Can This Russian Energy Firm Become an International Oil Major?

From The Motley Fool

By Sarfaraz A. Khan
Research Assistant: G Yousuf

The Russian energy behemoth and the world’s biggest listed oil company in terms of production and reserves, Rosneft, aims to compete with the big boys of the energy industry, such as ExxonMobil and Chevron . Within two years, it wants to increase its market cap by more than 60% to nearly $120 billion, which would make it almost as big as the European oil major BP.

Besides oil, Rosneft also wants to become a leading independent gas producer and has recently made a big acquisition in this regard. Russia is the key non-OPEC energy producer, which is also home to Gazprom (ADR) (NASDAQOTH: OGZPY.PK), the company which holds the world’s biggest natural-gas reserves. With Rosneft's natural-gas ambitions, the competition between the two firms would increase. While the latter struggles with output, the former is increasing its international presence. 

Both Rosneft and Gazprom have significant representation in the $1.1 billion Market Vector Russia ETF Trust (NYSEMKT: RSX) and the smaller $200 million iShares MSCI Russia Capped Index Fund (NYSEMKT: ERUS).

Rosneft nets a massive Chinese contract

Rosneft has been increasing its focus toward Asia, particularly the energy-starved nation of China, as the European market has been facing financial crisis, which translated into a fall in oil and gas deliveries. Rosneft exports 4.4 million barrels of oil per day (boepd); nearly 17% of these exports go to Asia.

Now, it has entered into a massive $270 billion deal with China whereby it will double its oil supplies to the world’s top energy consumer. Globally, this deal is, without doubt, one of the biggest ever in the history of the oil industry.

Rosneft’s CEO and one of the most influential individuals in corporate Russia, Igor Sechin, has said that his company, which currently exports 300,000 boepd to China, would supply an additional 300,000 boepd for a period of 25 years after 2015. Later President, Vladimir Putin announced that total supplies to China could touch 900,000 boepd.

What this means is that in the long run, Russia will increase its annual crude exports to China from the current 15 million tons to 365 million tons in a span of 25 years, and Rosneft is going to play a central role in this transaction.

Debt levels and the string of deals

Investors have shied away from Rosneft due to some of its major obligations that are due within the next three years. S&P has revealed that Rosneft has to manage some significant debt maturities by 2015. Nearly $6.6 billion is due this year, $15.9 billion next year and $16.2 billion in 2015. A large part of this debt was taken to fund the $55 billion acquisition of TNK-BP earlier this year.

However, it has recently received a cash boost from the Chinese contract, which included an upfront prepayment of ~$65 billion. The company is also making other financing arrangements. It has entered into an agreement with the Swiss-trading house Trafigura for borrowing $1.5 billion against 1.5 million tons of oil equivalents to be supplied over the next five years. A similar deal has been reached with Glencore International and energy trader Vitol for a $10 billion prepayment. Besides these, Rosneft has also entered into an agreement with Poland's largest refiner, PKN Orlen, to supply 8 million tons of crude for $7 billion.

Rosneft has also secured a $2 billion long-term loan facility from China Development Bank.

Therefore, I believe that Rosneft is prepared to meet any debt issues and can continue with its inorganic growth streak. The new agreements and the long-term loan facility will ensure that Rosneft’s balance sheet remains strong.

Gazprom vs. Rosneft:  Increasing natural-gas rivalry

Earlier this week, Rosneft announced the acquisition of the remaining 49% shares of Itera Oil and Gas for $2.9 billion. Itera is the second-biggest acquisition ever by Rosneft as the company moves closer to becoming Russia’s largest independent gas producer with output of 100 billion cubic meters (bcm) and capturing one-fifth of the domestic gas market by 2020.

The acquisition would be Rosneft’s big move into Gazprom’s category. Meanwhile, Rosneft and Russia’s second-largest gas producer Novatek are lobbying for LNG export rights against Gazprom, which currently holds a monopoly over exports. Both Rosneft and Novatek are planning to build LNG facilities in Asia and Siberia respectively.

Meanwhile, the changes in supply patterns coming from the U.S. shale-gas boom coupled with the sluggish economy of Europe and increasing competition from Statoil for the European gas market will make things extremely difficult for Gazprom as it moves forward amid waning market share and falling production. With growing domestic and international competition, coupled with the management’s failure to really launch Gazprom as a major natural-gas player in the international markets, I believe that the company is essentially a cash cow with diminishing growth prospects.

Rosneft is going in the right direction by partnering with some of the leading foreign players and oil majors from ExxonMobil to Japan’s Inpex. However, Rosneft has a long way to go before posing a real threat to Gazprom’s market share. Last year Rosneft produced 13 bcm of gas while Gazprom's output stood at 479 bcm. In 2012, Gazprom enjoyed 73.1% of the domesticnatural-gas market share. 

Conclusion

Due to Rosneft’s increasing foothold in Asia, including China, I am very optimistic about the future of Rosneft. The company is expanding rapidly around the world through a series of recent deals mentioned earlier. It is going to reduce its debt load and increase its revenue significantly.

Moreover, both Rosneft and Gazprom are the only firms allowed to extract oil and gas from the Russian Arctic shelf, which means that whenever crude is extracted from Russia’s Arctic, it is going to be supplied by Rosneft. Barring any political interference and management blunder -- that happened at Gazprom which prevented its rise -- I believe that the company has the potential to become the next European oil major; therefore I am long-term bullish on Rosneft.

In June, Rosneft’s production helped Russia to report post-Soviet record levels of output of 10.5 million barrels per day, showing a sequential increase of 0.5%; surpassing even Saudi Arabia, which produced 9.5 million barrels in the same period. Besides oil, Russia also produces 2 billion cubic feet of natural gas daily.

With the rise of Rosneft and increasing competition over natural gas, I believe that in the coming years, Russia is going to produce more oil and gas than ever before. For these reasons, I am long-term bullish on the two Russian-energy focused ETFs as well; the Market Vector Russia ETF and iShares MSCI Russia Capped ETF.

However, I prefer the bigger Market Vectors Russia ETF because it is not heavily focused toward Gazprom and allocates a greater percentage of funds to Rosneft as compared to the iShares MSCI Russia Capped ETF.

	ERUS	RSX
	Weightage	Weightage
Gazprom	16.34%	7.47%
Rosneft	4.88%	5.47%

When Gazprom performs poorly, then iShares MSCI Russia Capped ETF could also under-perform since it has significant exposure toward Gazprom. While Gazprom is also one of the biggest holdings in Market Vectors Russia ETF, the fund allocates just 7.5% toward this holding. 

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours of this publication. I wrote this article myself, and it expresses my own personal opinion. I have no business relationship with any company whose stock is mentioned in this article.