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Q + A – Exclusive anaysis expert on Russia’s oil , mine sector

Posted on: June 14, 2009

Reuters – Saturday, June 13

LONDON, June 12 – The slump in oil and commodity prices accompanying the global financial crisis has pressured Russian oil and mineral firms, and even the recent price recovery has not been enough to entirely resolve worries over their debt obligations.

Below, Exclusive Analysis regional specialists Teymur Huseynov and Joanna Gorska answer questions on what investors can expect in the volatile sector.

Q – Given the fall in oil prices, will Russia’s energy majors be able to meet their debt obligations? Which in particular look under threat? What recourse might foreign lenders have? Is the recent recovery in oil prices enough to get these firms out of trouble? If not, can we expect to see Kremlin activity?

A – The rapid drop in oil prices since late last year has significantly undermined Russian energy firms financials, though an increase in prices in Q2 2009 is likely to moderate this situation. All Russia’s energy majors have had to scale back their expansion plans, and some are facing difficulties meeting their debt obligations. Among the worst hit are state-controlled Rosneft and Transneft <TRNF_p.RTS>. Rosneft’s total debt is $24 billion, with roughly $7 billion due for repayment in 2009.

Transneft’s total debt is $8 billion, with about $4 billion due this year. As both firms have the Kremlin’s backing, default is not probable due to the state’s $350 billion of foreign exchange reserves. As Russia signed a 20-year contract for oil deliveries to China , Rosneft and Transneft both stand to receive loans of $15 billion and $10 billion respectively over the next two years, which in a way is a pre-payment for oil to be delivered by the Russians. Yet, we assess that both companies will have to scale down their ambitious expansion plans to a certain extent. Rosneft will have to focus on maintenance of current assets and development of deposits that will supply the Eastern Siberia-Pacific Ocean pipeline, which will transport oil to China.

Russian companies need the oil price to rise to $75 in order to start developing geographically difficult, capital and labour intensive deposits in Eastern Siberia and the continental shelf. Transneft will have to concentrate on building the VSTO pipeline at a cost of putting on hold development of the Baltic Pipeline System .

Russia’s gas export monopoly Gazprom <GAZP.MM> faces similar problems. In order to finance all its new projects (LNG initiatives, development of Yamal and Eastern Siberian deposits and the Pre-Caspian, Nord and South Stream pipelines) Gazprom would have to spend $30 billion annually for the foreseeable future. Even at times of high oil prices, Gazprom’s investment programme rarely exceeded $4 billion. With $60 billion debt ($10 billion due in 2009) and exports halved because of the fall in demand, it is in no position to continue expanding. More to the point, major Russian banks’ credit lines with Gazprom have reached their limits. It is possible that Gazprom will postpone development of capital-intensive Yamal and Eastern Siberian deposits and will concentrate on Shtokman, Nord Stream and South Stream projects, which are also politically significant for the Kremlin.

Though default by a major state firm is improbable, the government is unlikely to back private operators such as Lukoil <LKOH.MM>, or those already experiencing difficulties, such as Sibir Energy. Lenders to such companies can exercise their option of getting shares in them which in case of an interest can later be sold to either a Russian state energy company or a private entity.

Q – Will Russia’s largest aluminium producer Rusal be able to secure sufficient state financial support to stave off default? If so, what strings might be attached and what would they mean for investors? What broader implications would that have for investment risk in Russia?

A – Rusal’s problems have worsened since the sharp fall in demand and prices for aluminium worldwide, which has significantly affected its cash-flow model. Rusal owes $7.4 billion to a consortium of foreign banks and another $4.5 billion to domestic banks. For example, Alpha Bank has filed numerous legal complaints against Rusal, the country’s largest aluminium producer, in Russian and international courts, concerning $650 million in overdue loans; it demanded an immediate freeze of many of Rusal’s non-core assets.

By the time President Dmitry Medvedev criticised some Russian bankers for harshly treating their major debtors on 17 March, a court in Jersey froze over $20 million in assets controlled by Rusal’s major shareholder En+, which is managed by Oleg Deripaska. Furthermore, Rusal’s interests in financial services and in construction were coming up for review at the Moscow Arbitration Court in response to Alpha’s action. After Medvedev’s intervention, Alpha’s chairman Mikhail Fridman announced he was giving Deripaska some more time to set the company’s finances in order.

Deripaska is unlikely to be able to restructure all of Rusal’s $8 billion debt due for repayment this year. Recent events suggest Deripaska has been coming under increasing Kremlin pressure to sell off some of his equity in Rusal to a Kremlin-controlled Rostekhnologii or VEB. The deadline at the negotiations with foreign lenders on restructuring Rusal’s foreign debt is approaching on 11 June and Rusal is likely to ask for prolongation of repayment period by another 2-3 years with higher interest payments and may have to offer additional assets as collateral.

In addition to losing its non-core assets in energy, financial services and construction to its many lenders by year end, Rusal will probably have to invite the government to lend it support in exchange for giving up some equity. Overall, we think that unless the economic crisis deepens and becomes unmanageable, the ruling regime will remain stable.

Nonetheless, we assess that government investments into strategic sectors will be slightly curtailed by recent changes to legislation. Moreover, the crisis does present opportunities for foreign investors, as we believe the government will be more flexible in terms of allowing investments into major sectors of the industry, as there is acute need for cash injection into the Russian economy.

Q – How serious is the threat of nationalisation of indebted extractive firms requiring Russian state support? What impact would a state-owned metals conglomerate have on default risks and competition in Russia? Would there be implications for other sectors?

A – Russia’s metals firms are more than $50 billion in debt (more than half of this debt is owed to Russian state-controlled financial institutions) and much of it is due for repayment in the next two years. Faced with mounting default risk, Russia’s metals majors are in merger discussions. Merger talks are driven by the objective of ensuring security of supplies, reducing production costs and infusing state capital into the metals sector.

Various merger configurations are under consideration and the main participants include Evraz Group <HK1q.L>, Mechel <MTL.N>, Metalloinvest, Norilsk Nickel <GMKN.MM> and Uralkali. No matter what the outcome of the current negotiations, it is very likely the state will hold about a 25 percent stake in the conglomerate and the parties to the merger will effectively exchange all debts for this state equity interest. If this scenario becomes a reality, it will signify the end of the metal sector’s relative independence from the state; the Russian government has not formally held any major interest in the metals or mining sector for the last 15 years.

The government is unlikely to expand its formal influence in the metals sector beyond this 25 percent stake or to nationalise the sector, as it is not prepared to underwrite the companies’ debt to foreign lenders. This same argument is also applicable to the banking sector, in our view. This is consistent with the government’s plan to support the economy through the financial sector rather than bailing out individual private firms.

However, the state will probably appoint its representative to the conglomerate’s board to oversee that the conditions attached to state financial support are implemented. (It failed to do this with financial institutions, which used state funds for currency speculation rather than investment.) We also think Kremlin-friendly businessmen, such as Roman Abramovich and Alisher Usmanov , will also continue to divest themselves of non-core assets, particularly in construction and any overseas assets.


1 Response to "Q + A – Exclusive anaysis expert on Russia’s oil , mine sector"

I think the new pipeline deal points to the problem of corporate interests in thwarting EU integration in foreign policy. I’ve just posted on it at

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