Will U.S. sanctions against Rosneft work?

Correction: An earlier version of this story incorrectly said that one element of the sanctions prohibits U.S. financial institutions from purchasing new equity issued by Rosneft. The prohibition applies only to ­equity issued by two major Russian banks, Gazprombank and VEB. This version has been corrected.

The Russian state-owned oil company Rosneft, one of the main targets of the latest U.S. economic sanctions, has taken steps during the past year that have shored up its debt-
laden balance sheet and could make it easier for the company to withstand the new U.S. restrictions.

As part of a deal in June 2013 to double oil sales to China, Rosneft arranged to receive $60 billion to $70 billion of advance payments for oil sales to reduce its borrowings.

In the first quarter of this year, the Russian oil giant further trimmed its bank debt to $45 billion, according to the April earnings release, down 15 percent from the quarter before, thanks to huge cash flow from high-priced oil and natural gas production.

And just two days before the new U.S. sanctions were imposed against Russia for its continuing support of separatists in eastern Ukraine, Rosneft announced it would pay $500 million to buy the Russian and Venezuelan assets of Weatherford International, whose main operations are headquartered in Houston but which recently announced it would move its official headquarters from Switzerland to Ireland.

Rosneft, which has its own drilling unit, said in an investors’ presentation this year that more than half its drilling was still being done by four outside companies. It added that more than 60 percent of the Russian drill fleet was worn out. Weatherford’s Russian rig operations include 61 land drilling crews and a fleet of workover rigs, staffed by approximately 7,800 people.

However, even if Rosneft’s steps buy it time, the new U.S. sanctions will probably eat away at the company’s finances. The sanctions — which bar loans of more than 90 days duration to Rosneft, Novatek and two banks, including one tied to the gas monopoly Gazprom — will still hurt the Russian oil giant.

Rosneft has constant borrowing needs to pay for ambitious and costly plans to upgrade its refineries, more than double its natural gas output, explore offshore for oil in the Arctic, stabilize production in West Siberia and pay its share of costs on exploration blocks in the Gulf of Mexico.

“It means they are really out of the capital market,” said Anders Aslund, a senior fellow at the Institute of International Economics and former economic adviser to Russia and Poland. He said Rosneft and the other three major Russian companies sanctioned “need financing all the time.”

Rosneft issued a statement Friday saying that its financial position was “robust” and that operating cash flows would be able to fund current projects and service its debts.

But analysts said that could be challenging. In an April presentation to investors, Rosneft said that it had $13.3 billion of debt coming due by the end of the year and $18.4 billion due in 2015. Much of that, analysts said, would need to be rolled over and refinanced.

And while the new sanctions were not adopted by European nations, Rosneft will be unable to turn to European banks — at least if its transactions are in dollars. Just last month, BNP Paribas agreed to pay a $9 billion fine in a settlement with the Justice Department because it helped Sudan evade U.S. sanctions in dollar transactions that at some point clear through a U.S. institution.

In addition, the pre-payments for oil — including $2 billion from BP in June — are simply another way of borrowing against the future. A Citibank analyst report in May said that net debt, including the pre-payments, was down a more modest amount and still stood at $69 billion. A JPMorgan analyst report estimated net debt including pre-payments to be $72.4 billion.

Rosneft has been planning to raise money through the sale of a 19.5 percent stake now held by the government, according to various Russian news reports. The sale would still leave the government with a slight majority share in Rosneft.

“It seems to me that the United States is gradually trying to tighten the screws,” said James C. Langdon, a partner and oil industry expert at Akin Gump who divides his time among Texas, Washington and Moscow.

Rosneft issued a statement calling the sanctions “illegitimate and groundless.” It said, “Rosneft has no influence on either political or economic processes ongoing in Ukraine.”

The new financial measures come less than three months after the United States slapped restrictions on Rosneft’s chief executive, Igor Sechin, one of Russian President Vladi­mir Putin’s closest and longest-serving advisers. The Obama administration froze Sechin’s assets and barred him from traveling to the United States.

Sechin has been aggressively working to bolster Rosneft. It signed the long-term oil supply deal with China. It bought out all the bickering partners of the TNK-BP joint venture; as a result, BP (whose chief executive, Bob Dudley, is an American) owns almost a fifth of Rosneft. Rosneft also signed an Arctic exploration deal with Exxon Mobil; later the Moscow-based company acquired a 30 percent interest in 20 of Exxon Mobil’s deepwater exploration blocks in the Gulf of Mexico.

Rosneft is one of the biggest oil producers in the world. It has oil and natural gas output amounting to more than 5 million barrels a day, including 4.2 million barrels a day of oil.

As tensions mount in eastern Ukraine, and if the crash of Malaysia Airlines Flight 17 is tied to Russia, the United States and its European allies have other ways to ramp up pressure on Rosneft. Many sanctions advocates have urged the Obama administration to target Rosneft’s Gulf of Mexico interests, though the administration has steered clear of that.

Aslund, the economist, said that the Treasury Department could try to block Exxon Mobil’s Arctic exploration joint venture. Under the terms of that venture, Exxon Mobil pays for all the exploration drilling, which will cost hundreds of millions of dollars. Aslund said Treasury could decide that that is a form of long-term financing for Rosneft, which would share in revenue of any eventual production.

Exxon Mobil spokesman Alan Jeffers declined to comment, but advisers to the company said Exxon does not believe its ventures will be affected by the current sanctions.

Rosneft could also face pressure on drilling technology. Sources say that the administration has also drafted regulations that would limit technology transfers to Russia, and that could affect the use of U.S. oil and gas drilling technology, especially in harsh environments such as the Arctic or offshore Sakhalin Island, near Japan.

That would hurt a company such as Weatherford and might have spurred the sale of its Russian rigs to Rosneft. Both companies said the deal fit into their strategies. Weatherford said it was the second of several steps to divest “non-core” assets, and Rosneft said it fit with a strategy of developing “our in-house service business.”

But Weatherford might also have felt vulnerable. “What seems clear is that Weatherford is the only large Western service company with a truly material Russian footprint,” said Pavel Molchanov, an oil analyst at the investment firm of Raymond James. As of March, Weatherford had 346 rigs operating in Russia, he said, equal to 74 percent of Weatherford’s international rig count.

Finally, Rosneft could face steep payments, or asset seizures, if it loses a case before a ruling by the International Court of Arbitration in The Hague and one in the European Court of Human Rights in Strasbourg.

The case involves the Russian government’s seizure of the oil giant Yukos in 2003 and the jailing of its billionaire owner, Mikhail Khodorkovsky, who at the time was one of the most vocal critics of Putin and who was funding opposition parties. The Russian government said Yukos owed $27 billion in taxes, and Rosneft acquired most of the Yukos assets in forced auctions. Khodorkovsky spent a decade in prison.

Khodorkovsky’s former partners are seeking scores of billions of dollars in damages. If they prevail, they would seek to attach Rosneft assets in the United States and Europe.

Steven Mufson covers energy and other financial news.
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