China's Oil Investment in Russia Raises Questions

A private share sale to China is backed by a Russian loan.

Russian First Deputy Prime Minister Igor Shuvalov (L) and Rosneft's chief executive Igor Sechin (R) wait before a meeting between Russian President Vladimir Putin and Chinese Premier Li Keqiang at the Kremlin in Moscow, Nov. 8, 2016.

Nearly two months after the announcement of China's largest private investment in Russian energy, terms of the deal keep expanding along with questions about how they will play out.

On Sept. 8, privately-held CEFC China Energy Company Ltd. said it had agreed to buy a 14.16-percent interest in Russia's Rosneft oil company for U.S. $9.1 billion (60 billion yuan), marking the first major share sale of a state petroleum producer to a Chinese firm.

Shanghai-based CEFC agreed to acquire most of the 19.5- percent stake sold last December to a consortium of trader Glencore plc and the Qatar Investment Authority (QIA) that had become difficult to finance.

The deal with CEFC would effectively rescue the partial privatization of Rosneft, which the Russian government had been planning for years to help fund the state budget.

Financing for last year's sale to Swiss-based Glencore and QIA became unaffordable during a period of weak oil prices and western sanctions on Rosneft following Russia's seizure of Crimea in the war with Ukraine.

The faltering deal with the Glencore-QIA consortium was seen as an opportunity for the little-known but fast-growing CEFC to break into the ranks of the big energy investors in Russia, led by state-owned China National Petroleum Corp. (CNPC) and China Petroleum & Chemical Corp. (Sinopec).

Since the announcement, debt-burdened Rosneft has added further sweeteners to the plan for CEFC's minority share.

The deal has received preliminary clearance from the Chinese government and is expected to win final approval by the end of the year, Reuters reported, citing unnamed sources.

On Oct. 17, a CEFC spokesman said Rosneft had pledged to give the company access to 11 million to 13 million tons of oil annually (220,000-260,000 barrels per day), starting next year.

That volume reported by Reuters was slightly more than the 10 million tons per year promised under a strategic cooperation agreement signed in July, according to Interfax.

The Russian supplies will give CEFC a chance to compete with the world's largest oil trading firms. The "offtake" deal would eventually rise to 42 million tons per year (840,000 barrels per day), Reuters said.

CEFC’s chairman Ye Jianming reportedly plans to build a trading team of over 100 staffers with offices in Singapore, Hong Kong, London and the United States. Plans sound equally ambitious on the Russian side.

More deals to come

Speaking at an economic forum in the Italian city of Verona on Oct. 18, Rosneft CEO Igor Sechin said there would be more deals to come under a supplementary contract with CEFC, using a variation of the company's Chinese name, Zhongguo Hua Xin.

"We'll be developing a number of upstream (exploration and production) oil and gas projects and petrochemical projects with Huaxin on Russian territory," Sechin said, as quoted by Interfax.

"We're also interested in working with CEFC to set up logistics infrastructure in China. So we express our utmost satisfaction with this sort of cooperation," he said.

While the plans are far reaching, realization seems less certain.

The projected volumes of oil supplies have already raised questions. The eventual offtake estimate of 840,000 barrels per day (bpd) may be out of proportion with Rosneft's current capacity and CEFC's minority share.

Rosneft exported 34.5 million tons (692,000 bpd) of crude to China last year. In Verona, Sechin said this year's deliveries would reach 40 million tons (800,000 bpd) with plans to add 10 million tons annually (200,000 bpd) in each of the next five years.

But it is unclear how Rosneft would deliver that much oil, since its pipeline connections are already full, the Russian dailies Vedemosti and Kommersant reported.

In Verona, Sechin responded that all delivery options are being explored.

"We will export by any route, all possible routes with available capacity. At this stage, the volume is clear to us," he said, according to Interfax.

"We are working with (pipeline monopoly) Transneft, with other transport companies. We will fulfill the commitments we have made," Sechin said.

Some reports suggest Rosneft may resort to the long-abandoned option of shipping oil by rail through Mongolia, which China has rejected in the past.

Questions about financing

But financing for the deal may raise larger questions.

On Oct. 12, Reuters reported that CEFC planned to raise U.S. $5.1 billion (33.8 billion yuan) in short-term loans from VTB Bank, Russia's second-largest lender. The state-owned institution, formerly known as Vneshtorgbank, was established in the 1990s to finance foreign trade.

But it is unclear why loans from a Russian state bank would be needed to finance the share sale of a Russian state oil company to a Chinese firm to fund the Russian state budget.

"This is getting curiouser and curiouser," said Edward Chow, senior fellow for energy and national security at the Center for Strategic and International Studies in Washington.

On Oct. 13, VTB's president, Andrei Kostin, first raised the possibility of financing the China deal in an interview with Rossiya 24 state television news.

"I can say for certain that this company's participation in no way depends on whether VTB grants a loan or not," Kostin said, according to Interfax. "But in principle, we're prepared to do this if there is such interest, because this is a fairly interesting deal."

Days later in Verona, it appeared that deal would depend on borrowing from VTB after all.

At a press conference, CEFC executive director Li Yong said the company would take out a loan from VTB "at the first stage of financing," with funding from China Development Bank (CDB) "at the second."

Reuters quoted sources as saying that the first stage could last one or two years.

"We are still considering and trying to learn more about CEFC and will be very careful given the sanctions," said an unidentified banker involved in talks for a "CDB-led refinancing group."

Although CDB has financed both CEFC and Rosneft in the past, the apparent caution over the share deal may raise doubts that uncertainties over the original Glencore-QIA investment have been resolved.

"It doesn't sound settled if financing has not been arranged and CEFC needs a bridge loan from a Russian bank," Chow said.

Last week, VTB also appeared to add conditions to its loan terms.

On Oct. 30, VTB's first deputy chairman, Yury Solovyev, told Interfax that the bank was willing to finance the sale "if CEFC pledges the (Rosneft) shares to the bank."

"We are ready to assume such a risk, ready to provide financing secured with shares," Solovyev said.

CDB already has significant exposure to Russia due to a pair of loans to Rosneft and Transneft from 2009 totaling nearly U.S. $34 billion (225 billion yuan) to finance oil exports and the East Siberia-Pacific Ocean (ESPO) pipeline.

The loans represent China's largest foreign credits to date, according to recently released research on China's state financing and foreign aid by AidData, a research lab at the College of William & Mary in Virginia. Rosneft has been paying interest at an average annual rate of 5.69 percent on U.S. $15 billion (99 billion yuan) of the loans, the South China Morning Post said.

CEFC's big investment and the financing requirement also coincide with Chinese government's cautionary stance toward capital outflows since last year.

In the first nine months of 2017, China's non-financial outbound direct investment plunged 41.9 percent from a year earlier as regulators have barred many large overseas deals to keep capital in the country.

Winning approval

Reports have suggested that CEFC deal would win approval because it is consistent with goals of the government's "One Belt, One Road" (OBOR) initiative to invest in new trade links. The logic may be shaky, however, since OBOR is primarily aimed at boosting China's exports and infrastructure, while the CEFC deal appears aimed at increasing imports and assets abroad.

Although CEFC's role in Russia is growing, a clear picture of its convoluted connections may be clouded by its other investments during its buying spree.

According to numerous reports, the AnAn Group, a Singapore affiliate of CEFC, invested U.S. $500 million (3.3 billion yuan) in a U.S. $1.5-billion (9.9-billion yuan) initial public offering of Russia's En+ Group last week.

The energy and commodities conglomerate is owned by billionaire Oleg Deripaska, a cohort of President Vladimir Putin.

With the investment, AnAn was expected to gain a seat on the En+ board of directors and veto rights over "a whole range of issues," Interfax said, citing the IPO prospectus.

Others reportedly investing in En+ included QIA. Proceeds from the IPO will be used to pay down En+ debts to VTB, the prospectus said.

With all that investment, CEFC appears to be reaching for more.

Last week, Vedemosti reported that the company may buy a half-interest in a prize arctic oilfield from Russia's Independent Petroleum Co., owned by former Rosneft president Eduard Khudainatov.

CEFC also plans to open its own bank early next year, Reuters reported last week.