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Background

A brief overview of Rosneft’s history is important to understand the political circumstances and risks surrounding it today. Rosneft is the successor company to the Russian oil giants Yukos and TNK-BP. After the fall of the Soviet Union, Russia’s enormous natural resource base moved from state ownership to private (oligarchic) control, and Western capital flooded the country to take advantage of opportunities in its fledgling capitalist system. BP, one of the earliest Western oil companies operating in Russia, merged its Russian oil interests with some of the oligarchs in 2003, and its TNK-BP joint venture eventually controlled over a quarter of national oil reserves.

When Vladimir Putin took over the presidency in 2000, he felt that oligarchs had become too powerful relative to the Russian government, and cut them down to size by consolidating the country’s energy sector. Putin oversaw the consolidation of two gigantic state conglomerates, Rosneft for oil and Gazprom for natural gas. Rosneft acquired the assets of the country’s largest private oil firm – Yukos – after its founder Mikhail Khodorkovsky was arrested and jailed for opposing the regime. In Putin’s third term, TNK-BP (then Russia’s third largest oil producer) was merged into Rosneft in 2013, with BP retaining an approximate 20% stake in the combined entity. Both Rosneft and Gazprom are the crown jewels of Russian strategic assets, and have remained so even as oil prices fell in mid-2014. Rosneft’s CEO is Igor Sechin, Putin confidante since the early 1990s and a prominent name on the U.S. Treasury sanctions list. Sechin has served as President of Rosneft since 2012, and the strong momentum he placed behind Rosneft’s acquisition of TNK-BP is a major reason Putin supported the deal. Sechin is known to be ambitious, and has sought to outmaneuver rivals to gain power over other Kremlin elites.

Rosneft’s ascension

Until very recently, Gazprom held a monopoly over Russia’s natural gas exports, but lower global prices and diversification projects in Europe, Asia, and the Middle East have weakened Gazprom’s position in those regions. Buoyed by Gazprom’s troubles, Sechin has sought to strengthen Rosneft’s position, resulting in his 2016 acquisition of Bashneft, Russia’s sixth largest oil company. In 2017, Rosneft replaced two board members who had commercial ties to Gazprom with new appointees.The company has also sought to gain a slice of the natural gas market that Gazprom has long dominated. Rosneft increased its annual natural gas production from 2 bcm in 2012 to 67 bcm in 2016, and aims to produce 100 bcm by 2020. While still less than 25% of Gazprom’s production, it demonstrates Sechin’s desire to upend traditional business hegemonies and play an even greater role in Russia’s hydrocarbons sector. In addition, Rosneft has offered customers more flexible natural gas pricing options to win new business, which has forced Gazprom to do the same to preserve market share.

Rosneft’s expansive energy assets also serve as political leverage that the Kremlin can use to browbeat foreign governments. This has led many to wonder how involved the Russian government is in the company’s general strategy. Due to Putin’s close ties to Sechin and the Russian government being a 50% shareholder in Rosneft, many experts believe Putin’s government uses Rosneft as a geopolitical tool to challenge U.S. interests, most notably in Venezuela. This causes Rosneft to make foreign deals and investments that might not make sense from a purely economic perspective.

Rosneft in Venezuela

Sechin’s increasing power and influence have caused many to refer to him as Russia’s second foreign minister, as he represents the economic power behind Russia’s foreign policy. As an example, Rosneft has invested in Venezuela, a Russian ally that has a highly turbulent economy and political climate. Rosneft has been a crucial financial backer for the Venezuelan oil industry, and has lent the government approximately $10 billion over the past three years, helping it to avoid a sovereign default. In 2016, in return for Rosneft’s loans, Caracas offered a 49.9% stake in Citgo, the Venezuelan state oil company’s refining subsidiary in the U.S., as collateral. The was deal heavily criticized by the U.S. Congress as a national security threat.

Rosneft and Venezuelan Flags

Why is Moscow so interested in Venezuela? There are a few reasons. Since the early 2000s, Russia-Cuban relations have chilled, and Caracas’s oil reserves, OPEC membership, and geopolitical situation, made it a logical replacement. Close ties with Venezuela allow Russia to gain another well of oil and gas from which to draw (especially if they do not repay their debts), a greater measure of influence over OPEC, and, perhaps most importantly, strengthen Russia’s position in the Americas. Roseneft’s presence in Venezuela has given Russia access to markets it has traditionally not easily broken into. If Venezuela defaults on its loans (and hands over half of Citgo as collateral), Rosneft would have a significant influence over the US energy sector. Citgo currently owns 4% of U.S. refining capacity.

Rosneft as a global geopolitical instrument

Rosneft has used similar methods to support the regime of Bashar al-Assad in Syria, improve relations with the Iranian government, and to ally Moscow with Ankara amid heightening tensions between Turkey and the West. Russia has invested more than $4 billion in Kurdish oil fields, and Rosneft has become the primary buyer of Kurdish oil as Western oil majors reduce their investments. Rosneft has also invested heavily into other strategic geopolitical nations such as Saudi Arabia, Cuba, China, Egypt, North Korea, and Vietnam. This trend of the Russian government using oil as a political lever to counter the United States shows no sign of slowing down, and has alarmed foreign policy experts and members of Congress.

Due to Rosneft’s leading position in the Russian energy sector, its increased foreign expansion, and Sechin’s top-tier alliances within the Russian elites, many consider him to be the most powerful man in Russia after Putin. The U.S. government (along with many other NATO governments) increasingly views Rosneft as a strategic arm of the Putin administration. Rosneft’s investments in politically sensitive countries have increased since the 2014 invasion of Crimea, after which Sechin and the company were hit with sanctions, cutting off a host of investment opportunities in the West.

As a result of Western sanctions, companies such as ExxonMobil have pulled out of Russian joint venture projects. Rosneft plans to return to the project in 2019. In order to fund oil projects after being cut off from Western capital markets, Rosneft has turned to heavy borrowing from domestic bond markets. 2017 was Rosneft’s highest one-year borrowing, with the company raising $17 billion (approximately 1 trillion Russian rubles), more than it borrowed in 2015 and 2016 combined. Rosneft’s 10-year bonds have a coupon rate of approximately 8.35%. Future borrowing costs for Rosneft and other Russian companies depend on many factors, such as the price of oil and further Western sanctions. However, with the price of oil up to $75/barrel, Rosneft’s earnings have been very strong despite sanctions.

Conclusion

In sum, the delineation between Rosneft’s profit motive and the Russian government’s political motives is hard to discern, and Rosneft functions as a corporate lever that can empower Vladimir Putin’s foreign policy objectives. Due to Western sanctions on Russia, there are many developed markets in which Rosneft is unwelcome, which has forced the oil giant to deal in frontier economies that carry elevated geopolitical risks. In addition, Western sanctions (and the resulting loss of joint venture partners such as ExxonMobil) have forced Rosneft to raise capital via domestic debt markets, increasing the company’s leverage burden and making it more vulnerable to future oil price falls. All of these factors heighten Rosneft’s risk profile, as the effect of sanctions, combined with the pursuit of Russian foreign policy at the expense of purely economic motives, cause it to make investment decisions that may be suboptimal for shareholder returns.