Rosneft: bruised but not beaten
The loss of a valuable US partner has shaken Rosneft, but it's sticking to its expansion plans and global investment strategy
Rosneft is on the backfoot after US sanctions on Russia forced ExxonMobil to abandon their joint venture in Siberia, while a deal to sell a stake to a Chinese investor may have hit the rocks after an arrest.
Shares in Russia's oil champion tanked by as much as 5% in the three days after 28 February when Exxon announced that it was abandoning drilling ventures with Rosneft because of expanded US sanctions. That body blow was followed a day later by news that CEFC China Energy chairman Ye Jianming was being investigated for suspected financial crimes. The case jeopardises the Chinese group's $9bn acquisition of a 14% stake in Rosneft.
While the CEFC deal may still be completed, the Exxon withdrawal from potentially oil-rich projects in Russia's Artic hurts. Rosneft boss Igor Sechin has long treasured his alliance with Exxon and must have once hoped that the elevation of its former chief executive Rex Tillerson to US secretary of state would lead to even greater cooperation. "Rosneft loses a partner of choice, which could have brought financing and expertise for the development of the next wave of Russian oil supply," said Samuel Lussac, senior Russia research manager at Wood Mackenzie.
The current price of oil should make extraction from the Arctic seabed profitable, but sanctions are preventing Rosneft and Gazprom, the Kremlin's gas behemoth, from engaging Western companies with the technological expertise to exploit these resources. "The lifting of sanctions is unlikely in the near future, with relations between the West and Russia remaining tense," said Stanislav Pritchin, a Russia analyst at Chatham House. "A possible solution would be if Rosneft and Gazprom partnered with private Russian energy companies that have greater experience and technology in underwater projects."
But Rosneft has thus far displayed little interest in working with privately-held Russian firms. Its modus operandi has been to acquire or crush non-state opposition.
Investors were horrified last year by Rosneft's legal pursuit of Sistema, which was viewed as a personal vendetta by Sechin against the Russian conglomerate's owner, Vladimir Yevtushenkov. The legal battle wiped billions of dollars off the wider stock market and left Sistema reeling as its assets were frozen by the courts and the group defaulted on its debt.
Former economy minister Alexei Ulyukayev, who had opposed Rosneft's acquisition of Bashneft, was caught in the cross-fire. Sechin gave written testimony that he personally caught the quietly spoken technocrat red-handed with a bribe worth just $2m linked to the sale of Bashneft. The sting was dismissed by many commentators as a provocation.
In a shock Christmas day announcement, Rosneft said it had reached an amicable settlement with Sistema, which previously owned Bashneft before its so-called privatisation. Sistema is to pay 100bn roubles ($18bn) to Rosneft, and the parties will drop all claims against each other. Yet the settlement provided little succour for Ulyukayev, who faces another eight years in a strict penal colony.
While Rosneft dominates the domestic Russia market through its acquisitions of TNK-BP and Bashneft, Western sanctions have blocked its access to international capital markets and technology required to exploit deep-water shale oil, as well as the Arctic.
Hamstrung by the Opec production cut agreement and curbed by the ongoing deterioration in downstream profitability, Russian producers like Rosneft have been left with few commercially viable growth opportunities. Rosneft is looking for foreign investors to develop the Suzun deposit in the Krasnoyarsk Territory, according to a report in business daily Vedomosti in March. The company hopes to sell up to 49% of the field to Indian or Chinese investors, but intends to retain a controlling stake and keep control over operating activities.
The Suzun field went to Rosneft after its takeover of TNK-BP in 2013, has estimated oil reserves of 56.9m tonnes of oil and 40.8bn cubic meters of gas. "We value 49% of the asset at about $1bn, which could be used to fund other Vankor cluster projects," said Kirill Tachennikov, senior analyst at Moscow brokerage BCS Financial.
In mid-December, the board of directors approved a new "Rosneft-2022" strategy, including a bold target for liquids production to climb by 14%, to 250m tonnes a year, (1.98bn barrels) by 2022. Sechin said he expected the new strategy would increase the company's market cap by 25-30% over the next five years and produce 500m tonnes more oil over the next 20 years than previously forecast.
Gas production is forecast to rise to 100bn cubic metres a year by 2020, with the growth coming from the Rospan, Kharampur and Kynsko-Chaselskaya group of fields in an ambitious drive to capture 20% of the domestic gas market.
The company plans to finish modernising its refineries by 2025 and stop the production of fuel oil while the current petrochemical assets are to be allocated to a separate business, with separate financial records.
As a pilot project, Rosneft intends to spin off its retail business, which comprises of 3,000 filling stations and 152 depots in Russia with sales of 12m t/y of oil products and generates $500m of income.
But analysts have yet to be swayed by Rosneft's lofty forecasts when expansion is so clearly constrained by sanctions and the Opec production cuts deal. "We would still argue that these numbers seem too ambitious to be achieved via organic growth and may entail commercial risks," said Evgenia Dyshlyuk, oil and gas analyst at Gazprombank.
Rosneft, which accounts for about 40% of Russia's crude production, decided to defer the launch of several new projects in Eastern Siberia rather than cut output from brownfields. Indeed, most of the fall in Rosneft's output came from those new capex-heavy projects, like Vankor and Suzunskoe. Output has also been sliding at Rosneft's key production subsidiaries, Yuganskneftegaz and Samotlorneftegas: output fell 0.4% and 0.2%, respectively, in February.
However, significant growth has been recorded at its Taas-Yuryakh field in Yakutia, where output surged 16% in February. In January, production shot up 26% at the Uvat group of fields in West Siberia. This growth was offset, though, by falling production at brownfields in the Central Region, as well as at some brownfields in Western Siberia.
Rosneft produces more oil than any other publicly-listed oil company, but trails behind the market capitalisation of Western peers, such as Exxon, BP or Shell. The London-listed group has splurged an estimated $100bn on M&A since President Putin first came to power in 2000 and shows no sign of easing up. It has committed $3.5bn to finance drilling operations and pipeline infrastructure in the semi-autonomous Kurdish region in northern Iraq and provided a $6bn lifeline last year to troubled Venezuela, decisions which have alarmed many investors.
Rosneft may also take part in the development of Iran's Azar field, which is likely to cost another $2bn. The field's current output is 30,000 barrels a day, but after development, production is expected to rise to 65,000 b/d and eventually peak at 100,000 b/d.
The company claims its net debt was $37.5bn at end-Q3 in 2017. Sberbank CIB analysts, however, put the figure at $73bn when $35bn of pre-payments on supplies are factored in. Meanwhile, Q3 profits fell way short of expectations as free cash flow (FCF) plunged.
"Rosneft's continuing spree of M&A has dented the investment story," said Ilkin Karimli, senior analyst at Credit Suisse. "Promises of operational momentum, FCF inflection and subsequent deleveraging are not enough and we believe the company needs to start delivering. Until then, Rosneft remains largely a play on the oil price."
The Suzun field has estimated oil reserves of 56.9m tonnes of oil
Even analysts at state-controlled Russian investment bank Sberbank CIB have called on Rosneft to change its strategy "markedly" to rein in its aggressive M&A. The report's authors, in a section titled "Rosneft: We Need to Talk About Igor", said Sechin "almost single-handedly sets the strategy" in a company with about 260,000 employees.
If Rosneft doesn't reform of its own volition, senior Sberbank CIB analyst Alex Fak speculates whether external forces can pressure Sechin's Rosneft to change course. "The possibility cannot be rejected outright," said Fak. "However, if the combined effect of the drastic fall in the oil price and Western sanctions has not helped improve its capital allocation, it is unclear what would."
If Rosneft continues to backslide, the danger is of it falling into the same bracket as Gazprom in terms of corporate governance and shareholder value generation.
The appointment in September of former German chancellor Gerhard Schroeder as Rosneft's new chairman didn't inspire confidence amongst investors. Schroeder, a close friend of President Vladimir Putin, has already proved his worth as head of the Nord Stream consortium at Gazprom, which is more an instrument of Russian state policy than a public company.