Russian energy companies’ stocks could stage a rebound in the first half of 2019, after facing pressure from recent market volatility and rout in oil prices.

Although the cost of crude has been on a downward trajectory since October, it reversed course somewhat Wednesday following reports over the Christmas Day holiday that Russian Energy Minister Alexander Novak said prices could stabilize in the first half of 2019.

Novak’s optimism is largely attributed to joint efforts by the Organization of the Petroleum Exporting Countries (OPEC) and Russia-led non-OPEC producers to curtail supply. The international oil producing consortiums agreed earlier in December to cut their combined crude output by 1.2 million barrels per day from January.

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While the market to date has not been completely impressed by the move, the current crude oil contract rose around 8.7% to US$46.22 Wednesday before falling back again Thursday morning.

Although elevated oil prices earlier in 2018 generally helped Russian oil companies benefit from increased sales, the recent plunge in the cost of crude and slower economic growth in the country have contributed to a bout of deterioration in their equity.

Crude oil has plunged a little more than 44% since its 52-week peak in October, with Monday having set a new low for the year at US$42.53.

Against this backdrop, Gazprom Neft’s (OTC: GZPFY) GDRs have shed roughly 15.9% of their value since their 52-week high of US$30.175 set in mid-October, while Rosneft’s (MCX:ROSN) stock has plunged around 20% over roughly the same timeframe.

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Elevated hurdles

Meanwhile, Russia continues to find itself beset by a host of global challenges, which is likely to hamper progress among its non-financial corporates in the near-term.

Fitch Ratings analysts Nikolai Lukashevich and Tatiana Kordyukova recently noted that as Russia’s economy remains dependent on commodities sectors, softer pricing expectations “implies revenue contraction for export-focused commodity producers.”

Fitch pointed out that the “threat of a new wave of U.S. and broader Western sanctions is likely to influence strategic decisions for many Russian corporates, discouraging them from taking aggressive foreign exchange and refinancing exposure, high leverage, and undertaking large-scale investment projects.”

Furthermore, Fitch added that corporates “may need to maintain sufficient financial flexibility to mitigate exposure to the banking sector, as large Russian banks may become targets of new sanctions.”

Since 2014 the EU, the U.S. and certain other countries introduced a series of sanctions against Russia and some of its legal entities, including Gazprom and Gazprombank.

Gazprom had recently warned that “the current situation with sanctions, uncertainty and volatility of the financial and trade markets and other risks have had and may continue to have effects on the Russian economy. “

In the third quarter of 2018, Russian economic growth decelerated slightly, with annual GDP down to 1.5% from 1.9% in the prior quarter. Consumer demand had also slowed compared to previous months, with expansion largely based on non-food sales.

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To stave the risk of rising inflation — especially amid the nation’s upcoming VAT rate increase in January — the Bank of Russia at its mid-December monetary policy meeting elected to raise its key interest rate by 25bps to 7.75%.

The central bank noted that the environment remains “skewed towards pro-inflationary risks, especially over a short-term horizon,” and highlighted an elevated level of uncertainty over future external conditions and lingering threats to financial asset prices.

Moreover, the Bank of Russia said risks of supply exceeding demand in the oil market in 2019 “have increased.”

Weathering the downturn

Despite the external risks to Russia’s energy sector, the country’s major oil companies generally appear financially and operationally healthy enough to withstand moderate shocks, amid higher revenues and ongoing deleveraging.

For the nine months ended September 30, 2018, Gazprom’s total sales, for example, spiked 27% year-on-year, mainly driven by higher revenues of gas, refined products, crude oil and gas condensate.

Rosneft had a similar uptick, with sales up by more than 1.4 times over the prior year’s nine-month period to the end of September, primarily due to “favorable price dynamics and increased equity share in profits” of Russian and international projects.

The company said its cash flow more than quadrupled year-on-year to US$13.9bn on the back of high operating results and a favorable price environment. In Q3 2018 it also cut its short-term financial debt by 11.5% — from US$14.5bn to US$12.9bn — with net debt/EBITDA down by 39% since the beginning of 2018 to 1.3x as of the end-Q3 2018.

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However, foreign exchange headwinds impacted Gazprom’s net debt balance in the latest quarter, which climbed 10% year-on-year, as long-term, ruble-denominated borrowings rose while the U.S. dollar and euro appreciated.

Still, the market’s perception of Russian oil companies’ creditworthiness has remained positive.

Over the past three months, five-year credit default swap (CDS) spreads have barely budged, with Gazprom around 5bps tighter to almost 200bps, Rosneft Oil tighter by nearly 3.5bps to 237bps and Lukoil (OTC: LUKOY) having narrowed a little more than 1bp to just north of 200bps.

The sector’s cash spreads have also traded in a tight range, with some of Gazprom’s bonds recently about 1-2bps wider on the day Wednesday, while Lukoil International’s notes were wider by 1bp and Rosneft’s bonds widened by 3bps.

Although a myriad of risks loom in the backdrop, the promise of higher oil prices in 2019 could help stave some of the recent bleeding in Russia’s energy sector stocks, while continuing to help shore up some its oil companies’ credit profiles.