Moscow/London: Two years ago, the Kremlin’s oil flagship was foundering, hit by falling prices and international sanctions just as it faced $20 billion in debt payments.
Short of cash, Rosneft got about $15 billion of emergency aid with help from the central bank. But the deal spooked investors, requiring a massive rate increase to stem market turmoil. Chief executive officer Igor Sechin, the man Vladimir Putin had for a decade relied on to build Rosneft into a giant, faced rare disfavour from his patron, senior officials said at the time.
Now, Putin is turning to Rosneft for help. Sechin’s energy colossus is helping fill a yawning budget gap at home and support the Kremlin abroad. The company’s turnaround is a triumph for the Russian president, who vowed to protect the pillars of his state-dominated system from US and European Union pressure when they were slapped with sanctions two years ago.
Russia is among dozens of petro-states that are learning to make do with less as oil prices show no signs of major recovery. For some, like Saudi Arabia, the rout has provided an added impetus for economic overhauls, while others—including Putin’s Russia—the priority has been to paper over cracks with short-term fixes that don’t reduce their reliance on petroleum.
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“It’s very important to the Kremlin that Rosneft is a strong company," said James Henderson, a former banker who is now a senior research fellow at the Oxford Institute for Energy Studies. “Russia’s foreign policy as much as domestic policy relies on it."
Just last week, Rosneft spent 330 billion rubles ($5 billion) to buy control of another oil company from the government, the biggest privatization deal yet this year. Then Putin backed a plan under which Rosneft could provide an even bigger cash infusion, spending as much as $11 billion to buy a chunk of its own shares from the government. On 15 October, it announced a deal to buy a big refinery and other assets in India, under which it will pay $3.5 billion for a 49% stake. Putin presided over the signing of that agreement on a visit to Goa, confirming that Rosneft remains a favoured Kremlin tool for binding political ties with business links.
Even Putin seemed surprised at Rosneft’s recovery. At a meeting with budget officials, he said he’d “instructed the appropriate agencies to check that Rosneft had the funds on its accounts" and wouldn’t need to borrow to make the payments to the government.
The Kremlin, too, has managed to weather the worst of the pain so far, thanks to billions in petrodollars saved up when oil prices were high, the sharp devaluation of the ruble and help from China and other friends outside the West. His economy steadying, Putin shows no sign of softening his confrontational approach to the US and Europe. He’s pushing his advantage in Syria, moving new missiles to Europe’s borders and, according to US intelligence, deploying hackers to meddle in the presidential elections.
The key to Rosneft’s turnaround—even as oil prices have languished—was a combination of financial engineering, the weakened ruble, political support and a little help from some friends: billions of dollars in advance payments from buyers in China. Rosneft’s cash pile stood at more than $22 billion at the end of the second quarter, almost double what it had early last year.
A Rosneft spokesman didn’t respond to a request for comment for this article.
Once an also-ran made up of the scraps of the Soviet oil industry that the 1990s oligarchs didn’t want, Rosneft’s fortunes turned as Putin moved to restore Kremlin control of the strategic sector in the early 2000s. He installed fellow intelligence veteran Sechin to lead the company in 2004. Rosneft took over the bulk of Yukos, a company the government seized from Putin critic Mikhail Khodorkovsky.
In 2013 Rosneft became the largest publicly traded oil producer on the planet when it purchased TNK-BP, a venture of the British company and a trio of Russian billionaires, for more than $50 billion. It borrowed more than $30 billion for that deal, one of the largest-ever financings by a Russian company.
But soon after the TNK-BP deal, Rosneft’s proximity to Putin became a liability.
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Eager to hit the Russian leader in his pocketbook after the March 2014 annexation of Crimea, the US announced sanctions targeting Sechin, citing his “utter loyalty to Vladimir Putin." Later, the US and EU slapped limits on Rosneft, restricting access to technology and capital markets.
Foreign lenders who’d once battled for Rosneft’s favour couldn’t do business with it. BP’s CEO joked that Sechin’s new nickname was “Igor Sanction."
By that fall, Rosneft was again walloped as oil fell below $100. Soon, it was asking the Kremlin for a $43 billion rescue. Putin balked at the huge sum, which was nearly as big as the bailouts the largest US banks got back in 2009 and would have used up much of one of Russia’s two sovereign wealth funds.
“The crisis of 2014 made investors panic," said Oleg Popov, a Moscow money manager who owns Rosneft’s bonds. It was “a perfect storm."
But just days before a $7 billion payment to western banks came due in December 2014, Rosneft got its lifeline. Through a complicated series of transactions that stretched over several months, it issued 1 trillion rubles in bonds that a local bank used as collateral to borrow as much as $15 billion from the Russian central bank to lend on to the oil giant. The state bank that came up with the scheme couldn’t participate because of sanctions, so Rosneft took the idea to another lender, according to a person familiar with the deals. Apparently fearful the US could extend the restrictions to squeeze the institution involved, Rosneft kept the nature of the deal a secret.
But when word of the bond issue leaked out, its huge size alarmed local investors, who dumped the ruble.
Only an emergency 6.5-percentage-point rate hike and heavy Kremlin pressure on exporters to sell foreign currency were enough to stabilize the exchange rate. Sechin publicly denied any role in the ruble’s plunge, threatening to “deal with provocateurs" who alleged the company was involved. Rosneft’s London-traded shares dropped to the lowest level since the 2008 financial crisis.
The botched bailout angered top officials including Putin, people familiar with the situation said at the time. Sechin faced a rare public criticism from the president in a late-night meeting. A prominent Moscow newspaper editor tweeted that rumors were swirling among the capital’s elite gathered at the Bolshoi Theater for a ballet premiere that Sechin was about to be fired. Rosneft denied it.
Sechin tried to make amends, selling tens of billions of dollars earned from oil sales to buy rubles, helping steady the currency. He cut capital spending. To raise cash, the company pitched stakes in major Siberian projects to investors in China and India.
The plunging ruble became a blessing, lowering Rosneft’s costs in dollar terms and cushioning the blow of low oil prices, since crude is sold in dollars. A fifty-dollar barrel is worth 53% more, in ruble terms, today than it was two years ago.
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Further relief came when customers—never publicly identified by Rosneft, but assumed by analysts to be led by state-controlled China National Petroleum Corp.—made $15 billion in prepayments for future crude supplies in the third quarter of 2015.
By early this year, Sechin had reclaimed his traditional position in Putin’s good books, touting Rosneft’s results in a personal meeting with the leader. He also installed a veteran executive who’d built up government connections during a stint as a deputy energy minister, Pavel Fedorov, as his de-facto No. 2.
Rosneft’s market capitalization topped that of Gazprom, the state gas monopoly and its traditional rival for political affections, for the first time in April. BP, which owns a 20% stake in Rosneft, reported that its share of the Russian company’s profits last year contributed almost a quarter of its earnings, the largest share ever. In June, Sechin said he thought his company could be worth as much as $130 billion, twice its current value and more than BP. Crude production would be up after several years of declines, he said.
“Over the last year, we cut our debt load in half," he told state television. “For a company like ours that’s under sanctions, that’s a brilliant result," he added. Topping the market-capitalization ranks of Russian companies “just happened by accident," he said with a smile.
Still, investors have cause for skepticism. In its presentations, Rosneft doesn’t count the billions of dollars of pre-payments as debt. Rating agencies believe it should, since the company has to repay them, with interest, in oil. When the prepayments are included, Rosneft had reduced its net debt since 2013 by only about $6 billion as of the end of the second quarter, according to Alexey Bulgakov, an analyst at Sberbank-CIB in Moscow. That compares with the company’s claim to have cut net debt by more than $22 billion over the period.
S&P Global Ratings this month called Rosneft’s financial policy “aggressive," warning that future acquisitions could lead debt to spike.
The company faces as much as $16 billion in debt repayments before the end of next year, including the bulk of the central-bank facility, which the regulator is eager to see repaid, according to officials. At the same time, Rosneft still is pumping money into projects in Venezuela, where the business outlook is murky at best but the Kremlin is eager to maintain political ties.
Goldman Sachs this week cut Rosneft shares to neutral from buy, warning that the company could start diverting its cash to “value-eroding M&A."
Even Rosneft’s plan to buy its own shares is in part a reflection of weakness. The government efforts to find other buyers for the 19.5% stake it wants to unload have fallen flat, leaving Rosneft itself as the acquirer of last resort. “Real privatization" would happen at a later date, with Rosneft reselling it to unspecified outside investors at higher prices, Putin told reporters on the trip to India last weekend. On that visit, a jacket-less Sechin was sighted playing pool with the head of a state bank during a break in the talks. (Sechin won.)
Concerns about the giant company’s efficiency were among the reasons Prime Minister Dmitry Medvedev and senior members of his cabinet cited in opposing Rosneft’s bid for Bashneft, the company Rosneft bought in the privatization this month. They argued the sale should be used to boost the private sector. But Rosneft offered as much as $1 billion more than rival bidders and after months of mixed signals, Putin ruled against his officials, saying he was “a bit surprised" they’d ever been opposed.
“The current leadership believes that political control is more important than market efficiency," said Edward Chow, a former Chevron executive who is now a senior fellow at the Center for Strategic and International Studies in Washington. Bloomberg