The Propaganda War Over Ukraine
There’s an intense propaganda war raging now over Ukraine. The old saying applies: "Truth is the first casualty of war." Neither side has clean hands--the Russians claim that the US/EU subverted a duly elected government, while the US is busy demonizing Putin as a blood thirsty tyrant.
Cynical as it sounds, the crisis also offers major opportunities to make money. There is little chance of war between the West and Russia. As a member of the French Parliament recently stated: “We [NATO] were not ready to risk our lives for Ukraine, while Russia clearly was.”
P. Masood, at T. Rowe Price, agrees. “The Russian market is priced for the worst-case scenario, which is war,” she says. “We don’t think Russia or Ukraine will go to war. It is in neither country’s interest. If there is any sign of resolution, and stabilization in oil prices, we could see a very quick recovery in the market.”
Ten years ago, the Kremlin jailed the founding executives of Yukos, Russia’s largest private oil company, seized its assets and auctioned them off at highly discounted price to a small State-owned patchwork energy company, Rosneft.
That little company has now become an energy behemoth. In 2013, Rosneft’s $51 billion acquisition of joint Russian-Anglo company, TNK-BP, established Rosneft as the world’s largest listed oil producer, with hydrocarbon output of some 4.6 million bpd per day, producing more oil than Iran.
As of 31 December 2013, the Company's estimated possible recoverable hydrocarbon reserves amounted to 339 billion barrels of oil equivalent (46 billion tons of oil equivalent) , almost 70% higher than at the end of 2012, while gas production doubled (13.8 bcm), revenues rose by 69%, and debt fell by $8 billion.
Now the company is in joint venture partnership with Exxon, which holds the world’s second largest reserves, and BP, its newest 20% equity shareholder.
Russian stocks are among the cheapest in the world, with the benchmark gauge trading at 5.9 times forecast earnings, compared with a ratio of 11.6 for the MSCI Emerging Markets index. At a P/E of 4, Rosneft carries a market value far below most of its global peers. With a market cap close to $50 billion, a recently increased dividend of 8.37%, earnings per share at $1.08, and a recent share price of $4.50, Rosneft could easily be the best buy on the global energy market. Our eighteen month estimated price target: $9 to $12.
Rosneft is 70% state-owned, 20% owned by BP, 10% publicly-owned, and currently trades on the London Stock Exchange (LSE). The Kremlin has stated it is interested in selling a further 20% stake in the company sometime in 2015/16.
Gauging the Risk:
As effective as sanctions have become, it is collapsing global energy prices that are causing the major damage to the Russian economy, where energy accounts for 68% of exports and half of the Federal budget. The real question for potential Russian investors is whether global energy prices will stabilize, rise, or continue to fall.
In that context, recall that energy prices have always been cyclical. High energy prices lead to demand falling while low prices lead to higher demand. And currently lower prices leading to higher demand is exactly what’s taking place now. One example:
“Over the last six months, 53% of vehicles purchased in the U.S. were for light trucks of sports utility vehicles, which …use more gas than cars….That was the highest share in a decade from 51% last June, when oil prices peaked for the year….The longer prices stay low, the more you’re going to get a response of people purchasing less fuel efficient vehicle….It won’t be just the U.S. doing it” said Jason Schenker, President of Prestige Economics. Related: Impotent Western Sanctions Fail To Disrupt Russian Energy Exports
At the same time, falling oil prices [down over 50%] are drawing bargain hunters to the oil patch…like Blackstone Group LP. The world’s largest private equity firm has finished raising its second energy-focused fund, a $4.5 billion [fund]….That tops the war chest…of Warburg Pinkus LLC which raised $4 billion for energy deals… and also exceeds funds raised recently by big energy focused firms such as EnCap Investment LP, Riverstone Holdings LLC, and NGP Energy Capital Management LLC.
Blackstone said that …oil and gas production “ is probably the biggest dollar opportunity in 2015-16. (Josh Zumbrun, WSJ, 2.23.15, p. A2).
Bargain Hunting in Russia:
As Jim O’Neill, the guru of Goldman Sachs has recently stated on Bloomberg, Russian equities present the best dollar investment of any market, with a truce agreed to in Ukraine, the ruble improving, Russian interest rates falling, and some slight recovery in oil prices.
Bargain hunters are already moving on Russia, the second-best performing market of 2015. While Russia-exposed equity ETFs saw $70 billion outflows in January, the decline reversed into a $310 billion inflow in February... So far this year, Russia’ ruble-based Micex benchmark share price index is up about 29%, on the back of oil price recovery from its low (C. DeHaemer).
Currently, the Russian equity market carries one of the lowest P/E ratio in the world, at 5+. The market currently values Gazprom (OTC: OGZPY), the super-major oil and gas company, at $98 billion. It has a trailing P/E of just 2.14 with $24 billion in cash.
“Exxon Mobil Corp. has continued to buy rights to develop Russian oil deposits despite sanctions, increasing the area from 11.4 million acres to 63.7 million acres in 2014. It’s an area larger than the UK. In the US the oil major owns the rights to develop 14.6 million acres, and until last year was the company’s biggest single asset.”
“….Exxon has increased its Russian reserves at a time when Western countries are trying to isolate Russia, which likely means Exxon expects sanctions to be short-lived,” said Timothy Ash, chief economist for emerging markets at Standard Bank Plc in London (RT, 3.5.15).
Schlumberger, the world’s largest oil service company, increased its bet on Russia by recently buying Russia’s largest oil drilling company, Eurasian Oil Drilling, for $1.78 billion, a 68% premium to the market price.
There is major risk of increased sanctions further damaging the Russian economy. But there’s a good deal of evidence that there is an increasing divide between the EU and U.S. over increasing sanctions on Russia. The U.S. has little trade with Russia and is largely immune to the effects of sanctions on Russia. In contrast, the EU is a regular trading partner with Russia and fears that Russian sanctions could spill over and threaten the weak EU economic recovery, so it’s not surprising to find the EU much less interested in imposing sanctions than the U.S.
That is clearly one of the most important reason that in recent meetings (Feb. ’15) with the parties to the Ukraine crisis, the EU was represented by France and Germany, while significantly, the U.S. and U.K. were not invited. The EU is trying hard to avoid further sanctions, while also dampening the threat of a wider war, whereas the U.S. is proposing to provide heavy weaponry, U.S. military advisors to the Kiev government, while the U.S. Congress threatens military intervention. Related: Russia Prepared To Sell Strategic Deposits, But Who's Buying?
Germany is by far Gazprom's biggest customer in the EU, paying about $15 billion a year for Russian gas. It is no wonder that Merkel is carrying a clear message from German’s business lobby: No more sanctions. German companies fear losing a growth market opportunity built over decades, while European markets remains stagnant.
German companies opposing sanctions include the following: chemical giant BASF SE (partner w/Gazprom), engineering group Siemens AG, VW (in 2013, VW sold 300,000 cars in Russia), Adidas (closing 200 stores in Russia), and Deutsche Bank.
Some US companies also object to sanctions, including Boeing (contract w/ Aeroflot), ExxonMobil, Shell, BP, Total, and Statoil forced to do the same in Siberia, and Pepsico closing plants. German reluctance towards economic sanction also shared by US allies, Japan, Egypt, and Israel. (Corporate Germany Opposes Sanctions, WSJ, 5.2.14, p.A1.).
It seems clearer by the day that the European contending adversaries in Ukraine are currently meeting, talking, and signaling that all parties concerned want to reduce political tensions before they take on a life of their own.
In September (’14), a framework agreement was signed by the warring parties for a truce in the civil war but broke down with repeated breaches by both sides. This week (2.11.15), under the urging of Germany, France, and Russia, Ukraine and the rebels signed a similar agreement that called for a cease fire in the civil war, troop withdrawals, and greater autonomy in the breakaway regions. Although there are serious questions about the truce holding, both sides are removing heavy weapons from the front lines.
The Kiev government has said it is willing to open talks with the rebels, while the Russian have announced intentions to withdraw troops from the Ukraine borders, backed Ukraine’s general election, and urged the rebels to forestall their planned referendum.
Business Risks and Prospects:
On the business risk side is Rosneft’s huge debt level that increased by $51 billion with the take-over of TDK-BP (2012), with $16 billion coming due this year (’15), towards which the company recently paid $7 billion. So far the company has regularly paid down debt, the overall amount paid since December 2013 totaled $33 billion, in full accordance with credit agreements. Fitch Ratings is confident that Rosneft … won’t have any problem paying off the massive debts. But if sanctions and falling oil prices continue, debt repayment could become serious problem.
ExxonMobil’s $500 billion joint venture with Rosneft includes the following developments:
• Exploration of the Russian Arctic shelf, with Exxon gaining the rights to explore 600,000 acres (project currently suspended due to sanctions)
• A mega-project for oil fracking in W. Siberia’s gigantic Bazhenov field the “Russian Bakken", with an estimated 75 billion barrels of technically recoverable oil (EIA)
• Exploration and development in the recently discovered giant Siberian reserves in Yamal Peninsula.
• Future joint ventures in the Black Sea. where Exxon and Rosneft will invest billions to recover an estimated 1.25 trillion cubic meters of conventional gas.
• Future joint ventures in the Sea of Okhosk, recently recognized by UN as Russian waters.
Ukrainian state-owned Chornomornaftogaz oil and gas company, located in Crimea, which stands to make billions from the Black Sea gas bonanza, will likely become part of the Exxon/Rosneft joint venture.
BP and Rosneft
BP, which for years, made the largest percentage (20%) of company profits from its much-troubled joint venture with Russian oligarchs (TNK-BP), sold out the venture to Rosneft in a $61 billion deal, with the former oligarch owners following suit. Then BP re-invested much of the proceeds from the deal into Rosneft for a 20% equity share of the company and two Board seats. It is clear that BP, more than any other international oil company, has bet much of its future on Rosneft and Russia, its largest investments next to the Gulf of Mexico. Related: Rosneft Chief Slams OPEC
BP and Exxon, both deep-pocketed partners, are leading high tech energy companies, veterans of the US fracking wars, with more than thirty years of experience in successful development of the Alaskan Arctic, while both are giants in refineries and downstream operations.
China and Rosneft
The joint venture of Rosneft and China aligns the largest public energy company with the largest energy consumer in the world.
China National Petroleum Corp. (CNPC) last year paid the first $20 billion advance of an estimated $70 billion prepayment to Rosneft, for the building of the Siberian Chinese pipeline. That payment was part of a $270 billion, 25-year oil supply agreement, which would make China Russia’s biggest market for its oil.
CNPC is to join Rosneft in exploring three offshore Arctic areas for oil, one of the first such exploration and development deals Russia has signed with an Asian company.
China may double oil imports from Rosneft to more than 620,000 barrels a day while Rosneft has also agreed to an $85 billion, 10-year deal with China Petrochemical Corp (Sinopec).
Discussions are ongoing between the Kremlin and Chinese oil companies that may be offered a possible 50% stake in Arctic oil fields.
Other Asian Prospects:
Negotiations are ongoing with India, Japan, and S.Korean national oil companies to increase their stake in Rosneft’s energy development, with many of them currently in long term partnerships with Rosneft.
The risks to Russia will likely continue for some time, but the framework agreement to end the civil war is already in place. It’s clear to most observers that the Europeans are guided much more by the Merkle/Holland approach to working with Russia rather than pursuing even more sanctions.
The US and UK continue to strongly oppose current European negotiations with Russia, but are clearly losing influence over Europe’s attempt to avoid the threat of a widening war in Ukraine. Also, the price-conscious Europeans are skeptical about the US proposal to provide LNG as an alternative to Russian gas, because U.S. LNG is significantly more expensive than gas supplied by Russian pipelines.
Although there will be a continuing threat of breaches in the truce, patient, long term investors should be well rewarded as oil prices are likely to rise from their lows, Kiev and Moscow undoubtedly need each other and any possible “cold war’ or armed conflict between the rivals inflates the value of Ukraine far beyond its geopolitical significance to the West.
By Robert Berke for Oilprice.com
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