most undervalued
stock among the major oil & gas companies in EMEA. We believe investors doubt the
government’s commitment to carry out liberalisation of domestic gas prices and
hence hold a conservative view on future growth in Russian gas prices. We also
believe that the market is overly pessimistic on Gazprom’s long-term capex
requirements.
In our view, the market is underestimating the government’s resolve to raise
domestic gas prices while we believe the government has compelling reasons to do
so. Failure to raise gas prices would lead to greater domestic demand and lower gas
export volumes – ultimately causing a fall in the government’s gas export duty
collections. This is hardly a scenario the government can afford to play out, in our view,
given that it has just agreed to ease oil taxation. Based on our long-term Brent oil price
assumption of US$60/bbl, we forecast a 2008-15 CAGR of c.14% in domestic gas
prices.
In terms of capex, we believe investors may be blinded by the huge capex increases
that Gazprom is planning for the next two years as it finally starts developing its Yamal
fields. Considering the general concern about rising capex and low free cash flow
generation in the Russian oil sector, we understand investors’ concerns. However, we
believe Gazprom’s case is different. The company has been delaying development of
the Yamal fields for more than a decade. This has led to a situation where Gazprom’s
capex is set for a rapid increase over the next few years. However, we forecast the
company’s capex growth trend to reverse in three to five years from now as the
most capital intensive phase of its greenfield projects passes.
Our DCF model suggests more than 50% upside for Gazprom’s share price – the
highest among the EMEA major oil & gas producers under our coverage. We believe
Gazprom shares offer the best value for money among the Russian oil and gas majors.
The stock trades at a 2009F EV/EBITDA of 4.5x, on a par with Lukoil despite the latter
having inferior EBITDA growth.
We believe the Russian oil majors Rosneft and Lukoil, and Kazakh’s national E&P
company, KMG EP, are fairly valued on our long-term US$60/bbl Brent price forecast.
However, potential reductions in the Russian oil tax regime do not appear to be
fully priced in. We believe Rosneft and Lukoil stand to benefit the most and could
become attractive if the proposed tax reductions are implemented in full.
We like Russian independent gas producer, Novatek, as the company could be viewed
as a miniature high growth version of Gazprom. However, despite potential gas price
upside, we believe Novatek shares are fairly priced, benefiting from being the only
alternative for investors already long of Gazprom shares.

Contents
Executive summary 3
Investment case 4
Valuation – Gazprom offers the highest upside 8
Momentum is building for a reduction in sector taxation 10
Strong oil prices support higher valuations 12
Weak Russian production growth supports the oil price 15
We see capex stabilising as West Siberian basin matures 18
Companies 19
Gazprom 21
Lukoil  33
Novatek  43
Rosneft  53
Surgutneftegaz  63
KazMunaiGaz EP  73
Disclosures Appendix  84