Privatization, sanctions and security:
How Russia’s oil industry attracts foreign investment despite international sanctions
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.
WHY RUSSIA PRIVATIZED ROSNEFT
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.
WE HAVE NO MONEY, BUT OUR SPIRITS ARE HIGH
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.
NOT A WORD WITHOUT A LIE
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.
UKRAINE: ARE THE SANCTIONS NECESSARY?
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 MONEY FROM THE DEAL, WHICH REACHED THE RUSSIAN STATE BUDGET BY THE END OF THE YEAR, WILL FURTHER HELP RUSSIA FIGHT MORE ACTIVELY IN DONBAS AND SYRIA, KILLING MORE SOLDIERS AND CIVILIANS, AND DEALING DESTRUCTION AND CHAOS
The grand wizards. The Putin-Sechin scheme to attract foreign investment to Rosneft created a dangerous precedent and undermines the sanction regime