How and Why Rosneft bought Essar Oil

essar oil

The acquisition of the Indian oil refining company Essar Oil by Rosneft and partners will be the largest ever foreign direct investment in India. The $13 billion dollar deal is also Russia’s largest investment abroad.

The prized asset that Rosneft consortium gets out of the deal is the Vadinar refinery in the western region of Gujarat that can process 400,000 barrels of crude oil per day. Control over the second largest refinery in India will give the world’s largest listed oil producer a solid foothold in the fast-growing Indian market, as well as an outlet to energy-hungry South Asia. Other assets that are part of the deal include 2,700 petrol stations, a deep-water port at Vadinar, and power plant that provides electricity for the Vadinar refinery.

The Vadinar refinery was initially planned to open in 1996, but a variety of delays pushed back the open until 2008. The plant itself is modern and has the capacity to refine heavy and extra heavy crude oils. About 40-50% of finished products will be diesel fuels, 15% gasoline, and another 9-10% petroleum coke, a coal-like and carbon-intensive energy source.

The oil flowing into the plant mostly comes from abroad (The Middle East and Latin America), and only about 15-20% is domestically sourced from India. Under the new deal, Rosneft will supply 200,000 barrels of oil per day, or about half of the raw material, over a 10-year period. Rosneft will supply the refinery with pre-paid oil from Venezuela: in August, the Russian oil company lent Venezuelan state oil company PDVSA $6 billion, and the indebted company will pay it back with oil.

Crippling debt is also what led to Essar Oil to seek a buyer. Last year, the company was struggling to pay interest loans on time. In 2016, Essar Oil paid off $600 million in interest, which was about half of the company’s EBITDA (profit before depreciation, interest, taxes, and amortization). No dividends were paid out in the last fiscal year.

Transaction Details

Rosneft itself acquired 49% of the Indian company, and another 49% was acquired by a consortium which includes oil trader Trafigura Group and United Capital Partners (UCP).

There is an observation that the consortium companies play a purely ceremonial role, and were included to avoid international sanctions or interference by the US. Had Rosneft bought all the shares outright, then Essar Oil would become a subsidiary company and would be sanctioned.

According to a report by The Indian Express, Amsterdam-based Trafigura financed its share of the purchase with a loan from Russian state bank VTB. There is an alleged agreement in which Trafigura will transfer its stake to Rosneft in the future. The Moscow-based United Capital Partners has long been suspected of having special ties with Rosneft management. Head of United Capital Partners Ilya Shcherbovich considered it necessary to public refute these rumors.

The total transition amount was officially stated as $12.9 billion, of which $10.9 billion was for the Vadinar refinery asset itself, and another $2 billion for the remaining assets. Rosneft only paid $3.5 billion in cash, and the consortium paid the same amount. VTB will issue Essar a $3.9 billion loan in order to restructure its debt. In total, $10.9 billion was paid to Essar Oil.

Investment in Essar Oil (billions of USD)

Rosneft 3.5
Trafigura and UCP (via VTB loans) 3.5
VTB loan to Essar Oil 3.9
Total 10.9

Essar Oil shareholders received a total of $7 billion. According to the agreement, these shareholders will have to transfer about half of this sum back to Essar Oil to pay back the company’s outstanding accounts payable, including a $2.5 billion debt for Iranian oil deliveries.

Another $2 billion will be spent on the acquisition of the Essar Oil Vadinar oil terminal, an asset which was not previously owned by the company. The new buyers will receive the asset shares once the debts of the terminal (which are on Essar Oil’s balance sheet) are offset.

According to Indian analysts, the $10.9 valuation estimate was based on a 12.5 multiple of EBITDA. This estimate doesn’t look at the market capitalization of the company because the share value of a highly indebted company would be massively undervalued. Instead, the method gives a value to the enterprise as a whole without taking into account the debt load.

For Rosneft and the consortium of buyers, this means that the total return on invested capital was a ratio of 1:12.5, or 8%, and this is before depreciation and taxes. This estimate is approximately twice as large compared to other similar companies to Essar Oil. For example, India’s biggest oil refining company Reliance was estimated to have an EBITDA multiple of 7 at the time of sale.

Perhaps this is because there is potential to expand the capacity of the expensive equipment? Unlikely, as at the time of sale, the refinery was (and still is) operating at about 100% capacity. According to data from Essar Oil, only $5.3 billion in the capital was spent on construction. So, for the amount that Rosneft and its partners paid, it would have been possible to build two such refineries from scratch?

The price tag is linked to currency volatility. Before Rosneft agreed to buy Essar Oil, it was a condition that the company delist from the Indian stock exchange at the end of 2015. Before that, in June 2015, the company stock was worth about 100 Indian rupees per share. In mid-June 2015, after the announcement of a deal with Rosneft, the stock price jumped to 146 rupees per share. By December 2015, Essar Oil was forced to offer minor shareholders a buyout price of 262.8 rupees per share. The Indian government stipulated that Essar Oil had to offer minority shareholders the same share buyout prices it was planning to sell to Rosneft. The all ubiquitous VTB happened to provide money to Essar to buy out minority shareholders. Therefore, Rosneft paid about 2.6 times more than market value before the acquisition was announced. How much is this in monetary terms?

The market capitalization of Essar Oil (the cost of shares, ie the company’s value minus debts) in June 2015 prior to the announcement of the Rosneft deal was about 140 billion rupees, or about $2.2 billion. And Rosneft paid $7 billion for company shares. That leaves a $4.8 billion gap in transaction price and market capitalization.

Even if Rosneft was willing to overpay for access and control, certainly the company cannot justify such a massive discrepancy in value. Some news outlets reported that Saudi and Iranian oil companies initially showed interest in purchasing Essar Oil. This is doubtful – neither Saudi Aramco nor NIOC have ever made major investments abroad, nor do they have the cash.

Let us not forget that this deal carries significant political weight. It was signed at a meeting between Russian President Putin and Indian Prime Minister Modi at the BRICS summit.

Leading up to the Deal

One would think that before completing an acquisition, it would be worthwhile to carefully study what you are getting into. However, Essar Oil released its latest report for the 2016/2017 year on August 19, 2017, that is, almost the same day that the deal with Rosneft was finally sealed.

Apparently, the Russians were in a hurry and did not want to examine the company’s financial position in detail. It is possible Rosneft conducted its due diligence in conjunction with the audit before the company closed its books, although this would be a highly unusual practice.

Before completing the acquisition, one would think it would be worthwhile to study in detail what exactly you are getting. But, apparently, the Russians were in a hurry and did not want to examine in detail the financial position of the company before finally acquiring it. Perhaps, however, that they conducted due diligence simultaneously with the audit, before the closure of the company’s books – although this would be rather unusual. Another oddity is that the final report was produced according to Indian Accounting Standards, unlike previous years, when reports were done according to International Financial Reporting Standards. This is in no way illegal, but it is rather unusual and suspicious conduct right before a sale.

Essar Oil took made another extremely unorthodox move during this period and switched external auditors from Deloitte to an unknown Indian auditor to certify the financial statements. The last audit carried out by Deloitte was published with “qualification”, which doesn’t fully confirm the reliability of the company’s financial statement.

In the two years between the announcement of the sale and the final acquisition, Essar Oil showed significant improvement in its financial performance. For the 2014-2015 fiscal year, EBITDA totaled $900 million, and the next year it reached $1.1 billion, and in 2016-2017, it was already $1.7 billion. In two years’ time, the company’s profitability doubled, yet there were no significant developments in capacity or utilization.

Ahead of a sale, companies engage in “window dressing”, improving the appearance of a company before putting the enterprise up for sale. An example of such a number trick is an increase of activity in an affiliated company, Essar Energy Overseas Limited, which in 2016 shipped about $2.5 billion worth of products. Deloitte declined to recognize the debts as high-quality. We don’t know for sure if Essar Oil engaged in such methods, but if they did and it slipped under Rosneft’s radar, that’s another issue.

Who Exactly is the Seller?

Essar Oil is part of the Essar Group conglomerate, which is owned by the famous Ruia family in India. Originally from rural western India, the family began their business in construction and built a large business empire over the past few decades. In addition to oil, the family has interests in telecoms, banking, and metals.

In 1999, Essar Steel became the first company in the history of India to default on its international debt. More recently, the telecoms arm of the conglomerate has come under legal scrutiny over charges of fraud and bribery to government members to secure 2G services. The slump in commodities caused significant problems in their metals enterprises, and Essar Group debts reached 1.4 trillion rupees, or about $22 billion. Selling Essar Oil was the only way for the Ruia family to manage this heavy debt burden.

The deal was a relief for both the Ruia family and many of Essar Oil’s creditors. Standard Chartered Bank, according to estimates, was able to recover $2.5 of the $5.5 billion that it provided to Essar Group.

How the Purchase Affects Rosneft’s Balance Sheet

Rosneft officially only bought 49% of the shares, which means that Indian company’s activities will not be added to its balance sheet. This means that Essar Oil’s debt will not be added to Rosneft’s already heavy corporate debt situation.

At the end of the second quarter, Rosneft’s had a lot of cash on hand, $12.4 billion to be exact. This cash flow is pre-payments from the Chinese for oil supplies, in a deal struck several years ago.

Rosneft paid $3.5 billion in cash for its stake in Essar Oil. Given its cash reserves, this is of course more than feasible, but the indicators of net debt (debt minus cash) will increase by the same amount.

What’s next?

India is a very promising market with an ever-growing population and increasing purchasing power among the middle class. India is the third biggest oil buyer worldwide, after the US and China, and produces oil that covers 20% of its total oil demand.

Perhaps Rosneft made the right decision to invest in India and secure a foothold in the market, which will become one of the most significant in the world. At the same time, working in India presents its own set of challenge. Indians are tough business partners, and it is extremely important to understand local conditions and markets, especially in downstream products. The dynamic and sales-oriented approach is much more unique than developing upstream fields abroad.

How does the acquisition of an Indian oil refinery fit into the development Rosneft’s strategy? Is this a purely financial investment aimed at dividends, or should this new acquisition help the Russian company achieve some strategic goals?

Many believe the transaction was not of commercial interest but was a geopolitical move to build strong economic ties with India. In 2016, Rosneft offered India’s state Oil and Natural Gas Corporation will increase its stake in Rosneft’s Vankor project to 26 percent, and a group of Indian companies (Oil India, Bharat Petroresources, and Indian Oil) to increase their stake in the Siberian field Vankor to 49.9% for about $3.1 billion. However, it is rather useless to link these transactions: besides the fact they both contain the word “Indian”, they have nothing in common.

Another motivation for the deal could be Rosneft’s scheme to move 200,000 barrels of Venezuelan oil to India per day. Of course one of the main risks is that everything in Venezuela is hanging by a thread – if the Madura government falls, Rosneft could lose its source of oil for the refinery. Between the purchase of the refinery and the prepayments to Venezuela, Rosneft has spent about $17 billion. That is a very expensive risk.

In any case, it’s hard not to agree that the purchase of Essar Oil was truly a landmark deal. But only time will tell if this acquisition turns out to be profitable.

Louise Dickson

Russia Begins Deepwater Drilling in Vietnam

Photo from Rosneft press release

Rosneft has started exploration drilling off the south coast of Vietnam, the company’s press service announced today.

The release highlights that it is the company’s first time drilling an international well as a sole operator. The Russian company, which has previously only operated deepwater offshore drilling inside of Russia, is hoping the project will give the company experience to tackle complicated domestic shelf projects that rely on American technology. Cooperation with Russian companies in offshore, Arctic, and shale drilling are banned by Western sanctions.

“I am sure that the experience gained in Vietnam will be used by the company not only in its activity in the southern seas; these acquired skills will find application in planning and implementation of upstream projects in remote areas,” Rosneft CEO Igor Sechin said in the statement.

The expected recoverable reserves of natural gas are estimated at 12.6 billion cubic meters (bcm) with 0.6 million tons of gas condensate, according to the statement. At 162 meters sea depth and design depth of about 1380, the “deepwater” well wouldn’t be allowed inside of Russia under the current sanction regime.

The well is located in the Nam Con Son Basin, 370 kilometers off the southern Vietnamese coast and will be serviced by the USAt 162 meters sea depth and design depth of about 1380, the well located at Block 06.1, will be managed by US oilfield services provider Schlumberger.

At 162 meters sea depth and design depth of about 1380 meters, the well located at Block 06.1 will be managed by US oilfield services provider Schlumberger.

Rosneft – the world’s biggest producer at 5.1 million barrels of oil equivalent per day – gained access to Vietnam’s offshore blocks when the Russian company acquired TNK-BP in March 2013. Rosneft already jointly produces gas from two offshore blocks, also in the Nam Con Son Basin. Rosneft works in cooperation with state-owned PetroVietnam and India’s ONGC in Block 06.1 and is the project operator in Block 05.3/11.

The gas fields in Block 06.1 Lai Tay and Lan Do, had an initial estimated 68 trillion cubic meters in gas reserves and condensate deposits. Drilling is carried out along with Japan Drilling Company (JDC).

Rosneft is the biggest gas producer in Vietnam, and in 2015, the gas produced in Block 06.1 satisfied 12% of Vietnam’s energy demand, and since it started pumping gas in June 2015, has produced a total of 46 billion cubic meters.

The foray into Vietnam should surprise no one, as Russia has long been building energy ties in Vietnam. As a token of partnership, Rosneft rival Gazprom Neft offered Petrovietnam partnership in an Arctic project. Beyond hydrocarbons, Vietnam has commissioned Russia to build the country’s first nuclear power plant.

Gas fields in Western Siberia – which helped make the Soviet Union and later Russia an energy power – are fast depleting, and projects in Vietnam and elsewhere are seen as cushions to keep both Rosneft and Russia’s oil output stable.

Louise Dickson

Russia’s Highest-Paid CEO is Gazprom’s Alexey Miller at $27 million
Photo of Alexey Miller from

Alexey Miller, chief executive of Russia’s largest gas producer Gazprom, topped Forbes Russia’s top-paid managers list for the first time ever, hauling in an estimated $27 million in 2014.

Miller, who has been at the top post at Gazprom since 2001, was one of the few top-paid Russian executives to see his salary increase in dollar terms this past year, given the ruble’s massive devaluation.

Forbes published its annual ranking of Russia’s best-compensated CEOs on Thursday. The estimates are calculated using the companies’ compensation disclosures, in addition to analysis by Forbes journalists.

In second place was Andrey Kostin, CEO of Russia’s second-largest lender VTB, who saw his salary drop to $21 million from $37 million in 2013. In third place is another energy tsar, Igor Sechin, head of Rosneft, who made $17.5 million in 2014. This is the first time Sechin’s salary was published by Forbes Russia’s since the magazine was sued after reporting his salary was $50 million in 2013. After that, the Russian government ordered top executives from state-owned companies to make their salaries public.

Miller and Sechin’s pay are on par with companies that are far outperforming either Russian energy giant. ExxonMobil boss Rex Tillerson’s salary was estimated at $33 million in 2014 and Bob Dudley was compensated $12.74 million by BP.

Both Miller and Sechin are considered longtime confidants of Russian President Vladimir Putin, and have both worked with him since the 1990s, dating back to the president’s time in the St. Petersburg mayor’s office.

The more than $10 million gap between Miller and Sechin’s salaries would make sense if Gazprom were performing much better than Rosneft this year, which is not the case. Net income fell steeply and net debt increase by almost 50 percent.

Like Rosneft, Gazprom is suffering from low oil prices, but due to decreased demand from Europe, Gazprom is massively under producing. It is estimated in 2015 Gazprom will only produce 450 billion cubic meters of its 617 billion cubic meter capacity.

Back in 2008, when the company was valued at $360 million, Gazprom head Alexey Miller forecasted that within a decade the oil conglomerate would become the world’s largest company with a market capitalization of $1 trillion.

Now its market capitalization hovers around $51.5 billion. In the last year, stocks have lost more than 35 percent of their trading value.

However, it’s not all doom and gloom for Gazprom, as projects such as Nord Stream II, a pipeline from Russia to Germany, and two potential pipelines to China could strengthen the company’s position.

Louise Dickson

The Impending Breakup of Gazprom, Russia’s Gas Giant

gazprom split neftianka

In October, Russian President Putin will have to make a decision on breaking up Gazprom, the country’s largest exporter of natural gas, RBC reported. The company will likely have to give other companies, such as Novatek, Lukoil, Rosneft, and Surgutneftegas access to their pipelines and gas storage facilities.

Russia’s Federal Antimonopoly Service (FAS) has long been working to break up Russia’s “national treasure”, and believes that liberalizing the export market will bring about more fair and competitive gas transport prices and tariffs.

The verdict on whether or not to divy up Russia’s national breadwinner is split. The company, which accounts for 8 percent of Russia’s economy, is seen as a source of pride for many Russians. In 2012, when Russians were asked where they would work if they could choose any large company, 44 percent said Gazprom.

If the company is split, Rosneft is clearly a winner, as it will be able to sink its teeth into the $400 billion gas deal Gazprom sealed with China in May 2015.

The FAS will soon submit a formal request to break up Gazprom to Russian Vladimir Putin’s presidential commission on fuel and energy sector, RBC reported citing FAS deputy head Anatoly Golomolzin.

According to Golomolzin, discussions are being initiated by Rosneft. If action is taken, Gazprom will also lose its monopoly on gas exports to China, and Rosneft will be allowed to send its oil to China via Gazprom’s pipelines.

Vladimir Blinkov, the lead researcher at the Russian Institute for Strategic Studies, has accused the FAS of ‘anti-Gazpromization’, alleging that the regulator has a conflict of interest in helping Gazprom’s competitors.

The split shouldn’t be a shock to anyone, Gazprom has been under attack since the 1990s. In 2007 then-First Deputy Prime Minister Dmitry Medvedev gave the FMS orders to look at Gazprom. In 2013, Russian President Putin signed into law amendments to the gas export law aimed to break Gazprom’s monopoly on foreign export, particularly LNG.

Even though Gazprom achieved revenues of 4.48 trillion rubles in 2014, is a relic of the Soviet Union and isn’t keeping up with its competitors in profit. While in 2014 Gazprom’s profits reached 157 billion rubles, Surgneftgaz posted 885 billion rubles in profits. Rosneft outpaced Gazprom in profits by hundreds of millions, and Lukoil, the country’s second-largest oil company, topped it by about 24 billion rubles.

Novatek and Rosneft will aggressively take advantage of the liberalized export market and begin the export of liquefied natural gas (LNG), especially to growing Asian markets.

The behemoth has failed to innovate, especially in LNG technology, since a majority of the company’s revenues (50%) are made in pipeline transport of natural gas to Europe, a very lucrative market.

Competitors Novatek and Rosneft are eager to get into the LNG market, and already have plans for LNG facilities. Currently, Russia only has one LNG plant in operation, the Sakhalin-2 project in the Far East, a joint project between Gazprom (50%), Royal Dutch Shell (27.5%), Japan Mitsui (12.5%), and Mitsubishi subsidiary Diamond Gas (10%). Despite falling demand from Asia, the terminal plans to produce 10.8 million tonnes in 2016.

Rosneft plans to launch its own LNG plant on Sakhalin with a 5 million tons per year capacity in 2020. ExxonMobil is a partner.

Novatek’s Yamal LNG project in the Arctic, once finished, will have a 16.5 million tonnes per year capacity. Novatek has partners with France’s Total and China’s CNPC.