Russia Looks To Privatize Oil Assets, But Who Will Buy Them?

Success in Putin’s Russia isn’t a matter of persistence, cunning, or luck; sure, that’s necessary to an extent, but high-level success in today’s system of soft legal constraints is much more calculated, surreptitious, and ultimately out of your hands. It’s a system that Putin has used to great effect to corral the nation’s resources and establish a firm hand. In truth, the ruling apparatus is far more delicate and less weighted than it would appear – and it’s currently facing a challenge, economic and social, unlike any it has seen before.

The Russian economy contracted 3.7 percent in 2015, with industrial production and real wages notching significant drops. Inflation and poverty rates are climbing and the ruble’s volatile and downward trek continues – it’s down more than 6 percent to start the year. Optimism among the Russian population is now plainly on the decline. Related: Oil Production Rumor Mill Continues To Turn As Iran Hints At Freeze

Looking forward, GDP is expected to shrink between 0.5 and 1 percent in 2016 and the budget deficit could climb as high as 6 percent of GDP if oil continues to hover around $30 per barrel. With the Reserve Fund dwindling, budgetary measures totaling $20 billion are necessary to balance state finances this year and in the medium-term. Upstream oil investment is limited by a new tax regime, and production may drop up to 3 percent. What’s more, the specter of Yukos and its chairman Mikhail Khodorkovsky still lingers.

Khodorkovsky was taken down in spectacular fashion following a politically motivated – though not necessarily unfounded – trial on tax fraud in 2003. His company, Yukos – then one of Russia’s largest producers of crude oil – was bankrupted with the majority of its assets snatched up by state-owned Rosneft at auction. The political and economic ripple effect cannot be understated, and a period of increased capital flight and reduced investor confidence stilted what was an otherwise normalizing economy.

Khodorkovsky was unexpectedly pardoned in 2013, a political move that Putin probably wants to take a mulligan on. The former oligarch has not shunned the spotlight and has remained politically active from his bases abroad. His civil society initiative, Open Russia, aims to reform the nation’s democratic and justice systems, and the group will be supporting several candidates in the upcoming parliamentary elections. Russian officials are now pursuing criminal charges against Khodorkovsky in connection with a pair of late-90s contract killings. Related: Historic OPEC-Russia Agreement Will Have Minimal Impact

Further, Russia is still not off the hook for a $50 billion judgment awarded to Yukos’ former shareholders for the wrongful expropriation of their assets. A ruling on Russia’s appeal to The Hague Arbitral Tribunal is not expected until April, at the earliest.

With the stage framed, let’s return to Russia’s economic woes. In an effort to finance the federal budget deficit, Russia is proceeding with a suite of privatization plans aimed at raising roughly $13.5 billion. However, earlier privatization plans have fallen flat, and expectations for the latest round remain muted.

Up for grabs, are stakes in two of Russia’s premier oil companies, Rosneft and Bashneft, as well as diamond super-major Alrosa. Notably, Bashneft was expropriated from billionaire Vladimir Yevtushenko in 2014 via a regime of suspended punishment similar to that of the Yukos case. Related: Why OPEC Production Freeze Could Pave The Way For Actual Cuts

Terms are still being discussed, but privatization plans for Rosneft include the sale of a 19.5 percent stake, bringing state ownership to 50 percent plus one share. A 19.5 percent stake is worth $7.2 billion at today’s capitalization. Minority stakeholder BP opposes the sale, and company head Igor Sechin would prefer to wait until oil reaches $100 per barrel.

The plans for Bashneft – Russia’s sixth most productive oil company in 2015 – remain undecided. Russia’s largest private oil firm LUKoil is interested in buying a controlling stake – and only a controlling stake – but the government is hesitant to give up its majority share. Selling a 25 percent plus one share through the stock exchange is a less than ideal alternative, however.

To be sure, the assets have a relatively high upside regardless of whatever terms are set. Russia needs the cash, and, for the politically connected, a favor now could pay off handsomely in time. Still, let the buyer beware.

By Colin Chilcoat of Oilprice.com

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