Enron on the Moskva
Yesterday Rosneft and Transneft announced a deal with China, whereby the Russian companies would receive a $25 billion loan to build a pipeline to China. In return, Rosneft promised to deliver 15 million metric tons/year of oil to China over the next 20 years. Rosneft trumpeted the fact that the interest rate on the loan is a mere 6 percent—50 basis points over LIBOR. That looks like a great deal, given Rosneft’s and Transneft’s current financial condition, until you consider the pricing of the oil, which is much less clear.
The real pricing of the loan depends on the oil price agreed to in the contract. It is VERY interesting that this rather important detail was not disclosed.
One report puts the price at $20/bbl. I’ve done a quick back-of-the-spreadsheet calculation. Based on the current NYMEX forward curve (extrapolated beyond 2016), that represents a substantial discount. Taking the discounted price into account, the true interest rate on the loan (if the $20/bbl figure is right) is 23 percent. Even if you double the oil price to $40/bbl, the interest rate is still 14 percent. Given Rosneft credit spreads (which were 1000 bp in the fall, if I recall), something in that 14-23 percent range seems to make sense.
One thing is for sure, there is NFW Rosneft/Taftneft are borrowing at 50 bp over LIBOR for 20 years. The oil price in the structure surely favors China in a way that makes the effective interest rate far higher than LIBOR. Far higher.
So, it is quite likely that the deal is not nearly as advantageous as the Sechinists would like you to believe. Given the dire financial straits of Rosneft, and the strong Chinese bargaining position, and their reputation for hard-nosed negotiating, I would expect the Chinese to be able to extract a very nice deal.
As an aside, this type of transaction structure brings to mind some of the deals Enron did as it neared collapse. Enron engaged in some off-market swaps in which it received cash up front, in exchange for making off-market payments in the future. These were called swaps, but they were really loans in drag. The Russia-China deal seems to have the same characteristics; the loan “interest” payments understate the true interest cost, and the below market oil sales are effectively an interest expense.
Another thing to note is that this sets the stage for a huge pricing dispute down the line. I would place a pretty large bet that when oil prices rise, and especially if they rise dramatically, Rosneft will renege, claim that it entered the contract under duress, or claim force majeure, or something, to force the Chinese to renegotiate.
I would put that in the “when” column, not the “if” column. And won’t that be interesting to watch?
The reports are wrong. China will be paying market prices for all the oil they buy and Russia is required to sell.
The $25b loan is not a pre-payment or anything. It is just a loan and you have to think of it separately from the oil purchases.
Comment by d — February 21, 2009 @ 10:24 am
D–
Thanks for your comment, but . . .
Cite/link please.
The reports I have read are very slippery. They say things like (in the linked article): “The two sides estimated the value of the deal at $160 billion, based on a long-term oil price forecast.” That’s very different from saying what the actual transfer price in the transaction is.
And I can guarantee you the oil price in the deal is not at market price. Russian sovereign debt 5 year CDS trades at +750 bp. Rosneft trades wider than that. (I’m trying to get an exact number). Therefore, there is no way in hell that Rosneft and Transneft are borrowing $25 billion for 20 years at LIBOR. No effin’ way.
My guess is that the actual rate is in the 15-17 percent ballpark, given a 1000 bp spread for Rosneft.
Chinese companies give out loans for geopolitical as well as market reasons.
Comment by Da Russophile — February 22, 2009 @ 2:09 pm
But a major geopolitical motivation is to screw the Russians. No love lost there, believe me. And right now, with Rosneft/Taftneft facing some pretty challenging cash flow issues, and China having the cash, the Chinese are in an excellent bargaining position, and they know how to use it. Let me tell you, I have been indirectly involved in negotiations with the Chinese over far smaller matters, and it is my experience that they squeeze everything they can out of you.
Indeed, the fact that the low interest rate was trumpeted so loudly, even though it is evident on its face that this is not the true funding cost of the transaction, makes me all the more certain that the Chinese got the better end of the deal. They let RN/TN save face by agreeing to a low rate, and even engaged in what is probably some Kabuki theatrics, where Sechin crowed about how he was able to get the rate reduced from 7 percent.
The opacity of the oil pricing part of the deal, and all the theatrics surrounding the interest rate, strongly suggest to me that the real economics of the deal are very unfavorable to the Russian cos.
And I have a scenario of the future for you, the SWP resident futurist;-) In 10 years, say, for one reason or another Russia finds the pricing terms unacceptable, and demands a renegotiation. The Chinese refuse. Russia cuts off the oil flow. By that time, the Russian population of Siberia has fallen substantially. What does China do then? How would you complete the scenario?
1. Chinese geopolitical analyses tend to see the US and Japan, in that order, as their potential strategic enemies, and emphasize the importance of good Russian relations = a secure northern flank.
2. Disagreed, because not everybody shares your view that the oil spike was just another peak in the commodity cycle. I believe it will now enter into a steeping decline of oil production, even greater falls in oil exports, and more and more sources of oil will be getting “locked up” by far-sighted and wealthy nations. Your guess on this is no better than mine or d’s.
3. Since the Chinese do not have anywhere near a majority demographic presence in the region and because Russia has far more nuclear weapons, I would posit that they’d just have to suck it up.
Comment by Da Russophile — February 22, 2009 @ 5:55 pm