Pri­va­ti­za­tion, sanc­tions and se­cu­rity:

How Rus­sia’s oil in­dus­try at­tracts for­eign in­vest­ment de­spite in­ter­na­tional sanc­tions

The Ukrainian Week - - CONTENTS - Vi­taliy Mel­ny­chuk

How the Ros­neft deal hap­pened with the Rus­sia sanc­tions in place

Swiss oil trader Glen­core and Qatar's sov­er­eign wealth fund Qatar In­vest­ment Author­ity (QIA) closed a deal in late 2016 to in­vest EUR 10.2bn in the Rus­sian gov­ern­ment by buy­ing a 19.5% stake in Rus­sian state-owned Ros­neft­com­pany. Ros­neft shares were pur­chased in con­tra­ven­tion of US and EU sanc­tions, which were later joined by Switzer­land, Canada, Ja­pan and other coun­tries. These were in­tro­duced for Rus­sia’s an­nex­a­tion of the Ukrainian Crimea and military ag­gres­sion in Don­bas. Fi­nan­cial Times called the deal "a tri­umph for Pres­i­dent Vladimir Putin," - this was the first ma­jor for­eign in­vest­ment in Rus­sia since the be­gin­ning of the Rus­sian ag­gres­sion in Ukraine, and it also in­volves state-owned Ros­neft, which is on the Sec­toral Sanc­tions Iden­ti­fi­ca­tions List. Ob­vi­ously, the money from the deal, which reached the Rus­sian state bud­get by the end of the year, will fur­ther help Rus­sia "rise from its knees" and fight more ac­tively in Don­bas and Syria, killing more sol­diers and civil­ians, and deal­ing de­struc­tion and chaos.


Ros­neft pro­duces 5 mn bar­rels of oil daily and is one of the world's largest oil com­pa­nies. Its con­trol­ling stake is owned by the state. Be­fore the deal with Glen­core and QIA, the state held 69.5% of its shares. To­day it owns 50%+1, which gives the gov­ern­ment com­plete con­trol over the com­pany. Since 2013, BP has owned 19.8% in Ros­neft. Another 1% be­longed to Ros­neft man­agers, and 9.75% have been traded on the Moscow and Lon­don stock ex­changes.

Af­ter the col­lapse of oil prices that eroded state rev­enues, Rus­sian lead­er­ship made a de­ci­sion to pri­va­tize part of the state as­sets and chan­nel the money to the state bud­get. The sale of 19.5% in the state-owned Ros­neft was the main item on the gov­ern­ment's pri­va­ti­za­tion agenda for 2016. Ac­com­plish­ing the task was not so easy. Ros­neft’s profit in Q1 2016 fell by four times. Its net debt as of the be­gin­ning of the year to­taled USD 23.9bn. In Novem­ber, Ros­neft bor­rowed from the Rus­sian Na­tional Wel­fare Fund RUR 1trn (over USD 15.6bn) to re­fi­nance the com­pany's debt. This is de­spite the fact that Rus­sia pro­duced and ex­ported more oil in 2016 than it did in 2015.How­ever, its rev­enues from oil ex­ports fell sharply: in Jan­uaryAu­gust they de­creased by nearly 30%, from USD 63bn (2015) to USD 46bn (2016).

As a re­sult, Ros­neft shares on Lon­don Stock Ex­change in late Fe­bru­ary 2016 traded at a price two times lower than the of­fer­ing price in 2006: USD 3.62 com­pared to USD7.55 per share at that time. That is, in 10 years the com­pany's mar­ket value dropped from USD 79.8bn to USD38.4bn, de­spite the fact that Ros­neft ac­quired TNKBP for USD55bn in 2013 and Bash­neft for USD5.2bn in 2016, af­ter rob­bing Mikhail Khodor­kovsky of YUKOS as­sets, which the Per­ma­nent Court of Ar­bi­tra­tion as­sessed at USD 61.1bn. In­ter­na­tional sanc­tions, fall­ing oil prices, tra­di­tional Rus­sian poor man­age­ment and gov­ern­ment cor­rup­tion have done their job, and the sale of 19.5% share brought a third of pos­si­ble rev­enues to the state bud­get.


Nev­er­the­less, on Fe­bru­ary 20, 2016 Rus­sian First Vice Prime Min­is­ter Igor Shu­valov signed a direc­tive on prepa­ra­tions for Ros­neft pri­va­ti­za­tion. One of the main items of the plan was to en­gage an in­vest­ment con­sul­tant who could de­velop the struc­ture and ma­te­rial terms of the share sale trans­ac­tion. One of such con­sul­tants was the Ital­ian bank In­tesa San­paolo, de­scribed by Reuters as an Ital­ian in­sti­tu­tion with ob­scure se­crets and un­sa­vory rep­u­ta­tion.

At first, the Rus­sians and their in­vest­ment ad­vis­ers looked for In­dian and Chi­nese in­vestors. In late June 2016, Bloomberg re­ported that "Vladimir Putin is con­sid­er­ing sell­ing part of Rus­sia’s cor­po­rate crown jew­els to China and In­dia. [...] Bring­ing two of Asia’s three largest economies into Ros­neft [...] would help Putin cover bud­get short­falls while strength­en­ing his geopo­lit­i­cal hand [...]."

But it didn't not work, and it looks like in­ter­na­tional sanc­tions were the ma­jor ob­sta­cle. The US Trea­sury Of­fice of For­eign As­sets Con­trol (OFAC) blocked the ac­qui­si­tion by Ros­neft of a 49% stake in an In­dian oil com­pany

Swiss oil trader Glen­core and Qatar's sov­er­eign wealth fund Qatar In­vest­ment Author­ity (QIA) closed a deal in late 2016 to in­vest

EUR 10.2bn in the Rus­sian gov­ern­ment by buy­ing a 19.5% stake in Rus­sian state-owned Ros­neft­com­pany

Es­sar Oil. This sent a strong mes­sage to the In­dian banks that fi­nanced Es­sar Oil, as well as to other in­vestors.

Af­ter the un­suc­cess­ful at­tempts to sell to In­dia or China, head of the Rus­sian state-owned Ros­neft Igor Sechin, long­time Putin's as­so­ci­ate, con­vinced him that sell­ing the com­pany's shares fol­low­ing the pri­va­ti­za­tion of Bash­neft­would at­tract for­eign buy­ers. On Oc­to­ber 12, Prime Min­is­ter Dmitry Medvedev signed a de­cree on the sale of 50.1% state-owned con­trol­ling stake in Bash­neft. The buyer was Ros­neft, which paid for it USD 5.2bn to the state bud­get. At that time, Putin ac­knowl­edged that such agree­ment was "not the best op­tion," hint­ing that Ros­neft needed for­eign in­vestors, not Rus­sian ones.


In De­cem­ber 2016, such in­vestor was found. This was an in­ter­na­tional Con­sor­tium, a vol­un­tary tem­po­rary as­so­ci­a­tion of com­pa­nies es­tab­lished to ad­dress the is­sue. The Con­sor­tium was made of two en­ti­ties: Swiss oil trader Glen­core and Qatar In­vest­ment Author­ity. Glen­core only pur­chased EUR 0.3bn worth of Ros­neft shares (1.9% out of 19.5%), whereas Qatar's sov­er­eign fund bought EUR 9.9bn worth (17.6%). There was not and could not be any par­ity between the Con­sor­tium's par­tic­i­pants when buy­ing the share pack­age, de­spite Rus­sia's dec­la­ra­tions made at the top level, prob­a­bly due to the fact that Switzer­land was among the first to join sec­toral and other sanc­tions against Rus­sia im­posed by the US and EU.

So, what are the Con­sor­tium’s mem­bers and what schemes al­lowed them to ob­tain a share in the prop­erty of the Rus­sian state com­pany and to fi­nance the deal?

Glen­core, which pur­chased 1.9% of the Rus­sian sta­te­owned Ros­neft, is num­ber one trader in Rus­sian oil. Be­sides, it has long been in­vest­ing in Rus­sia and owns a 25% share in RussNeft PJSC, con­sid­er­able agri­cul­tural as­sets and a share in UC Rusal. Glen­core al­ready has a con­tract with Ros­neft for 2013-2017, un­der which the trader was sup­plied 47 mn tons of oil (344 mn bar­rels, or about 190,000 bar­rels daily). The cur­rent arrangement in­cludes a new five-year con­tract (2017-2021) with Ros­neft for 220,000 bar­rels a day. This huge sup­ply vol­ume of 400 mn (!) bar­rels is es­ti­mated at USD 20bn, as­sum­ing bar­rel price at USD 50.

There is also another con­sor­tium that is al­most never dis­cussed: a con­sor­tium of fi­nan­cial in­sti­tu­tions made of In­tesa San­paolo and un­named Rus­sian banks, which fi­nanced the deal un­der the man­age­ment of the "ob­scure" In­tesa.

It is to this con­sor­tium that Glen­core pledged 9.75% of its own shares to ob­tain the funds to pay for Ros­neft shares. At the same time, Glen­core rep­re­sen­ta­tives em­pha­size that they will have no im­pact on the value of Ros­neft shares and deny hav­ing any in­ter­est in this deal other than that of an oil trader. By the way, Qatar In­vest­ment Author­ity fund, in turn, is Glen­core's ma­jor share­holder that holds a third of its shares. It is there­fore not sur­pris­ing that Glen­core dis­tanced it­self from the is­sues that are not quite their own.

The bulk of the sold Ros­neft shares went to Qatar's sov­er­eign fund Qatar In­vest­ment Author­ity, whose as­sets amounted to USD 250bn as of the end of 2015. It seems that Putin per­son­ally ne­go­ti­ated with the emir of Qatar the pos­si­ble in­vest­ment in Rus­sia from the sov­er­eign fund. The proof of this is the re­port pub­lished by Bloomberg the day be­fore the sales deal on Ros­neft shares was signed that Moscow joined OPEC ef­forts to re­duce oil pro­duc­tion and an­nounced re­duc­ing pro­duc­tion by 300,000 bar­rels a day af­ter the car­tel's coun­tries agreed to jointly cut pro­duc­tion by 1.2 mn bar­rels a day.

Qatar played a key role in achiev­ing the OPEC agree­ment, act­ing as an in­ter­me­di­ary between Saudi Ara­bia, Iran and Iraq and host­ing meet­ings of their oil min­is­ters. "The agree­ment was made pos­si­ble only thanks to your

per­sonal con­tri­bu­tion," said Ros­neft ex­ec­u­tive di­rec­tor Igor Sechin at a meet­ing with Putin that was aired by Rus­sian tele­vi­sion.

How­ever, de­spite its al­most un­lim­ited fi­nan­cial pos­si­bil­i­ties, Qatar's sov­er­eign fund de­cided not to spend its own money to buy shares of the Rus­sian state-owned Ros­neft. Out of the to­tal trans­ac­tion amount of EUR 9.9bn, it paid only EUR 2.5bn with its own funds, which is about 1% of its as­sets. The re­main­ing EUR 7.4bn were provided by the con­sor­tium of un­named Rus­sian banks led by the "ob­scure" Ital­ian In­tesa, ap­par­ently un­der the fund's guar­an­tees. At the same time, In­tesa is fi­nanc­ing 50% of the deal amount (EUR 3.7bn), while the un­named Rus­sian banks pay the other EUR 3.7bn.

In­ter­est­ingly enough, at dif­fer­ent UN votes, in­clud­ing the last one held on De­cem­ber 19 that con­demned the an­nex­a­tion of Crimea and the Rus­sian-in­sti­gated war in Don­bas, Qatar has con­sis­tently sup­ported Ukraine's ter­ri­to­rial in­tegrity. Why it opted for such in­vest­ment de­spite the in­ter­na­tional sanc­tions re­mains an open ques­tion.


Here is an in­ter­est­ing de­tail. As Putin spoke on Rus­sian TV, he said that the deal would bring EUR 10.5bn to the state bud­get, and all Rus­sian me­dia re­it­er­ated on these EUR 10.5bn, whereas the ac­tual trans­ac­tion amount was EUR 10.2bn.

With this phrase from the Rus­sian Pres­i­dent, Ros­neft up­dated the text of its press re­lease. The orig­i­nal ver­sion stated that the agree­ment would bring to the bud­get not less than RUR 710.9bn (EUR 10.5bn), out of which the sale of the shares would amount to RUR 692bn (EUR 10.2bn), with the dif­fer­ence of RUR 18bn (EUR 0.3bn) cov­ered by "ad­di­tional div­i­dends". The up­dated ver­sion only men­tioned RUR 710.8bn (EUR 10.5bn) of the rev­enue from pri­va­ti­za­tion.

Nev­er­the­less, the deal will pro­vide Rus­sia with the much-needed for­eign cur­rency. Be­sides, it will close the hole in this year's bud­get which cur­rently amounts to about RUR 700bn thanks to the con­tract that guar­an­tees the sales of 400mn bar­rels over five years. In this way, Rus­sia will be able to con­tinue the wars in Ukraine and Syria, while wait­ing for the sanc­tions to be lifted al­to­gether.

"This is a great vic­tory for Ros­neft," Head of Eq­uity & Trad­ing at Rus­sian in­vest­ment com­pany BCS Luis Saenz wrote in a com­ment. "It is very im­por­tant that Rus­sia is over­com­ing iso­la­tion and the sanc­tions regime." Vladimir Putin in a Rus­sian TV broad­cast said that the deal is "the largest in the world en­ergy mar­ket in the cur­rent year," thus em­pha­siz­ing that Rus­sia re­mains its pow­er­ful and in­dis­pens­able player.


And what about Ukraine? Nei­ther the For­eign Min­istry nor se­ri­ous ex­perts re­acted to the deal, as if noth­ing had hap­pened. As if we could with­stand on our own the se­cond largest nu­clear power of the world, and are no longer in­ter­ested in any sanc­tions against it. Well, there would be a cer­tain logic to this, if not for a slight prob­lem.

The Rus­sian ag­gres­sion against Ukraine started in March 2014 with the oc­cu­pa­tion of Crimea and the armed at­tacks on lo­cal au­thor­i­ties and key in­fra­struc­ture in Donetsk, Luhansk, Kharkiv, Za­por­izhzhya, Odesa and other oblasts that were man­aged and im­ple­mented by Rus­sian spe­cial forces and the armed groups that they cre­ated. The large-scale military in­va­sion of the reg­u­lar troops of the Rus­sian Armed Forces to Ukraine in Au­gust 2014 was the cul­mi­na­tion of the ag­gres­sion.

The stren­u­ous ef­forts of the Ukrainian army helped stop the in­va­sion. How­ever, the war con­tin­ues. It al­ready took the lives of over 10,000 Ukraini­ans, over 100,000 were in­jured, 1.6 mn be­came IDPs, cities, vil­lages, bridges, schools and hos­pi­tals were de­stroyed, eco­nomic devel­op­ment slowed down, and poverty-re­turned.

The world’s third largest nu­clear ar­se­nal, con­sist­ing of tac­ti­cal and strate­gic weapons and in­her­ited by Ukraine af­ter the col­lapse of the Soviet Union, could have pro­tected the coun­try against any ag­gres­sor, with­out hav­ing to beg from the mem­bers of the "nu­clear club" for any sanc­tions in case of ag­gres­sion.

How­ever, due to the po­lit­i­cal naivety of the coun­try's lead­er­ship and un­der the enor­mous pres­sure from the nu­clear pow­ers, per­ma­nent mem­bers of the UN Se­cu­rity Coun­cil, es­pe­cially Rus­sia and the United States, Ukraine gave Rus­sia its en­tire stock of tac­ti­cal nu­clear mis­siles and war­heads with a range from a few tens to hun­dreds of kilo­me­ters in the amount of 4,000 units de­signed to de­stroy large tar­gets and en­emy forces, in­clud­ing well for­ti­fied ones (mines, pro­jec­tiles, rock­ets, etc.). Then it "vol­un­tar­ily" re­nounced its nu­clear power sta­tus and got rid of all of its in­ter­con­ti­nen­tal bal­lis­tic mis­siles with a range of over 5,500 km in the amount of 176 units (130 mis­siles with six war­heads each and 46 solid-fuel SS-24 rock­ets with ten war­heads each) and de­stroyed all of its nu­clear war­heads and launch­ers (mis­siles, strate­gic bombers, mines, etc.). In­ci­den­tally, no other gov­ern­ment in the world fol­lowed Ukraine’s suit. To the con­trary, new nu­clear ef­forts were launched over time.

In ex­change for aban­don­ing its nu­clear sta­tus, United States, Bri­tain and Rus­sia gave Ukraine "se­cu­rity guar­an­tees," sign­ing on De­cem­ber 5, 1994 the Bu­dapest Mem­o­ran­dum, which was later joined by other per­ma­nent mem­bers of UN Se­cu­rity Coun­cil, France and China.

Un­der the terms of the Bu­dapest Mem­o­ran­dum, its mem­ber states pledged to re­spect in­de­pen­dence, sovereignty and ex­ist­ing bor­ders of Ukraine and to re­frain from the threat­en­ing to use or us­ing force against the ter­ri­to­rial in­tegrity and po­lit­i­cal in­de­pen­dence of Ukraine. Should Ukraine be­come a vic­tim of ag­gres­sion, the guar­an­tors pledged to seek im­me­di­ate ac­tion to pro­vide as­sis­tance.

When Rus­sia com­mit­ted an act of military ag­gres­sion against Ukraine, the guar­an­tor states did not pro­vide it with timely and ef­fec­tive as­sis­tance un­der the terms of the mem­o­ran­dum. Later, US and EU ini­ti­ated eco­nomic sanc­tions against Rus­sia, which were joined by a num­ber of other coun­tries. These sanc­tions have a ma­jor im­pact, if im­ple­mented prop­erly. How­ever, can we be as­sured that af­ter the Ros­neft's agree­ment with Glen­core and QIA, there will be no other agree­ments that would de­stroy the sanc­tions regime and leave Ukraine alone to deal with the world's se­cond largest nu­clear power?


The grand wizards. The Putin-Sechin scheme to at­tract for­eign in­vest­ment to Ros­neft cre­ated a dan­ger­ous prece­dent and un­der­mines the sanc­tion regime

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