Option a la Rosneft: Beijing’s geoeconomic play for Russian oil

By Max Hess

The Chinese government effectively has an option to buy a 14.16 per cent stake in Rosneft for US$9.1bln. This follows reports on 2 March that its state-owned portfolio and investment agency Guosheng Group took control of CEFC China Energy on 16 February. Guosheng’s assumption of control was precipitated by a flurry of claims that the ostensibly private Chinese oil firm’s founder and CEO Ye Jianming was detained for questioning. It was only last September that CEFC’s investment into Rosneft was first announced.

It appears likely, but not certain, that the deal will go ahead. CEFC’s investment initially aimed to close by the end of 2017, and the firm was reported to be in talks with Russia’s state-run bank VTB to secure a US$5bln loan to do so that October. However, CEFC’s purchase is nominally from commodities trading giant Glencore, a longstanding Rosneft partner, and Qatar’s Investment Authority, a far newer one that poses its own questions given Russia’s concurrent attempts to deepen ties with Qatar’s arch-rival Saudi Arabia.

The Italian job

However, Qatar and Glencore’s investment faced doubts from the onset, including claims that the pair were merely acting as temporary custodians and the risk of most funds invested appeared to lay with the Russian state. Ultimately it was revealed that VTB provided more than 700bln rubles – roughly €10bln – in financing for the deal, which at least initially made up the vast majority of the associated risk. Arguably in a bid to stave off questions about the Russian state providing the financing itself, and to provide the appearance of being largely immune to Western sanctions, Rosneft was able to secure Intesa San Paolo’s support for the deal to the tune of €5.2bln.

However, by late August 2017 it was clear that Intesa was unable to syndicate the deal among Western banks. Following the CEFC investment announcement less than two weeks later, the bank said it expected to recoup the amount it had supplied in financing. There are myriad questions about Intesa’s involvement, particularly as carrying the multi-billion euro deal on its books even only for the better part of a year presented a highly concentrated risk for a bank whose market capitalization is roughly €50bln.

A 25 February interview by Russian state-run news agency TASS with the bank’s head of Russian operations, Antonio Fallico, implied Intesa has not been paid back yet but that it also remains supportive of Russia more generally, with Fallico criticizing the EU for not explicitly supporting the Nord Stream II project. But there is nonetheless good reason to believe that it may have the ability to seek recourse with Russian state-owned enterprises given their involvement in the original deal and subsequent talks about financing the CEFC tie-up as well.

‘It’s the Geoeconomy, stupid’

The CEFC deal grew from principles similar to the geoeconomic strategy that has guided Rosneft since Igor Sechin’s takeover as CEO in 2012. The concept was perhaps best defined by Chatham House as “the interplay of international economics, geopolitics and strategy”.

In addition to being a lynchpin of efforts to secure good relations with Saudi Arabia through the production cut agreements between Russia and OPEC, the firm has also secured a seat at the table for Moscow in talks around the future of Iraqi Kurdistan, recently whose energy company PDVSA has pawned away many of its best assets to Rosneft.

For Rosneft, the deal with CEFC needed to not only make business sense but geopolitical and strategic sense as well. It easily ticked those boxes. China’s large-scale buying of crude for its strategic reserve has been among the most important factors in global energy markets in recent years, and CEFC had grown at a rate impressive even compared with its state-owned competitors Sinopec and CNPC. CEFC founder Ye’s ties to the Chinese military created the sense that as Beijing was backing his investment decisions.

It is unclear why financing for the CEFC investment has not yet been forthcoming. But given the geoeconomic motivations for the deal, it is likely that these same factors again played a role. Perhaps Russia’s state banks have grown exasperated with Sechin’s motivation by its political, rather than financial, bottom line. While Rosneft’s spat with Sberbank CIB over a report critical of Sechin could be seen as providing evidence to this effect, that Sberbank was forced to publicly apologize should alleviate such concerns. Finally, it is unlikely Russia’s financial masters will challenge Sechin, who just engineered an eight-year colony sentence for ex-economy minister Alexei Ulyukayev over their protests.

Borrowed over a barrel

Rosneft however undoubtedly faces financial challenges. It was decoupled from Russia’s sovereign credit rating in S&P’s latest Russian ratings review, with the agency maintaining its BB+ rating for the firm on 27 February despite upgrading most other sub-sovereigns, including Gazprom, to BBB- on the back of its earlier sovereign upgrade. The ratio of the firm’s current assets versus current liabilities fell to 52% from 117% in the year between September 2016 and 2017. By the end of 2017, Rosneft had added one trillion rubles – US$17bln – in new debt, its biggest borrowing year on record.

2017 was certainly a wise choice of year for a Russian sub-sovereign to go on a borrowing spree. Russia’s baseline long-term borrowing costs, as measured by 10-year sovereign bond yields, fell dramatically throughout 2017 amid the global bull market in emerging market debt meaning that what financing Rosneft has been able to secure has been far cheaper than that available to the firm in 2015 and 2016. The yield on those 10-year bonds is now less than one per cent off the all-time low of 6.26%.

Despite the firm’s repeated denials and the healthy credit environment, sanctions have clearly had an impact on its ability to secure financing. This was witnessed by the issues with Intesa San Paolo syndicating its loans to the Qatar-Glencore consortium. Rosneft’s 2017 debt issuances also were almost entirely on Russia’s domestic bond market, which has yields higher than dollar or euro debt markets. Rosneft has even reportedly run into significant difficulties arranging financing for its new Indian subsidiary, Essar, from Western banks. This is likely at least in part due to the fact that VTB head Andrei Kostin acknowledged the takeover of Essar was specifically structured to avoid sanctions, which guaranteed that any serious compliance operation would view them as violating the spirit, if not the word, of sanctions.

Counting the cost

Rosneft’s shift to a becoming a geoeconomic giant has reaped the Kremlin many benefits, as well as personal gains for its directors. The Financial Times recently named Sechin Russia’s ‘most powerful oligarch’ by the FT and even the New York Times has run front-page coverage declaring the firm one of the most powerful instruments of Russian foreign policy. While the recent recovery of energy prices is set to boost Rosneft’s bottom line, there are still significant geopolitical risks.

The title to its assets in Iraq remains under question, additional US sanctions could still be forthcoming, and there is no feasible plan on the table for it to see a return in the foreseeable future on the more than US$6bln it has lent Venezuela. Almost all of this debt has built up within the Russian financial system including the Essar deal, with VTB having offered nearly US$4bln in loans to the firm before the deal went through to restructure its debts.

Beijing will likely support CEFC; it would have been difficult for its strategy to have gone as far as it did otherwise. Even if the firm’s overseas debt-fueled investment phase is over, Rosneft will be keen to retain it as a partner, particularly if its take-over by the Chinese state is made permanent. Yet Beijing is also a geoeconomic actor.

Beijing is willing to provide Russia financing when advantageous to China, most famously evidenced by the 2014 agreement on the Power of Siberia pipeline deal in which China reportedly secured significant discounts. By 2016, Gazprom went back to China for further funding, raising €2bln from the Bank of China in its largest-ever loan from a single lender. As Rosneft’s debt builds up in line with its geoeconomic activity, Beijing now stands in a position where its decision-making may be the single-most important factor regarding Rosneft’s short-term creditworthiness.

A decision to cancel the deal would send a shock through the two countries’ bilateral relationship and risk shifting the market narrative around Rosneft firmly onto its growing debt and its concentration within Russia. But China is aware of this and, harking back to the definition of geoeconomics, will seek to balance its geopolitical interests with its economic ones. Whether it be through an advantageous financing agreement for the deal, a quiet restructuring of some of its terms, or through a geopolitical negotiation, expect China to exercise its option over Russia’s oil giant shrewdly and with its own geoeconomic bottom line in mind.

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