Gazprom and Rosneft win big, but at what cost?

Two very interesting articles on the Russian oil and gas industry appear one after another in Upstream Online, and I am not sure whether or not their juxtaposition was intentional.

The first:

Russian state-controlled giants Gazprom and Rosneft have been handed monopoly rights to all hydrocarbon developments on the Russian shelf, Natrual resources Minister Yuri Trutnev has confirmed. Trutnev’s statement – made in an interview with Moscow financial daily – comes after the upper house of parliament, the Federation Council, approved amendments to the law on foreign investments in strategic sectors, which limits foreign participation in developing Russia’s biggest oil and gas reserves. Once the amendments – which were approved by the State Duma earlier this month – are signed into law by the president, the two state-control giants will automatically be handed operatorship of any new offshore projects.

The amendments to the subsoil and offshore laws give the right to develop Russia’s offshore reserves only to those companies “which have five years’ experience in working offshore Russia and in which the state owns at least 50% interest”, he said. State-run Gazprom and Rosneft, as well as Zarubezhneft, are the only companies that meet the amendments’ requirements

….

Trutnev told the paper the two state giants will share the resources between themselves without holding auctions or tenders.

Which, for those of you who aren’t familiar with the background and terminology, is the door finally slamming shut on not only foreign energy companies playing major roles in Russia, but also any independent Russian operators not owned by the government. Foreigners and independents are now going to have to be satisfied with being a junior partner in a consortium run by Rosneft or Gazprom, i.e. the Kremlin. This will no doubt cause broad grins to appear across the faces of much of the Russian population.

The second article might not.

Russia needs 61 trillion rubles ($2.6 trillion) of investment to develop offshore oil and gas deposits, said Rosneft boss Sergei Bogdanchikov.

Exploration alone of offshore regions until 2050 will cost 16 trillion rubles and production 45 trillion rubles more, Bogdanchikov told reporters and government officials in Moscow today.

$2.6 trillion!! Ouch!! Even in oil and gas terms over the period in question ($62bn per year), that is a serious amount of money. The obvious question must be where is this investment going to come from? Gazprom, despite being rumoured to be the largest company in the world by some measure or other, is heavily in debt:

Gazprom’s total long-term borrowings, including affiliates, rose to 1.105 trillion roubles [$47.3bn] from 806 billion roubles [$34.5bn] at the end of 2006.

Net debt fell by 28% in the first half of 2007 to 578 billion roubles [$48.1bn].

Bear this in mind next time you hear about Gazprom investing in trans-saharan pipelines, Libya, and Nigeria. Despite the political rhetoric and talks of the massive potential and influence of Gazprom, it is Russia’s most indebted company.  In other words, Gazprom is unlikely to be in much of a position to be financing mega-projects any time soon, and if it is going to sink billions into places like Africa, having never run a major project on home soil let alone in a political minefield like Nigeria, Russians might be waiting a while for their offshore gas receipts.

Will Rosneft be in any better position to fund this development? They are in slightly better shape than Gazprom:

Rosneft said its net debt fell to $23.8 billion at March 31 from $26.3 billion at Dec. 31 and $27.8 billion at Sept. 30.

But having borrowed heavily to fund acquisitions, not least that of Yukos at a knock-down price, they are not in much of a position to be stumping up $2.6 trillion.

And what about the Russian government? Surely they have loads of cash, what with its stabilisation fund topping $160bn or thereabouts? Yes, but there are a few obstacles in the way of spending this money. Firstly, it is supposed to be a reserve in order to balance the federal budget during times when the oil price drops beneath $27 per barrel, and although this is unlikely and tapping into the fund could be done whilst leaving enough for a rainy day, the amount that could be withdrawn is limited. Secondly, much of this fund must be earmarked for the reforming and upgrading of Russia’s outdated institutions and crumbling infrastructure. The Russian government has wisely not tapped the stabilisation fund for this purpose yet, as Russia is already battling against inflation which is in danger of affecting Russia’s army of low-paid workers, and particularly pensioners. But expenditure in these areas will have to come eventually, and unless Russia wants state-of-the-art platforms offshore and no roads, running water, or electricity onshore, the development of the Arctic oilfields is going to have to wait. And when somebody actually does the calculations of what it will cost to bring Russia’s institutions and infrastructure up to modern standards, the cost of developing and operating the Arctic oilfields is probably going to seem like chump change.

Almost certainly, Gazprom and Rosneft, and by extension the Russian government, are going to have to borrow this money, and equally certainly they are going to have to borrow this money from the west. Those schlopping sounds you just heard like wet cloths hitting a tile floor are the broad grins of several million Russians, beaming from reading the first article, falling from their faces. Oh dear! Hasn’t the Russian government just spent the past three years telling everybody that relations with the west don’t matter?

Actually, they do. Just as we need Russian gas, they need our financial services. Take this by way of example:

Russia’s biggest oil producer Rosneft is seeking $2 billion worth of loans from Deutsche Bank and Societe Generale to refinance debt used to buy the assets of bankrupt producer Yukos, sources involved in the deal said today….

The Russian giant was forced to seek cash in the loan market after abondoning a sale of bonds in July as the collapse of US subprime mortgages caused yields to soar. The company has a deadline of 19 March to refinance $5 billion of the 12 month bridge loans used for the $22 billion acquisition of Yukos assets in May last year

….
The loans, which fall due in March and September, were arranged by ABN Amro Holding, Barclays, BNP Paribas, Calyon, Citigroup, Goldman Sachs Group, JPMorgan Chase and Morgan Stanley.

I bet not too many Russian newspapers carried the story – from January 2008 – that the primary Russian state oil producer was seeking loans and refinancing packages from western banks, as we are bang in the middle of a lengthy narrative whereby Russia has repaid all its foreign debt, has loads of oil and gas, and hence stands atop the world once again telling the US to eff off.

Actually, Rosneft and Gazprom are in a relatively common situation here. Most of the national oil companies in the Middle East have enormous reserves and massive production figures, but are loaded down with enormous debt from the days when oil was $10 per barrel, not to mention that these companies have elevated expenses due to them generally being inefficient, overstaffed, and used as a piggy-bank by the sitting government. It is not uncommon for the giant national oil companies of the Gulf States to partner up with a cash-rich western supermajor in order to provide the investment needed to develop a new project or upgrade a field.

But the major handicap that Gazprom and Rosneft face when they apply for a loan with a western financial institution or partnership with a supermajor is that their owners – the Russian government – have demonstrated that they don’t respect the contents of a signed agreement, and they feel they can do whatever they please to their contracted partner because they have the monopoly of force in the country. Having used the blunt instrument of selectively applied laws to forceably take control of major projects or entire companies from foreign investors and independent Russians alike, one would think twice, and three times, before investing money into a major Russian oil and gas project. A paragraph in the last article I quoted is telling:

Rosneft may pay interest of 0.95% more than the London interbank offered rate for a five-year loan term, a banker involved in the deal told Bloomberg. The rate is about 0.5% more than the Moscow-based company’s existing loan, added the banker.

There may be several reasons for the increased rate of interest on the loan, one of which is almost certainly a deterioration in trust – and thus an increase in risk – between the lenders and Rosneft. In working so hard to increase the levels of mistrust between themselves and, well, everybody else, the Russian government has now increased the risk attached to any inward investment.

Without a doubt, Russia will still attract inward invesment, enormous amounts of it, and much of this will be into its oil and gas sector. But this investment will come at an increased cost, be it in the form of upfront payments or reimbursable terms on major projects, higher interest rates from banks and financial institutions, or more stringent guarantees and performance criteria. At a time when Russia is going to be shopping around for $2.6 trillion of investment, it could probably have handled things better this last few years.

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8 Responses to Gazprom and Rosneft win big, but at what cost?

  1. Conformist says:

    Tim your thoughts are interesting but it is clear, that you never studied business administration.
    Yes, Rosneft and Gazprom are indebted, but with their loans they financed projects which will bring a higher return(e.g. Sakhalin for Gazprom or Yukos for Rosneft) than their interest payments- i.e. this investments have positive net present value. Another point is, that the Dollar slided against the Rouble and thus the debt lost value in Roubles. Well, it is discussible whether Gazprom and Rosneft will really draw profit out of it, cause their sales are largely in Dollars, but they still manage to generate some revenue in Russia(especially Gazprom).
    One thing you can definitely tell is that their rouble net profit will be higher because of this(less debt), but this is probably largely an accounting thing.
    I do not see 45 bln $ for Gazprom as something overly threatening, Gazprom’s IFRS net profit for 3q of 2007(they still have not reported yet for the whole year in IFRS) was 426,26 RUB, around 18 bln $, that’s for 9 monhts. They could repay their debt’s with within two years with the current profits and you should not forget, Gazprom still has a real cash cow in petto, which they only started to milk- the Russian market where prices will more than double in next few years.
    The situation for Rosneft is maybe a bit more threatening, because they do not have the potential to rise prices as much as Gazprom, but still their net profit last year was 13 bln $.For a comparison Deutsche Telekom had a debt of 80 bln Euros in 2003 and a net profit of 1,3 bln Euros, and still they are not dead…
    At last your worry about borrowing costs for Russian state companies is overdone, they borrow nearly at the same costs as the Russian state would, their credit rating is relatively high.

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