Russia has entered its second financial crisis in seven years. This one is tougher for the Kremlin to handle than the crisis of 2008-2009, because oil prices — which account for a large part of gross domestic product and government revenues — have fallen drastically and are not rebounding. Moreover, Russia's economy slowed in 2014, when foreign direct investment fell by at least 50 percent, capital flight reached approximately $151 billion and the ruble lost 46 percent of its value.
The Kremlin's reserves are very healthy, totaling about $543.5 billion. However, as Russia learned in the 2008-2009 crisis, these funds can be depleted quickly if the Kremlin has to prop up the banking sector, keep the currency and markets fairly stable and financially assist firms it deems strategic.
This financial and economic crisis is worsening, and Russia is set to enter another recession this year. In response to these difficulties, the Kremlin announced Jan. 14 that except for the defense sector, the state budget would be cut 10 percent across the board. The Russian government has also implemented several financial assistance measures, including a $21 billion Anti-Crisis Package announced Jan. 26. Within this package, the government will recapitalize banks and subsidize chosen industrial enterprises and businesses. Given the limited amount of assistance from the government, competition is growing for such aid. In addition, each firm affected by the budget cut is looking for alternative sources of funding.
The largest and most strategic firms in Russia are natural gas giant Gazprom and oil giant Rosneft. Although the Kremlin considers them Russia's most treasured companies, they have not yet been made a high priority for state funding. Other energy firms that have been struggling, such as Novatek, have already received bailouts. This apparent snub of Russia's two crucial energy firms is due to several factors, including the firms' short-term ability to find funds elsewhere and political standoffs within the Kremlin regarding Gazprom and Rosneft.
Gazprom's Position
Gazprom announced Jan. 27 that it would cut its capital expenditures for 2015 by nearly 20 percent to $30 billion. In 2014, Gazprom abandoned one of its more ambitious projects, the South Stream pipeline; though the company said political pressure from Europe led it to abandon the project, the heavy costs involved certainly were a factor. Gazprom will bear a heavy financial burden in the coming years, with many large-scale projects planned or underway.
When it announced its capital expenditure cuts, Gazprom was sure to emphasize that its projects involving Asia, particularly the Power of Siberia pipeline to China, would not be cut. Instead, as Stratfor sources reported, Gazprom will postpone new projects to supply Europe, such as the Baltic liquefied natural gas project, and production at various Yamal fields and the Yamal liquefied natural gas project. This confirms that Russia is looking for alternative natural gas customer bases as tension lingers between Russia and Europe and as Europe continues its attempts to diversify away from Russian energy supplies.
Just as Gazprom is focusing on sending natural gas supplies eastward, so too is it looking to the east to secure alternative funding. The natural gas firm's ability to raise funds in traditional Western markets is limited. Gazprom is not under Western sanctions, although its banking branch, GazpromBank, is. Nevertheless, Western sentiment toward Gazprom remains poor. Typically, Gazprom has held its "investor days" in London and New York to drum up investor interest. However, Gazprom held a weeklong series of events in Hong Kong and Singapore the week of Feb. 1. The firm was listed on the Singapore exchange in June 2014 and said in January that it could also list on the Hong Kong exchange. Moreover, China's top credit rating agency, Dagong, assigned Gazprom its highest rating — AAA — on Feb. 1, in stark contrast to the negative watches from Western agencies Fitch, Standard & Poor's and Moody's.
Gazprom and China National Petroleum Corp. signed a landmark $400 billion natural gas deal in June 2014, under which the Russian firm will supply 38 billion cubic meters (bcm) of natural gas to China per year starting in 2019. Gazprom expanded this deal in November, adding another 30 bcm annually. Gazprom and China National Petroleum Corp. have tentatively agreed to a $24.5 billion pre-payment and $25 billion loan to contribute to the construction of the Power of Siberia pipeline and the necessary fields. However, it is not clear when those funds will reach Gazprom's accounts during the current financial crisis.
Gazprom Shores Up Its Political Support
While it seeks outside funding, Gazprom has been buttressing its political position within the Kremlin's top echelons. On Feb. 5, when nominations for Gazprom's board of directors took place, Energy Minister Alexander Novak joined the list of usual faces. Novak has long been considered part of Prime Minister Dmitri Medvedev's circle. Medvedev is one of Gazprom's political champions, having once served as chairman of its board. The large energy firm is one of the few power bases Medvedev has maintained during his turbulent political career as prime minister, then president, then prime minister again.
Gazprom is trying to fortify itself in the Kremlin as several important issues affecting the company reach a climax. The first is Gazprom's quest for funding for its large projects. Though it is looking for funds outside the Kremlin's coffers, the natural gas firm could turn to Moscow for financial assistance as the recession in Russia worsens. In addition, the Kremlin is considering several proposals meant to affect Gazprom's position as an exporter. The Russian government already has ended Gazprom's monopoly over all natural gas exports, allowing competing firms to export liquefied natural gas. Now, these competitors, particularly Rosneft and Novatek, are urging the Kremlin to end Gazprom's monopoly over piped natural gas exports. Rosneft has hinted that it could accept Gazprom's continued hold over piped natural gas exports to Europe if Rosneft can have access to piped natural gas to Asia. Medvedev and Novak have opposed this, but many within the Kremlin remain divided over the future of Gazprom-controlled exports.
Rosneft's Position
Among Russian firms, Rosneft is in one of the toughest positions — if not the toughest position — amid lower oil prices and sanctions from the West. Energy revenues make up 25 percent of Russia's gross domestic product, and oil revenues — mostly from Rosneft — make up 85 percent of Russia's energy revenues. More than half the government budget comes from energy revenues, with Rosneft again as a major contributor. Years of high oil prices made Rosneft the Russian government's cash cow; any oil revenues above $93 per barrel were deposited directly in the state's various funds. However, when oil prices fell by half in the latter part of 2014, Rosneft's revenues declined sharply, as did its ability to contribute to the state.
Rosneft announced Feb. 4 that, like Gazprom, it would cut its spending for 2015 by 10 percent. The company also said it would peg its budget on $50 per barrel oil. However, Rosneft has a heavy debt burden. The firm owes approximately $40 billion to be repaid over the next two years, with nearly half of that amount due in 2015. Under Western sanctions, Rosneft's access to financing among EU and U.S. institutions — its traditional partners — is limited.
Rosneft has asked the Kremlin repeatedly for a $40 billion bailout. However, the Kremlin has made it clear that it has too many other priorities to simply hand over the funds. Moreover, Putin has been careful to weigh his close relationship with Rosneft chief Igor Sechin to avoid alienating other members of the elite and to avoid appearing to play favorites.
The strongest opposition to a Rosneft bailout comes from officials in Russia's financial circles — Finance Minister Anton Siluanov, former Finance Minister Alexei Kudrin and Deputy Finance Minister Arkady Dvorkovich — and many connected to Rosneft's rival, Gazprom, including Medvedev and Novak. Kudrin has slammed the prospect of a bailout, saying that it would only entrench Putin's cronyism and harm legitimate business practices in Russia. Siluanov and Dvorkovich have suggested that Rosneft privatize a 19.7 percent stake in the firm to raise funds to cover its debts.
Rosneft's prospects for financial aid were unclear for months, but Putin put the rumors to bed Feb. 4, when he flatly denied that Rosneft would receive funds under the current circumstances. Putin publicly scolded Rosneft's chief, saying that although the company's interests are important, so are the interests of the entire Russian economy. When Sechin asked instead for revisions to the heavy tax burdens on Rosneft and other oil producers, Putin reproached him, asking, "Where is the real Sechin? Before or after (becoming head of Rosneft)?"
The public display of tension between Putin and Sechin came during three days of meetings, during which Putin publicly berated many government members. Speculation has arisen that Putin was attempting to show the Russian public and other members of the elite that he can maintain a hard stance against those deemed closest to him. However, despite the display of anger targeting Sechin, the Russian government has aided many of Rosneft's controversial moves to raise funds to help with its debts. Moreover, on Feb. 9 Rosneft was put on a list of 199 companies eligible for aid, alongside Gazprom.
In recent months, Rosneft has used new and old tactics to raise funds before a string of debt payments are due. Many of these attempts would require approval from the top. Thus, although Putin has rebuked Sechin publicly, he could still be supporting Rosneft behind the scenes.
Rosneft's Bond Scheme
In December 2014, market traders and analysts, politicians and news media accused Rosneft of playing a part in the ruble collapse. The details are sketchy, but it seems that on Dec. 12 Rosneft issued approximately 625 billion rubles in new bonds worth approximately $10.9 billion at the time. The bonds carried a rate lower than similar government bonds. Several Russian state banks bought the bonds and then deposited them into the Central Bank. That same day, the Central Bank announced a 625 billion ruble liquidity auction — the same amount of the Rosneft bonds deposited in the Central Bank. Also that day, the Central Bank added Rosneft securities to a list of bonds that could serve as collateral for Central Bank loans. No bond buyers were ever disclosed, so it is unclear how Rosneft actually raised the money.
These events contributed to the start of the ruble crash that led to a precipitous fall on Dec. 15 after the Central Bank announced its largest interest hike since the 1998 crisis. If Rosneft had not raised the $10.9 billion before the currency crash and rate hike, the company would likely not been able to pay its $7 billion loan payment on Dec. 21.
When accusations began to mount that the Central Bank and Rosneft colluded to help the oil firm at the currency's risk, Sechin denied the accusations. Six weeks after the bond issuance, deposit and auction, Russian Central Bank chief Elvira Nabiullina finally spoke on the matter, condemning Rosneft's moves but taking no responsibility for the Central Bank's actions. Rosneft's and the Central Bank's actions likely would have been possible without approval from Putin, especially since the events contributed to the ensuing currency volatility.
The Practice of 'Hedge Accounting'
Rosneft is also criticized for its new accounting practices, though the details of the changes are unclear. On Feb. 3, Rosneft announced it was adopting a new practice called "hedge accounting," which will record the impact of currency fluctuations in real time instead of on a quarterly basis. The hedge accounting practice will also reorganize any gains or losses derived from the ruble's volatility as part of its comprehensive income, so the currency fluctuations will not affect the profit or loss of the company. Rosneft is retroactively adopting its new practices as of October 2014 in order to account for the currency volatility in December. British energy major BP, which holds a 19.75 percent stake in Rosneft, is comfortable with the change. On Feb. 3, BP announced a series of capital investment cuts for 2015. Due to BP's stake in Rosneft, many analysts expected the British firm to report a loss for the fourth quarter of 2014. However, with the new accounting practice in place, Rosneft added $470 million to BP's profits in recent days.
Searching for Alternative Funding
Rosneft says it has the revenues to cover its debt payment of $7 billion on Feb. 13. As of January, Rosneft reportedly held $10 billion in cash and short-term investments. However, the firm is looking at two potential sources to raise more funds.
First, Rosneft reportedly has negotiated with Swiss oil trader Trafigura to expand a 2013 deal under which Rosneft sells the trader 150,000-200,000 metric tons (1.1-1.58 million barrels) per month – a deal that was considered extraordinarily large at the time. In recent days, multiple reports have surfaced among energy analysts indicating that Rosneft had expanded this deal for February to 500,000 metric tons. It is unclear how much financing this deal would raise, though if it is structured like the previous deal, Rosneft would gain much of the money through pre-payment.
Second, Sechin held several meetings in the past three months with representatives from China's large energy firms. In 2013, Rosneft and China National Petroleum Corp. signed a $270 billion, 25-year supply agreement. Also in 2013, Rosneft and China Petrochemical Corp. signed an $85 billion, 10-year oil supply agreement. Under these two agreements, Rosneft is scheduled to receive $63 billion in advance payments between 2014 and 2018. It is possible Sechin is attempting to time these pre-payments to ease the financial pressure on Rosneft, as the funds would be more than enough to cover the firm's current debts.
Rosneft has one other alternative for funding, though it would further sour investor sentiment in Russia. Ever since the Russian government nationalized medium-sized oil firm Bashneft at the end of 2014, many other energy firms have voiced concerns that the Kremlin could begin another series of energy consolidations such as those seen between 2003 and 2007. The seizure of Bashneft from Russian oligarch Vladimir Yevtushenkov's Sistema holding company was the first major seizure by the Russian government in years. Many in Yevtushenkov's circles said Sechin, who has long coveted Bashneft, was behind the nationalization. However, since nationalization, the oil firm has remained under the Russian government's control, not Rosneft's.
At the end of January, Russian media repeatedly questioned the office of Arkady Dvorkovich, the deputy prime minister, about whether Rosneft was interested in nationalizing and taking over Surgutneftgas, another medium-sized Russian oil firm. Dvorkovich's office, which traditionally takes advantage of any opportunity to cast an unflattering light on Rosneft, declined to comment. It could be that Rosneft switched its focus from Bashneft to Surgutneftgas due to the firm's recent report indicating that Surgutneftegas holds $36 billion in cash.
However, if the Russian government again shows it is willing to nationalize firms instead of purchasing them, it could further alienate investors. As sanctions continue, the Kremlin could grow less concerned about investor opinion in the short term, favoring instead the health of its strategic firms such as Rosneft, but the Kremlin's decision could depend on the larger negotiations taking place between Russia and the West.
