Financing issues surrounding CEFC China Energy are raising a range of questions about its tie up with #Rosneft.

There was a brief moment back in September 2017 when everything touching Rosneft from which had anything to do with China seemed to be made of gold. It was September 3, 2017 when Rosneft and CEFC China Energy signed up for a cooperation and supply agreement which was slotted to see more than 60 million tonnes of oil shipped to China over 5 years.

Then less than a week later, the same company unveiled plans to buy the combined 14% stakes held in Rosneft by Qatar Investment Authority and Glencore for more than $9 billion USD, at a 16% premium to the 30 day weighted Rosneft price.  That had the management team on Sofiyskaya Naberezhnaya not only with Exxon and BP bedded down with major stakeholdings and long term cooperation agreements, but staring the prospect of a significant player from the world’s preeminent oil growth market smoothing the passage of future Rosneft sales into the Middle Kingdom.

That was then. Now, that rosy future is getting murkier by the day, and in recent days it has been getting murkier very very fast.

Which Chinese company?

CEFC China Energy says, on the English language page of its website, it is ‘a private collective enterprise with energy and financial services as its core business,’ and when it agreed to outlay $9 billion USD for a sizeable stake in Rosneft it stated it had gas and oil assets in Europe and Asia and had annual revenues of more than $40 billion.  So far, so good.

But late last week it was disclosed that another Chinese company, Huarong Asset Management, had purchased a 36% stake in the CEFC China Energy vehicle, CEFC Hainan International, to buy the Rosneft stake. The other 64% will remain with another CEFC vehicle, CEFC Shanghai International.  It is about here that things start to get opaque.

There are a number of reports suggesting that the founder and CEO of CEFC China Energy, Ye Jianming, is experiencing some sort of difficulty with Chinese regulatory authorities, and even claims that Huarong had been ordered to conduct a debt for equity swap by the Chinese government, which have subsequently been denied.  The SCMP also reported that an agency of the Shanghai municipal government had been directed to take control of management of China’s largest non-state oil company.

Who will come up with the funding?

At the same time there have been persistent claims that CEFC China Energy may be stretched financially.  It has recently experienced some credit downgrades and warnings on its debt from Chinese ratings agencies.  Reservations about its funding for the Rosneft stake purchase are close to the core of these concerns.

‘Sources close to the matter said CEFC China planned to pay $4 billion using its own cash, with the rest coming from bank loans, including from the China Development Bank. But domestic institutions have grown cautious about the deal, the sources said.
“CEFC China is eagerly searching for money …. But the Chinese government has remained silent and domestic banks are hesitant,” said a source close to the matter. “If CEFC China can’t get the money to make the transaction by the end of February, the deal is likely to fall apart and CEFC China may face fines.”
China Chengxin said the reliance on borrowed funds means the deal — regardless of success or failure — will put pressure on CEFC Shanghai. If the deal succeeds, the company will face a greater debt burden. If not, it will bear investment losses, the rating agency said.’(Caixin)

Ultimately the financing issues may call into question the ability of CEFC China to conclude the Rosneft deal, which Vedomosti reported required the payment of $1.8 billion by 1 April, 2018, and a further $7.3 billion by September.  The doubts have mounted to the point where there is uncertainty about the ability of CEFC China to finance the deal. Glencore has already flagged recently that the settlement dates may be subject to some wiggle room, simply referring to 1H 2018 for the initial payment.

In comes some Russian financing?

Another report from the SCMP suggested considerable desperation, but added another Russian angle to the CEFC China buyout of the Rosneft stake, suggestions of which had been about for some time.  

‘CEFC’s single largest source of financing has been China Development Bank (CDB) which was also expected to play a large role in funding CEFC’s US$9.1 billion purchase of a 14.16 per cent stake in Rosneft, the Russian oil major, announced last year.
Nomura, one of the banks initially tapped for finance, was later told to step down as CEFC was set to raise US$5.1 billion in short-term loans from Russia’s second-biggest lender, VTB, according to a separate source with direct knowledge of those discussions.
CEFC was in separate talks with CDB to later refinance the short-term bridging loan being offered by VTB, Reuters reported at the time.’ (SCMP)

It can be assumed that Sberbank will not be interested following a November report that expressed concern about Rosneft’s organic growth prospects after 2019, to the point where Rosneft was advising therapy for the analyst.

All of a sudden what looked like a superb deal last September has now turned into a flaky entity buying into Rosneft using #VTB to finance a large chunk of the deal.

The State of the deal

That the Chinese state all of a sudden looks far closer to the Rosneft deal than it did last September will not necessarily worry Rosneft.  After all, the QIA was closer to Qatar and it often requires feeler gauges to work out where Rosneft stops and the Kremlin begins.  When the two states are Russia and China where state control of the economy is an acknowledged fact, the state angle will be, in the first instance, even less of a concern.

But one issue which may be somewhat unnerving for Rosneft and the Russian state is that China, which has driven some hard energy deals, and thoroughly nailed long term gas contract prices to the floor for its $400 billion dollar 30 year deal with Gazprom, may want to look a lot more closely at the Rosneft purchase.  Particularly if it thinks the purchase was made by a highly leveraged spendthrift oligarch, and particularly against a backdrop of concerns about capital flows offshore, which may have put paid to attempts by Fosun International and Polyus gold to tie up.  Any revisiting of the terms and conditions under which CEFC China agreed to buy out QIA and #Glencore carries risks for Rosneft and the Russian state.

Valuation Issues – goodbye Rex

If the Chinese government were to become more interested in the pricing and financing of any purchase of a stake in Rosneft, then the timing is uncomfortable.  The share price has been pared since the disclosure Exxon was walking away from its cooperation agreement with the Russian oil major.

That cooperation agreement had been the legacy of a deal engineered by then Exxon CEO Rex Tillerson, who was dumped unceremoniously as Secretary of State by US President, Donald Trump, this week.  Although it never quite came off as hoped for, the deal had been designed to provide Exxon with access to Arctic oil reserves and Rosneft with the technological and financial capacity to exploit those reserves, in a world where the concept of ‘Peak oil’ provided the backdrop.

The dumping of Tillerson as Secretary of State was the denouement of earlier hopes that his presence in the administration may strengthen ties with Russia.  With another year of Russia related news in the United States likely to be a political football, the prospect of any lessening of sanctions imposed after the 2014 Russian annexation of Crimea appears remote.  It also reduces the desirability of any stake in Rosneft, and limits the number of financial institutions who may potentially take part in financing any potential buyer.

Valuation Issues – Novichok & sleepy London suburbs

Also a downside risk to the value of Rosneft as a strategic stake is uncertainty which has erupted in the last week, over claims from the United Kingdom that the Russian state is involved in the poisoning of a former Russian intelligence official, Sergei Skripal, and his daughter, in Salisbury, UK.  The uncertainty will no doubt be ratcheted even higher upon the news that that the death of another Russian resident of London is subject to a police criminal investigation, and that Russian identities in the British capital are being warned for their safety by UK police.

As with almost all intelligence ‘events’ it is fairly certain that the wider public will never know what has unfolded.  But without going into speculation about who, how, or why, the simple widespread perception that there is Russian official involvement, and that the poison used is one developed in Russia during the 1990s, increases the geopolitical risks involved for anyone considering major M&A activity in Russia, and adds to the risks of increased sanctions and global instability.  And that is at a bare minimum.  If there are any increased sanctions, or coordinated political responses designed to punish Russia, then those risks are magnified.

Valuation Issues – sanctions

Both of the above diminish the prospect of any lessening of global financial sanctions against major Russian corporates, including Rosneft, and a range of identities including Igor Sechin. Indeed in recent weeks we have seen the US expand the number of Russian individuals sanctioned, ostensibly on the basis of Russian involvement in US politics, but more generally just reflective of an overt anti Russian sentiment in the US, and now UK public domain, which is reflected in the media of both nations, and is ultimately shaping political sentiment in both.  Russia has surprisingly little trade with both the US or the UK, but financial sanctions do hurt – particularly for large companies with significant financing needs such as Rosneft.  Any further expansion of sanctions may impinge on the ability of Russian corporates to use London based financial and legal services, or possibly limit Russian gas access to the UK – with the first Russian LNG shipment to the UK just last December.   As was the experience in 2014, however, it is sometimes not the sanctions, but the uncertainty around the geopolitical environment which hurts the most.

This uncertainty becomes even more pronounced when thinking about the remaining strong links between BP and Rosneft.  Rosneft has a 5% stake in BP and BP owns 19.75% of Rosneft in an arrangement which dates from 2011.  Unlike the placement of stakes with QAI and Glencore which were also financed through VTB, which CEFC China is now ostensibly buying out after complications with international banks, BP stumped up its own cash.

Through the imposition of sanctions the agreement has held, despite BP CEO Robert Dudley needing to leave the room whenever Igor Sechin addresses the board and a host of other irritations to the working arrangements between the two companies.  It has been a marriage of convenience, for sure, Rosneft accounts for an outsized chunk of BP production, and the skills BP brings enables Rosneft to look at projects it may otherwise not.  It also lends a patina of global respectability to a company synonymous with the Kremlin, which has attracted criticism for its management. But it is also a relationship being sorely tested again.  Dudley, in particular, has impeccable form when it comes to dealing with Russia’s exigencies, but the reliance on Russian production may not last forever, and the greater the stress the closer sunset looms.  The departure of Glencore and QIA, and Exxon from the panel of Rosneft’s close associates already highlights a sense of needing to keep BP in play, if for no other reason than to avoid the impression that strategic investors may be pining for an exit – which may put downward pressure on prices expected of incoming strategic investors.

Valuation Issues – crude prices and shale

But the other great lesson of 2014 is also one which Rosneft, any buyers of strategic stakes in Rosneft, and their financiers will be keenly aware.  That is that we have entered something of a new era for global crude markets, where the swing producers as far as price is concerned are now the shale plays of North America, and that once the global price goes beyond roughly $60-$65/bbl, these come back into play as significant production factors. This has been underlined by market moves since the original announcement of the CEFC China Energy buyout of the QIA Glencore stake in Rosneft in September 2017  – a move from mid 50s to 60 then a push above 65, which has receded as US production has surged.

More strategically, it is increasingly obvious that the sun is starting to set on the use of oil as a transport fuel.  Certainly its use for a range of purposes will long continue, and even its transport use is likely to be enduring.  But with North American shale producers likely to crowd the price with additional production over the shorter term, the faster takeup of electric vehicles and alternative energy sources is increasingly problematic for the longer. And China’s focus on electric vehicles will crimp the margin just that much more.

The upshot

So the upshot of all this is that the deal, which is still most likely to eventuate, will be considerably different from those envisaged by the signatories last September. What was then seen in Moscow as the alternation between two older strategic stakeholders and a new entrant, against the backdrop of an oil market which had bottomed out and was looking to move higher, is no longer.  What is unfolding is starting to look more like a state to state deal against a backdrop of limited upside demand and price growth, with that backdrop looking increasingly clouded by geopolitical complexity.

That change in backdrop can be expected to see the Chinese state questions the deal to which it now seems to be party, and history tells us that when it deals with Russia over price it can be expected to pare margins wherever it thinks it can.