Russia Sanctions & The Curious Case of Nayara Energy
JULY 8, 2019: With Western sanctions in their 5th year and US-Russian relations at an all-time low, there is continuous speculation that Vladimir Putin’s Russia could be in for more pain in the near future. In fact, three new comprehensive sanctions bills — the DASKA, DETER and ESCAPE Acts of 2019 — are currently languishing in the US Senate. Meanwhile, several other bills that take aim at Russia’s energy export pipeline infrastructure are waiting to be heard in the US House of Representatives.
Against the backdrop of tensions running high, our new journey begins in Russia but will take us all the way to India with random stops in Switzerland, Cyprus, the Netherlands, Singapore and the British Virgin Islands. This is a story of Russia’s largest and most politically exposed oil company, Rosneft, or rather of its recent investment in a large Indian refinery complex. This is also a story of sanctions evasion at its prime, or maybe not? See for yourselves — and safe travels!
NB. For my previous article, published in October 2018 and updated in January 2019, where I look into Russian oligarch Alisher Usmanov’s key assets and the implications of potential US sanctions for his sprawling business interests, see here.
INTRODUCTION. गुजरात में आपका स्वागत है!*
(* “Welcome to Gujarat!” in Hindi)
Standing side by side in mid-October 2016 at a BRICS summit in the resort town of Benaulim, Goa, India’s Prime Minister Narendra Modi and Russia’s President Vladimir Putin witnessed a historic bilateral event. A consortium composed of Russian oil company Rosneft, Swiss commodity trader Trafigura and Russian investment company UCP officialized their intention to buy out a large Indian refinery from its majority owners in a nearly $13B deal. The definitive agreements were inked just days later and the purchase closed successfully in August 2017, after months of back-and-forth with local creditors and regulators.
Essar Oil, which de-listed from the Bombay Stock Exchange and the National Stock Exchange of India in early 2016 [a small group of minority shareholders had not tendered their shares and continue to own 1.74% of the share capital], was subsequently rebranded as Nayara Energy, effective June 2018. [“Nayara” is a portmanteau term combined from “Naya” — “new” in Hindi — and “Era”, to mean just that, the new corporate era under the new leadership.] Its acquisition represented the largest-ever foreign direct investment in India and Russia’s biggest outbound investment anywhere in the world at the time of the announcement.
Nayara owns the 20MMTPA Vadinar Refinery (pictured above), India’s 2nd-largest single-location refining complex; a nationwide chain of more than 5,000 retail outlets (with another 2,600 at various stages of completion); the Vadinar Port with a 58MMT dispatch and storage capacity; and the Vadinar Power Plant, a 1,010 MW multi-fuel power generation unit that supplies both steam and electricity to the refinery. Inhabited by fewer than 10,000 residents, Vadinar is a small coastal town on the edge of the western Indian state of Gujarat whose total population exceeds 60M.
_____________________________
PART 1. THE COMPANIES
(reading time: ~7 min)
Rosneft owns its 49.13% stake in Nayara Energy via Singapore-registered Rosneft Singapore Pte Ltd, a special purpose vehicle established in July 2015 as Petrol Complex Pte Ltd (renamed in February 2018). The SPV’s issued and paid-up share capital exceeds $4B.
Trafigura and UCP jointly control an equivalent 49.13% stake in Nayara via Kesani Enterprises Company Ltd, a Cypriot-registered holding company which is indirectly owned by Singapore-based Tendril Ventures Pte Ltd (est. September 2016). While Trafigura and UCP hold 49.6% each in Tendril Ventures, the former owners of Essar Oil, the Ruia family, own the remainder (0.8%).
Tendril Ventures Pte Ltd and its wholly-owned domestic subsidiary Tendril Ventures 2 Pte Ltd have a paid-up share capital of $656.4M and $666.4M, respectively.
Since UCP has no local presence in Singapore, both companies are in fact registered to Trafigura’s offices (c/o Trafigura Pte Ltd) at 10 Collyer Quay, which is home to the Ocean Financial Centre (pictured).
The oil giant
PAO NK Rosneft (est. 1995) is Russia’s and the world’s largest publicly traded petroleum company by booked reserves and total liquids output. In FY2018, it produced 230.2M metric tons of liquid hydrocarbons — to be compared with its nearest publicly listed competitor, US-based Exxon Mobil Corp.’s ~113M metric tons.* As of December 31, 2018, Rosneft had SEC proved (1P) reserves of 41.4B barrels of oil equivalent (boe). In contrast, the US rival last year increased its SEC-compliant 1P reserves to 24.3B boe. Yet, ExxonMobil, which has stronger diversification across its upstream, downstream, chemicals and natural gas & power marketing business lines, remains much more profitable. Its 2018 earnings grew to $20.8B against total revenue of $290.2B. Meanwhile, Rosneft had ~$8.9B in net income against total sales of ~$133.7B in 2018. The US energy giant leads by market cap as well, with $322.11B (at close on July 5, 2019) vs. $68.89B for its Russian peer.
* Exxon’s figure includes “crude oil, natural gas liquids, bitumen and synthetic oil.” Rosneft’s definition of liquids encompasses “crude oil, gas condensate, gas condensate liquids and hydrocarbons extracted from unconventional sources” such as biofuel, GTL and CTL.
When Rosneft’s current CEO Igor Sechin joined its board as chairman in 2004, the company was Russia’s 8th-largest by oil production and 7th-largest by reserves. As of 2005, its oil output swelled from 21.6M metric tons the year before to a whopping 74.6M metric tons. It ranked almost overnight 3rd- and 2nd-largest in Russia, respectively. In 2006–2007, Rosneft further managed to snatch top spots both domestically (oil production) and internationally (recoverable liquid hydrocarbons). That was made possible by its being the principal acquirer of Yukos Oil Co.’s assets in a series of bankruptcy auctions held from December 2004 to mid-2007. [In 2004, Rosneft secretly bought Yukos’ key asset, Yuganskneftegaz. By 2008, former Yukos assets had been yielding over 72% of Rosneft’s consolidated oil and gas condensate production. Yukos’ former main shareholder and CEO Mikhail Khodorkovsky was arrested in 2003 on tax evasion charges and subsequently spent over a decade in prison.]
Following the 2013 acquisition of TNK-BP (renamed RN Holding, see the chart) by Rosneft in a ~$55B cash-and-stock deal, BP Plc became the latter’s 2nd-biggest shareholder. It has since owned a 19.75% stake via BP Russian Investments Ltd. State-owned Rosneftegaz (est. 2004), through which the Russian Government holds various energy assets including a 10.97% direct stake in Gazprom, currently owns 50.00000001% of Rosneft’s share capital. Prior to December 2016, Rosneftegaz had owned ~69.5%, but as part of the oil company’s partial privatization a 19.5% stake was sold for €10.2B to a consortium formed between Qatar Investment Authority (QIA), the Qatari sovereign wealth fund, and commodity trader Glencore. Since September 2018, QIA has owned 18.93% of Rosneft through its wholly-owned subsidiary QH Oil Investments LLC. At the time, Glencore, which had effectively withdrawn from the consortium in QIA’s favor, retained a residual minority interest of 0.57%. [In 2017 and again in 2018, Reuters reported on how instrumental Russian state-controlled VTB Bank had been in arranging financing for the Rosneft deal, including a $6B loan to Qatar. For more on VTB, see Part 3.]
The commodity trader
With its global HQ in Geneva, (pictured), Trafigura (est. 1993) was the world’s 3rd-largest commodity trading house in 2018 with group revenue of $180.7B, just behind Vitol ($231B) and Glencore ($222.4B). It employs more than 4,300 people across 66 offices in 38 countries, with ~2,200 employees working in Latin America alone. Trafigura Group Pte Ltd, incorporated in 2010 in Singapore, is the group’s main entity. It is owned by a chain of Dutch, Singaporean, Luxembourgian and Maltese holding companies and is ultimately controlled by Farringford NV, a public LLC registered in Curaçao in 1992. [Curaçao is a tropical island in the south of the Caribbean Sea, opposite the northern coast of Venezuela, and a constituent country (“land”) of the Kingdom of the Netherlands.]
Unlike Glencore, which went public in 2011 in London and Hong Kong, both Vitol and Trafigura remain closely held. As per Trafigura’s corporate disclosures, it is wholly-owned by its executive management and ~600 senior personnel. In addition, the group has an equity participation plan open to all employees whereby the controlling shareholders acting through Trafigura Control Holdings Pte Ltd may award preferred shares in Trafigura Beheer BV (see the ownership chart) to top performers. Although they carry limited voting rights once vested, such shares cannot be freely disposed of, are not readily exchangeable for cash and must be returned to the company in case of termination of employment.
Trafigura currently has two of its senior employees serving as non-executive directors on the Nayara Energy board. Chin Hwee Tan has been APAC CEO since 2016, having joined from US private equity firm Apollo Global Management where he was the founding partner of its Asian operations. Of higher interest to us is Jonathan Kollek, 59 (pictured), who has been head of OOO Trafigura Eurasia, based in Moscow, since 2013. He began his career in the 1980s with Marc Rich & Co AG, the predecessor of Glencore, and joined Russia’s Tyumen Oil Co. (TNK) in 2002. A year later, he transferred to TNK-BP, a newly established JV between TNK and BP, before joining Trafigura in the wake of TNK-BP’s takeover by Rosneft in 2013.
The investment firm
Formed in 2006, United Capital Partners (UCP) is a Moscow-headquartered investment management company operating as a hedge fund (by focusing on blue-chip stocks and liquid debt), a PE firm (via long-term investments) and a hybrid of the two (special situations). It claims to have ~$3B in assets under management, with own capital of nearly $2B according to a 2016 interview. The firm is perched on the 26th floor of a 27-story office tower (pictured below) and employs ~60 investment professionals. The executive board is led by President/Managing Partner Ilya Sherbovich [for more, refer to Part 2] and comprises seven other individuals, each with the title of Partner. All but two previously worked with Sherbovich, first at Russian-based United Financial Group (UFG) and later at Deutsche Bank, which acquired the whole of UFG between 2004 (40%) and 2006 (60%).
The UCP group’s structure is not immediately clear. It visibly includes an entity in Russia — OOO UCP Advisory — and another in Cyprus — UCP Asset Management Ltd. The main corporate website says that Sherbovich beneficially owns over 70% of the entire group. UCP Advisory’s FY2017 report merely mentions him as its indirect [via Cyprus-based UCP Financial Assets Ltd] majority owner, with a 71.27% stake.
Meanwhile, UCP holds a 49.6% ownership interest in its and Trafigura’s Singaporean co-investment vehicle, Tendril Ventures Pte Ltd, through UCP PE Investments Ltd (est. 2008 in Cyprus), a wholly-owned subsidiary of Cypriot-registered Rainlane Investments Ltd (est. August 2016). Since April 2018, the latter has been owned by BVI-incorporated Wynd Portfolio Corp. whose identity is shrouded in complete mystery due to the lack of accessible corporate information in its home jurisdiction. [According to Rainlane Investments’ profile in the Cypriot business register, a transfer of shares occurred in October 2018, yet the registry does not provide further details.]
Even with several $B in AUM, the UCP group does not belong in the same league as Rosneft (“R”) and Trafigura (“T”) whose total assets stood at ~$203.7B and $53.8B, respectively on December 31, 2018 and September 30, 2018. [In FY2018, UCP Advisory, the core Russian entity, had pretax income of only ~$1.25M (“R”=~$12.9B; “T”=$966.9M) and operating cash flow of ~$1.19M (“R”=~$23.3B; “T”=$314.6M).] Its comparatively small footprint did not prevent UCP in 2016 from suing Russia’s oil transportation monopoly Transneft, headed since 2007 by ex-KGB spy Nikolay Tokarev who befriended Vladimir Putin in East Germany during the 1980s. Although Transneft ultimately prevailed, the legal challenge would have never materialized without bulletproof political cover — almost certainly provided by Rosneft.
_____________________________
PART 2. THE PEOPLE
(reading time: ~6 min)
The cast of characters involved in Essar Oil’s transformation into Nayara Energy comprises not one but several strong personalities. Each of them would have successfully auditioned for Season 9 of “Game of Thrones” had Season 8 not been the last.
Rosneft’s CEO, Igor Sechin, is so powerful in his native Russia that he can (with Vladimir Putin’s blessing) land anyone in jail almost without lifting a finger.
UCP Managing Partner and President Ilya Sherbovich has evolved from a little-known banker into a power broker wielding billions of dollars. He frequently punches above his weight, suggesting solid backing from someone far more influential (Uncle Igor, some say).
The Ruia brothers have nothing to do with Russia, except only for the deal they made with Rosneft and UCP. They have built together an immense business empire resting on a high pile of borrowed money, with many lenders left hoping that India’s would-be Lannisters will always pay their debts.
The heavyweight
As a close confidant of President Putin, Rosneft CEO Igor Sechin, 58 (pictured), is arguably Russia’s 2nd-most powerful man. In a naked show of force, he ambushed Economic Development Minister Alexey Ulyukayev in an anti-graft sting operation of late 2016. The apparently unsuspecting cabinet official received from Sechin’s hands a basket of homemade sausages — a Rosneft specialty stamped with a personal greeting from the CEO (“From Ivanych”, in reference to Sechin’s slightly mispronounced patronymic). Together came a $2M kickback. In 2017, a Moscow court sentenced Ulyukayev to eight years behind bars and slapped him with a hefty fine equivalent to the bribe he had allegedly solicited from Sechin. The court eagerly agreed that the money was meant to compensate the disgraced minister for supporting Rosneft’s bid for Bashneft. [In 2016, this regional oil company was re-privatized by Rosneft after its nationalization/expropriation from the previous owner, Russian billionaire Vladimir Yevtushenkov.]
Following Putin’s ascent to the presidency, Sechin served as his deputy chief of staff (1999–2008). After the boss was made (read: made himself) prime minister, his loyal acolyte became a deputy. His subsequent appointment as CEO of Rosneft in 2012 legally turned Sechin into a man of great riches. In 2014, Forbes Russia estimated his annual income at not less than $50M — Sechin sued and the magazine had to retract its story. A couple of years later, it put him at #2, right after Gazprom head Alexey Miller, in a ranking of Russia’s highest-paid CEOs, with total pay of $13M p.a. Sechin did not sue Forbes Russia, but the ranking was discontinued the next year. However, in 2016 he successfully sued two other prominent media outlets, Vedomosti and Novaya Gazeta, respectively for materials about his unfinished country residence near Moscow and a luxury yacht called St. Princess Olga (pictured above). Sechin’s now-former 2nd wife Olga had repeatedly used the yacht for jaunts in the Mediterranean. It costs upward of $100M and, if rented, will easily set one back $1M a week.
To top it off, last October Russian investigative journalists uncovered Sechin’s new property in a prestigious Moscow neighborhood: Five floors, 1,229 sq m (=13,229 sq ft), a private cinema, a Turkish steam bath and a wine cellar, all with an assessed market value exceeding $31M. No, Igor Ivanovich did not run to court at the first opportunity. After being contacted by reporters for comment, his spokesman at Rosneft just blurted out: “Go to hell!” [NB. The Russian original is a bit more vulgar.]
The banker
Ilya Sherbovich, 44 (pictured), is a Russian financier whose net worth is estimated by Forbes Russia magazine at $950M. Prior to founding UCP in 2006, he had worked at United Financial Group (UFG) since 1995, including as president since 2002. In 2005, he was voted Russia’s investment banker of the year. Following UFG’s acquisition by Deutsche Bank, Sherbovich assumed the leadership of DeutscheUFG and served in parallel as Deutsche’s country head of IB in 2006–2007. In the 2nd half of 2007, he took the helm of UCP as president and managing partner.
Sherbovich sat on the board of Rosneft (!) from 2012 to 2013 and allegedly remains to date on particularly good terms with its CEO. Their proximity has long fueled speculation that Scherbovich may be nothing more than a respectable front for Sechin’s personal business interests. In 2014, the founder of Vkontakte, the Russian equivalent of Facebook, accused UCP of acting on Sechin’s behalf when the previous year it snapped up a 48% stake in his social network. [Despite being ousted from Vkontakte in early 2014, Pavel Durov subsequently managed to develop a successful messenger app, Telegram, which made him a billionaire. As for UCP, it had earlier failed to enforce a claim to property rights over the beta version of Telegram.]
While Sherbovich publicly argues he met Sechin shortly before his appointment to Rosneft’s board in 2012, their connection could stretch as far back as 2007. At the time, a low-key Russian LLC called Prana outbid Rosneft for a collection of prime assets, marketed together as lot #13 and formerly owned by Yukos Oil Co. [For details about Rosneft’s involvement in the demise of Yukos, refer to Part 1.] Rosneft eventually succeeded in buying the same assets from Prana. Interestingly, several of Sherbovich’s now-former employees at UCP had placed calls and gone to see the tender documentation relating to lot #13 — all in Prana’s name. Sherbovich has, unsurprisingly, always denied his purportedly close ties to Sechin, but we have enough reasons to not take him at his word.
The Ruia clan
Prior to divesting themselves of nearly all of their 98.26% stake in Essar Oil in August 2017, the powerful Ruia clan controlled the company via Essar Energy Holdings Ltd and Oil Bidco (Mauritius) Ltd. Both were ultimately owned by Caymans-based Essar Global Fund Ltd. The family currently retains in what has now become Nayara Energy an indirect residual interest of 0.39% through its 100% ownership of Oil Holdings Ltd, which was registered in June 2014 in Mauritius. This holding company owns a 0.8% direct stake in Singapore-based Tendril Ventures Pte Ltd (see the ownership chart). According to an October 2016 announcement by the Competition Commission of India, Oil Holdings Ltd’s single shareholder is Rewant Ruia, the only son of Indian billionaire Ravi Ruia.
Ravi, 70 (pictured, left), and his elder brother Shashi, 75 (pictured, right), jointly possess a net worth estimated at $2.8B by Forbes magazine. Both originally hail from Chennai, but have long made Mumbai the family’s power base. With an investment portfolio worth ~$18B, Essar Group has assets in steel-making (Essar Steel), O&G (Essar Oil & Gas E&P), refining & marketing (Essar Oil UK), infrastructure (Essar Ports, Essar Projects), power generation (Essar Power), shipping (Essar Shipping) and IT & communications (AGC Networks).
Since the end of 2018, Lakshmi Mittal’s ArcelorMittal has been eyeing cash-strapped Essar Steel India and EPC Constructions India [ex-Essar Projects India.] The two entities were previously cornered into bankruptcy by their respective creditors’ committees as a result of unsustainable debt loads. The Ruias’ debt problems are old as the hills: Back in 1999, Essar Steel already “distinguished” itself by becoming the 1st Indian company to default on international debt, i.e. ~$250M worth of Eurobonds.
_____________________________
PART 3. THE DEAL
(reading time: ~10 min)
A close analysis of the Essar Oil/Nayara Energy deal shows just how much sway Rosneft has over the company, in spite of its non-controlling stake, and how little influence is consequently exercised by its Swiss and Russian partners.
Firstly, while Rosneft paid for its stake in cash, Trafigura and UCP took out a loan from Russia’s state-controlled and sanctioned VTB Bank, which covered 85% of their joint capital commitment. The Trafigura-UCP SPV’s shares are effectively pledged to VTB, raising at least the theoretical prospect of Nayara falling into the hands of two sanctioned Russian entities that are ultimately controlled by the Government of Russia.
Secondly, every effort has been made to banish the word “control”, even if joint, from Nayara’s ownership structure. For Rosneft, the company remains an associate over which it exercises significant but non-exclusive influence. While Trafigura has changed the status of its co-investment vehicle from “JV” to “associate”, UCP apparently accounts for it as if it had no value — the clearest admission so far of its technical role as a shiny facade.
Thirdly and finally, although Rosneft’s nominees to the Nayara board fall well short of a majority, thus depriving it in theory of an ability to control board decisions, the contrary seems true. Thanks to its privileged relationships with both Trafigura and UCP, Rosneft appears to be in control of their own board members. Its influence also extends to the management committee, which features several Rosneft alumni in key positions.
The bank loan
When the acquisition was completed in August 2017, the Ruia family-owned Essar Group released a public statement putting total transaction value at $12.9B. An article published on the same day in The Economic Times stated that the new owners were assuming ~$4B worth of outstanding debt and allocating an additional $1B for working capital adjustments. In its annual report for FY2017, Rosneft pegged the price it had paid for its stake in Essar Oil at $3.9B. Rosneft Singapore Pte Ltd’s financial statements shed more light on the ins and outs of the deal, as viewed from Rosneft’s perspective. In fact, in 2016 this Singapore-based SPV subsidiary of the Russian oil company made a capital commitment of ~$4.3B toward the future acquisition, also depositing $300M in cash to the same end. As of December 31, 2017, its cash-only investment in Essar Oil shares was recorded on the books with an accounting value of $3.84B.
Kesani Enterprises Company Ltd (see the chart) tells the other half of the story. Its 2017 report explains that total consideration paid by the Trafigura-UCP consortium, which is behind the Cypriot SPV, for its 49.13% interest in Essar Oil amounted to ~$3.86B. Only $579.7M, or 15%, were paid in cash whereas the remainder (85% or ~$3.28B) took the form of non-recourse bank financing. The entire issued share capital of Kesani Enterprises Co. was thereby pledged to a 3rd-party lender [The Cypriot company’s local records show that the pledge agreement was made in June 2017 and registered a month later. In January 2017, Kesani Enterprises Co. had allocated 1,061 shares worth $1 each to Kesani Holdings Ltd. In August 2017, at the time the deal was finalized, the latter received one more share for almost $585M. An additional, 1,063rd, share was issued to the same buyer in October 2017 for $8.6M.]
As disclosed by Kesani Enterprises Co., the bank that lent the money to it is no other than VTB Bank (PJSC) (HQ pictured), Russia’s 2nd-largest credit institution by net assets (~$226.9 billion as of June 2019). Its CEO (since 2002) is a Vladimir Putin confidant named Andrey Kostin, who has been under US sanctions (SDN) since April 2018 and sanctioned by Canada since March 2019. VTB Bank is under sectoral restrictions in the US, the EU, Canada, Switzerland and Japan. In 2014, Kostin was named by Forbes Russia magazine as Russia’s highest-paid CEO, with 2013 total pay estimated at $37M.
Importantly, both Rosneft and VTB Bank are controlled by the same governmental entity, the Russian Federal Agency for State Property Management, which directly owns 60.93% of the bank’s common shares and — indirectly — 50.00000001% of the oil producer [Rosneft has no preferred stock.] As per Cypriot law, legal title to shares of stock and associated voting rights remain with the pledgor as long as there is no default. While chances are slim that the Kesani consortium led by cash-rich Trafigura will default on the VTB loan, in theory Nayara could end up being co-owned in equal proportions by two sanctioned Russian subjects — and therefore automatically and unequivocally coming itself under sanctions. [It should be noted in passing that, having worked with the Ruias since 2014, VTB Bank advised Essar Group on its Essar Oil divestiture and reportedly loaned $3.9B for the refinancing of legacy debts.]
JV no JV
Leading Russian business news agency Prime reported in January 2019 on Nayara Energy’s plans to invest ~$850M into a petrochemical facility provisionally due by 2022 in Vadinar. It called the Indian company a “joint venture.” In contrast, the Rosneft website announcement, to which Prime referred, said nothing about a JV. Understanding whether Nayara could qualify as a JV or not is crucial from the sanctions perspective — to be discussed in Part 4. At first sight, it has some trappings of a JV as per the following two criteria: (1) Nayara Energy is organized as a separate legal entity; (2) The combination seeks to pool Rosneft’s and Trafigura/UCP’s technical and financial resources with a view to winning new business in the Indian downstream market.
However, to be recognized as a JV a legal entity also needs to be jointly controlled through equity, i.e. all significant decisions require the unanimous consent of actively involved shareholders [the 1.74% non-controlling interests represented by Essar Oil-era residual shareholders do not conflict with this principle.] Alternatively, key decision-making may require a majority or supermajority (e.g. 75%) whereby no decision can be effectively taken without unanimity. As regards Nayara, the case for a JV is moot. The company has not made public its articles of association nor has it ever disclosed any shareholder or contractual agreement. Its website contains the cached version of an undated “memorandum of association” clause 86 of which states that board resolutions call for a majority of votes; to boot, the chairman has a casting vote. Nether condition meets the definition of a JV under the IFRS and/or the Indian GAAP.
Rosneft never refers to Nayara Energy as a jointly controlled entity and consistently accounts for it as an “associate”, just as shown below based on disclosures in its annual reports for FY2017 (left) and FY2018 (right). This indicates that Rosneft does not consider itself to be either the controlling shareholder or a joint venturer.
It is unclear to date which accounting classification (JV vs associate) is reserved for Nayara by Kesani Enterprises Company Ltd, the co-investment vehicle set up by Trafigura and UCP. [In case you’ve already lost your way, refer back to the ownership chart.] Kesani’s annual report for the period ending March 31, 2017 has details only on Tendril Ventures Pte Ltd, its ultimate parent based in Singapore:
Trafigura, too, categorized Tendril Ventures Pte Ltd as a JV in its annual report for the period ended September 30, 2017…
…before switching the classification to “associate” (but, of course, not the accounting treatment, which is the same for associates and JVs) in the FY2018 report — for no obvious reason and without any explanation whatsoever:
Things get even more complicated when it comes to UCP PE Investments Ltd, which holds the UCP stake in Tendril Ventures Pte Ltd. In fact, its direct owner, Rainlane Investments Ltd, considers its one and only subsidiary to be worth no more than (ta-da!) a lonely greenback with a George Washington portrait in the middle. In FY2016, the subsidiary’s recorded value was impaired by $2,803. [Rainlane’s reporting period is from the 1st of January to the 31st of December.]
How is it possible at all that UCP PE Investments Ltd, a holding company that owns — on UCP’s behalf — nearly half of Tendril Ventures, is worth close to nothing? The 248 shares (out of 500) in its possession have a book value* in excess of $325M. With the initial impairment recorded in 2016, that is before the acquisition of Essar Oil, Rainlane could have reversed it the following year (as permitted by the IFRS) and at any rate should have revalued UCP PE Investments Ltd to its true value. [The mystery around this low-key SPV is further compounded by the fact that in its 2017/2018 annual report Nayara Energy describes itself as an “equity accounting investee” for both Rosneft and Trafigura, but strangely not for UCP.]
* ignoring retained earnings/losses and stock buybacks.
The governance
The de jure lack of any shareholder’s control over Nayara is reflected within its system of corporate governance (see below). Upon change of ownership in 2017, Rosneft nominated four candidates to the board of directors whilst UCP and Trafigura nominated two each, in line with their respective shareholdings. The current directors for Rosneft are (1) Didier Casimiro, Sechin’s deputy (VP) in charge of refining, petrochemicals, commerce and logistics; (2) Alexey Karavaykin, Rosneft’s director of investment analysis and an advisor to Sechin; (3) Krzysztof Zielicki, the oil company’s former head of strategic development; and (4) Alexander Romanov, Rosneft’s VP for oil refining [unlike Casimiro, he is not a member of the Rosneft management board.]
Nayara’s executive chairman Charles Anthony Fountain (5) represents UCP. He previously served as head of refining & marketing at Reliance Industries and has a 25-year career history with BP. The other UCP representative is UCP’s investment director Alexander Bogdashin (6). Meanwhile, Trafigura participates in the board’s deliberations through Chin Hwee Tan (7) and Jonathan Kollek (8) [refer to Part 1.] The rest of the board is made up of one executive director who is not affiliated with any shareholder, the refinery manager Chakrapany Manoharan (9), as well as two independent directors. [Until recently, the board also included a nominee of Life Insurance Corp. (LIC) of India, which used to be Essar Oil’s major lender before the post-acquisition debt restructuring.]
Ilya Sherbovich’s long-standing closeness to Igor Sechin patently suggests UCP’s lack of independence vis-à-vis Rosneft [for more details, refer to Part 2.] A similar conclusion can be made for Trafigura based on its ties to the Russian oil giant. These ties have grown into a strategic partnership since Kollek, a former TNK-BP employee, headed up Trafigura’s Moscow office in spring 2013. Two years on, the lucky trader surged past Glencore and Vitol to become the 2nd-largest offtaker of Rosneft crude. In September 2015, the two companies threw a lavish party on the sidelines of an energy conference in Singapore, according to a Reuters report. The event probably remained imprinted in many an attendee’s memory not so much for its content as for the greeting kiss that, as the FT writes, Sechin heartily administered to Kollek’s both cheeks.
With four directors of its own and four others under its influence, Rosneft de facto controls Nayara’s 11-strong board. Its influence also visibly extends to the management committee. Of its eight members, only one has previously worked for either Trafigura or UCP: Nayara Energy CEO B. Anand was Trafigura India Pte Ltd’s CFO from 2012 to 2017. In contrast, Chief Commercial Officer Evgeny Storozhuk, Head of Development (Refinery) Sergey Denisov and Chief Marketing Officer Alan McGown are all former employees of TNK-BP/Rosneft. [As of July 2019, McGown is stepping down to join the executive committee of Puma Energy Holdings Pte Ltd as chief transformation officer. Trafigura owns 49.41% of Puma Energy via Trafigura PE Holding Ltd.]
_____________________________
PART 4. THE SANCTIONS
(reading time: ~9 min)
Since 2014, Rosneft has been sanctioned in five jurisdictions: the US, the EU, Canada, Switzerland and Norway. Sanctions limit its access to debt (US and Canada) or debt and equity capital markets (EU, Switzerland and Norway) as well as to goods, technology and services involved with certain types of oil exploration and production.
Under US sanctions law, the 50% Rule dictates the application of the same sanctions to any legal entity owned 50% or more by Rosneft. The rule is somewhat different in the EU, namely insofar as the minimum threshold is set above 50% and both ownership and control (through means other than equity instruments) count for sanctions purposes. Even though the US Treasury does not formally rely on the principle of control, it reserves the right to pinpoint designations aimed at preventing a circumvention of mandated restrictions.
Lastly, as our analysis nears its logical conclusion, it is increasingly clear that Nayara Energy can be considered as being subject to the sanctions against Rosneft. In particular, EU persons cannot lend funds to it for longer than 30 days — something that a couple European banks have already done before. Across the Atlantic, it is rather dangerous to assume that OFAC will turn away at the sight of a US person doing a similar thing. What’s more, US Russia sanctions under CAATSA extend to foreign persons as well — to the extent that Nayara Energy may ever make it to an OFAC list.
Rosneft
In the wake of the Russian annexation of Crimea and following instability in eastern Ukraine during the 1st half of 2014, Rosneft came under so-called sectoral sanctions in several Western jurisdictions. In July 2014, it was sanctioned by the US Department of the Treasury’s Office of Foreign Assets Control (OFAC) as per the terms of Executive Order 13662 (Directive 2) of March 2014. More specifically, US persons were banned from extending or otherwise dealing in new Rosneft debt with maturities exceeding 90 days. In September 2017, Directive 2 was amended by a new sanctions bill, The Countering America’s Adversaries Through Sanctions Act (CAATSA), to the effect that the maximum allowed maturity was lowered to 60 days for new debt issued on or after November 28, 2017.
In September 2014, EO 13662 (Directive 4) further restricted Rosneft’s access to goods, services and technology supplied by any US person in connection to “special crude oil projects” within Russia, such as deepwater, shale and Arctic E&P ventures. [Beginning on January 29, 2018, CAATSA expanded said directive’s geographic scope to the entire world for co-ventures owned 33% or more by Rosneft and other sanctioned entities, or in which the latter own the majority of voting rights.] The European Union has enacted similar restrictions on Rosneft, unchanged since September 2014, under Council Regulation (EU) No 833/2014 of July 2014. However, they apply to both new equity and debt with maturities exceeding 30 days. The same regulation conditions the supply of items than can be used for “special crude oil projects” (see above) to strict licensing requirements and outlaws the provision of associated technical services, such as drilling.
Under Canada’s Special Economic Measures (Russia) Regulations (SOR/2014–58), Rosneft is subject to debt restrictions for maturities of more than 90 days and a blanket ban on the sale or transfer of specified oil equipment and technology. As for Norway, its 2014 Regulations on measures concerning Ukraine’s integrity (Forskrift om tiltak vedr. Ukrainas integritet mv.) mirror the EU’s legal language. Switzerland remains the outlier, though: Its Ukraine-related Ordinance RS 946.231.176.72 of August 2014 prohibits neither the issuance of Rosneft financial instruments with maturities longer than 30 days to, nor the provision of loans by, Swiss persons to Rosneft. Instead, such transactions are simply subject to authorization. In the same vein, no automatic ban has been in effect as far as procurement for deepwater, shale and Arctic oil projects in Russia is concerned.
Finally, Igor Sechin is under personal sanctions in the US and Canada, respectively since April 2014 and March 2019. [The Canadian Government sanctioned him at the same time as VTB Bank CEO Andrey Kostin.] In July 2017, his SDN status cost Exxon Mobil Corp. and two of its subsidiaries $2M in civil penalties levied by the US Treasury. The American authorities established that in the course of May 2014 the two subsidiaries’ presidents had signed with Sechin eight legal documents relating to oil and gas projects in Russia. [ExxonMobil later argued in court that Sechin had been sanctioned in his personal rather than professional capacity. This line of argument was predictably, and legitimately, brushed aside.]
Ownership vs control
In 2009, OFAC implemented the so-called “50% Rule” as part of its Côte d’Ivoire sanctions program (31 CFR 543.411). Shortly after, the Treasury issued one-page guidance effectively extending the application of the rule to all sanctions programs administered by OFAC (for the archived version, see here). The guidance was further amended in August 2014 (see here for the current version) to allow for the aggregation of ownership stakes held by sanctioned persons. That is, if Person A and Person B are both “specially designated nationals” (SDN) and each of them owns at least 25% of Entity C, that entity is considered blocked. The blocking, or freezing, of Entity C’s assets — whenever they come within US jurisdiction or into the possession/control of a US person — occurs if sanctioned persons own, individually or in the aggregate, an interest equal to or greater than 50%.
The 50% Rule equally applies to Sectoral Sanctions Identifications (SSI) List entities, including Rosneft. [Take a little pause here and look back at the ownership chart to make sure you understand, if it’s not already the case, why every single Rosneft company on the left side is subject to the same restrictions as Rosneft itself.] It is important to keep in mind that the flow-down of ownership for sanctions purposes is different from economic ownership. For example, Rosneft (SSI) owns 50% of Entity B, which owns 50% of Entity C. Although Rosneft ultimately owns only 25% [50% x 50%] of Entity C, the latter is nonetheless subject to sectoral sanctions because it may be argued that Rosneft can direct the activity of Entity C via Entity B.
Similarly, Council Regulation (EU) No 833/2014 extends EU sectoral sanctions to “[any] legal person, entity or body established outside the Union whose proprietary rights are directly or indirectly owned for more than 50% by [Rosneft].” The discrepancy from the US sanctions regime is fourfold: (1) no sanctions apply within the EU; (2) sanctions apply only in case of an ownership interest greater than 50%, thus leaving out most JVs; (3) ownership interests are not aggregated [still, deliberate circumvention may backfire]; (4) the EU uses both ownership and control to establish the applicability of sanctions. Control is defined in 55b of the Guidelines on Implementation and Evaluation of Restrictive Measures (Sanctions) in The Framework of the EU Common Foreign and Security Policy (for the latest version dated May 2018, read here). It encompasses both “the right to exercise dominant influence” and “the power to exercise the right to exercise dominant influence” — a clear nod to Rosneft’s influence over Nayara Energy [refer to Part 3].
While OFAC does not rely on the notion of control, its general guidance (see FAQ #398) leaves no doubt as to its readiness to forestall the circumvention of sanctions by means of targeted designations. This policy is obviously valid for both SDNs and SSI List entities, Rosneft included.
OFAC urges caution when considering a transaction with an entity that is not a blocked person (a non-blocked entity) in which one or more blocked persons have a significant ownership interest that is less than 50 percent or which one or more blocked persons may control by means other than a majority ownership interest. Such non-blocked entities may become the subject of future designations or enforcement actions by OFAC.
Nayara Energy
From day one, the acquisition of Essar Oil has been touted by its proponents as a sanctions-free transaction. Back in October 2016, Essar Group CEO Prashant Ruia told the media: “The way it is structured, it is fully compliant. We are well within the rules that govern Russian companies.” VTB Bank CEO Andrey Kostin said as much: “Rosneft will not get a controlling stake, partly because of these reasons.” Besides the Russian dimension, Essar Oil’s dependence on crude supplies from Iran and Venezuela has been viewed as a cause for concern. [In FY2018, the company sourced half of its crude in the Middle East and a third in Latin America.] Rosneft Deputy CEO Didier Casimiro told Russian news agency RBC in May 2019 that oil deliveries from Iran to India had fallen to zero. In contrast, Venezuelan oil supplies to Indian refiners — including not only Nayara Energy but also Reliance Industries Ltd — had been reportedly cleared by the US Department of State.
After paying down or restructuring debt owed to a handful of domestic lenders, Essar Oil went on a fundraising spree, starting in early 2018. Between March and October of that year, Trafigura and BP forked up $1.45B worth of prepayments in two tranches ($700M and $750M), to be repaid with cargoes of refined petroleum products over eight and 15 months, respectively. Western banks had reportedly signaled scarce initial interest in co-lending funds. By November 2018, when Trafigura and BP launched work on a further $1.5B loan facility repayable in as many as four years, Deutsche Bank and ABN AMRO Bank had already joined other unnamed banks in a syndicate, Reuters says. The deal was closed in spring 2019 for half the initial amount, thereby enabling Nayara Energy to cut for good its traditional reliance on short-term Indian-origin debt.
In August 2018, Nayara also went through with its maiden domestic bond issuance, raising ~$380M in rupees. The bonds have a three-year maturity and bear a 9.5% coupon rate. The following month, the Indian press unveiled the company’s intention to issue its first overseas five-year bonds worth ~$500M with JP Morgan Chase and Deutsche Bank acting as lead managers. It is unclear whether any such debentures have been put up for sale. Moody’s Investors Service assigned a Ba2 rating to Nayara with a stable outlook in October 2018. The rating is predicated on the business’s strong operating track record and improved debt and liquidity profiles as well as an implicit assumption of support from the new shareholders. “[… The] rating assumes that Nayara will not be subject to current or future sanctions imposed on its shareholders”, according to the rating decision.
We are finally going to answer our main question: Is Nayara Energy subject to the Western sanctions against Rosneft? Under EU law, the demonstrable existence of control by Rosneft over its Indian affiliate tilts the balance toward a “yes.” Consequently, neither ABN AMRO nor Deutsche Bank nor any other EU person (e.g. BP) can be deemed compliant with sectoral sanctions by lending Nayara money for more than a calendar month. OFAC does not consider it a listed entity (for now), but enjoys full latitude to make a separate designation and generally discourages US persons from dealing with entities controlled by sanction targets. Furthermore, CAATSA’s Sec. 228 could have grave implications for any foreign person that engages in or facilitates “significant transactions” with or on behalf of Nayara should the latter be designated alongside Rosneft. [Canada’s and Switzerland’s sanctions regimes appear too restrictive to extend to Nayara while the Norwegian case is moot at best for lack of guidance.]
_____________________________
FINAL THOUGHTS
The world of sanctions is notoriously difficult to navigate, especially now that the fundamental divergence between the US and EU sanctions regimes has considerably widened post-CAATSA (and we are not even talking about Brexit!). Rosneft’s acquisition of a minority stake in Nayara Energy — just short of the controlling threshold and in agreement with two smaller partners whose autonomy vis-à-vis the oil company can hardly be taken for granted — is a good illustration of that new complexity. And what if Rosneft suddenly transitioned from an SSI List entity to an SDN in the event of further tightening of US sanctions, for instance in retribution for Russian support to Venezuela’s Nicolás Maduro? Only time will tell.
* * *
