Streetwise Professor

September 26, 2014

Sanctions Bite. Just Ask Igor Sechin . . . and Morgan Stanley

Filed under: Commodities,Economics,Energy,Politics,Russia — The Professor @ 1:05 am

Some months ago, Morgan Stanley agreed to sell its oil trading business to Rosneft. Now the deal is at risk of unraveling, due to the effect of sanctions on the Russian company:

Rosneft has enough cash to buy the Morgan Stanley unit, which sources said carries a price tag of between $300 million to $400 million. But to operate day-to-day, the business requires billions of dollars of bank lines of credit, funding that is difficult to secure given the sanctions.

Reuters could not learn the precise size of these credit lines, but trading houses that compete with Morgan Stanley such as Vitol, [VITOLV.UL] Mercuria and Trafigura [TRAFGF.UL] each have $30 billion to $40 billion worth of credit lines with dozens of banks.

“This deal just cannot go through. It is not an issue of finding $300 million to buy the business. Rosneft has the money. But it won’t be able to operate it,” one Russian-based source with direct knowledge of the matter said.

Trading is an extremely working capital intensive business. Depending on its size, a supertanker can carry oil worth $50 million-$300 million, and this has to be financed during the period of the voyage. A decent-sized trading operation can have several tankers on the water, plus additional oil in storage, all of which needs to be financed. A major trading operation needs access to billions in funding on a continuous basis.

Typically, traders finance this with bank credit, with the bigger ones using open lines with banks (which offer considerable flexibility). (I discuss commodity trade financing in my white paper, The Economics of Commodity Trading Firms-bonus video!) You cannot compete efficiently in this business without access to such credit/credit lines. Loss of access to credit is a death sentence to a trading firm, and one that can’t get access in the first place will never be born. That’s where Rosneft finds itself now.

This is another blow to Sechin’s (and Putin’s) aspirations to make Rosneft into a peer super major like BP or Shell or Total that have ┬árobust trading operations. The firm’s longer term ambitions have been seriously dented by the withdrawal of western firms from deepwater and unconventional onshore drilling projects in response to sanctions.

This is also a pain for Morgan Stanley, which is under government pressure to exit the physical trading business: it’s not clear that there’s anyone with enough appetite to pay what Rosneft agreed to. But its pain is nothing compared to Rosneft’s, which will remain dependent on traders to market its oil for the foreseeable future.

Breaks me all up.

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