Oil Stock Underperformance - Tailwinds Difficult to Ignore

Oil and gas stocks have been among the biggest underperformers in the Russian market in 2020. The reason was clear early in the year, as oil tumbled and the ruble proved more resilient than expected. However, Russian oil and gas stocks have continued to underperform even as the oil price has recovered. Moreover, sector stocks have largely ignored the ruble's recent depreciation from USD/RUB 69 to 73 currently.The price of Brent in ruble terms has been the best determinant of the sector's relative performance (the correlation is shown in the charts below). However, the ruble oil price and oil stocks have diverged recently. The last time such a divergence emerged was in late 2017-early 2018, before the market fully realized the benefits of the fiscal rule for O&G companies. At that time, the divergence became a harbinger for the impressive sector outperformance of 2018. We believe that now the gap will close again, and hence we expect O&G stocks to outperform the market until either the oil price retreats or the ruble appreciates.Within the sector, we favor Tatneft, Lukoil and Gazprom. The first two offer the strongest, near-double-digit FCF yields, even assuming Brent near $40/bbl. They also pay dividends based on their rich FCF. Gazprom is a longer-term play on an eventual recovery of global gas prices, and also benefits from a much improved dividend policy. At $45/bbl Brent and USD/RUB around 73, oil sector economics should improve considerably next year, as the oil price in ruble terms would be up around 20% both y-o-y and relative to our assumption. All oil companies would be set to benefit, while the sector FCF yield would improve to 10-13%. The names most sensitive to these assumptions would be Rosneft and Gazprom Neft, the FCF yields for which would jump from 5-6% to 10-11%.