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By Tim Seymour

Today we stare at the headlines, and there are two pressure points on Brent crude oil (BNO, quote) not WTI: Iraq imploding and Russia cutting off gas supplies to Ukraine.

(click to enlarge)We expect what is good for Europe and Ukraine is ultimately good for Russia, so we do not expect this to be a protracted stalemate that keeps gas from flowing into Europe in the near future.

As for Iraq, what is unfolding clearly has implications for an oil market that we believe was already running major supply disruption risks that will keep prices high into the summer demand season as we also see signs of an uptick in global demand.

So what does Russia get from this backdrop in terms of a bid to its oil and gas sector? Well, based on history, you have a sentiment indicator which is supportive but hasn’t led to major market gains in the post crisis Russian market as oil spikes, versus pre-crisis when all commodity disruptions were boons to the underlying producing companies and the stocks that were the producers.

The Russian economy still relies on oil and gas for more than 40% of its GDP, but trading oil price sensitivity with Russia is not that easy. Russian taxation on the oil sector is very progressive and closely linked to underlying prices (with a 9m lag). Thus, while it’s intuitive for investors to assume that Russian oil and gas stocks should benefit from global turmoil which escalates oil prices, the actual benefit is meager. For every Dollar higher in Brent above $100, Russia oil companies effectively get only 10% of the additional revenue flowing back to them. The pure upstream plays in Russian oil are largely gone but the largest integrated players in Russia still are more focused on upstream than downstream. Thus, Rosneft (OTC:RNFTF), Lukoil (OTCPK:LUKOY) and Surgut (OTCPK:SGTZY) are really quite removed from windfall gains from higher oil taxes.

The companies with more refining capacity and downstream retail are best positioned (Gazprom (OTCQX:GZPFY) and Bashneft (OTC:BNSFF). So a rally in oil prices doesn’t really affect the oil companies, but it does have a major read through for the rest of the economy.

The impact on the Ruble and overall wealth effect for the consumer are well documented and have been the best way to play Russia in recent history when oil has spiked. It should be noted that even prior to Ukraine, Russia was having significant macro trouble even with oil above $100/bbl. The best way to play a spike in oil prices that may unfold is to look at the companies most exposed to the consumer and the broader economy. A sustained move higher in oil prices (more than 2 months) will be seen as a global economic headwind, but for Russia this will be priming the pump for the retailers, mobile players, and other light industrial consumer plays. The highest sensitivity to higher oil prices coupled with our screening of the highest quality companies (corporate governance, valuation, growth) leaves us with the following Russia “oil basket”:

  • Magnit (OTC:MGJCL): Leading Russian retailer in discount format; top growth and margins in the sector.
  • Mobile TeleSytems (NYSE:MBT): Top cellular player and exposed to data and interconnect.
  • MVideo: The top electronics retailer with online format as well.
  • Yandex (NASDAQ:YNDX): Leading search and online advertiser in Russia.

While an investment in the Russian consumer requires other key factors like Ukraine and macro risk to be reduced, Russia remains a very attractive market for consumer consumption and growth. Russian disposable income growth and consumption trends are near the top of the return profile in Emerging Markets (NYSEARCA:EEM) as Russians have low household debt, often own their real estate, and have low costs for medical and schooling.

We remain convinced that Russia consumer names will overcome near term geo-political threats from the recent unrest in Ukraine but may ultimately reap the benefit of a fresh focus on oil prices moving higher in 2H.

Disclosure: None

Source: Russian Oil Stocks As Oil Goes Higher - Not How You Play It