By Simon Pirani
Russia’s biggest M&A deal yet – the sale on 10 February of a stake in the Sakhalin I project to India’s state oil company – was made possible by political will, and by the best conditions production sharing agreement (PSA) legislation has to offer.
The purchase of 20% of the upstream oil project by ONGC-Videsh, the overseas arm of the Oil and National Gas Corporation of India, from Rosneft-Sakhalin and Sakhalinmorneftegaz-Shelf, subsidiaries of the Russian state oil company Rosneft, will trigger the biggest international investment ever by an Indian company.
The deal comprised two parallel agreements: first, the equity stake purchase by ONGC-Videsh for $225 million plus $90 million to cover Rosneft’s previous expenses; second, a carry-finance agreement that provides for the Indian company to cover costs, up to the project’s break-even point in 2005, both for itself and for the 20% that remains in Russian hands – an estimated $750-$1,000 million. The Indian company expects its total investment in the project to reach up to twice those figures.
The political will for the deal came from the Indian government, which wants to lessen its reliance on Middle Eastern oil for 70% of its energy needs, and supports ONGC’s strategy of expanding into the former USSR, west Africa and Latin America to make itself world-class. Russian president Vladimir Putin – who visited India in October last year and is keen to build on Soviet-era relationships to increase sales of nuclear technology, aircraft and other expertise there – made things happen too.
Also crucial to the deal’s success was PSA legislation that covers Sakhalin I (now owned 20% by Rosneft subsidiaries, 20% by ONGC, 30% by ExxonMobil subsidiary Exxon-Neftegaz, and 30% by the Japanese consortium Sodeco) and other natural resources projects with large-scale foreign investment.
Jack Langlois, partner at Akin, Gump, Strauss, Hauer & Feld who headed the legal team advising ONGC, said PSA provisions on project owners’ rights to control transport, access export markets and be paid in foreign currency had proved sufficiently clear, and allowed sufficient flexibility, for the “heavily negotiated commercial transaction” to succeed. It was the first assignment agreement to be negotiated under Russian PSA law.
Sakhalin I’s PSA, signed in 1995 with Exxon Neftegaz as operator, is one of three “grandfather” agreements whose terms can not be altered by future changes in the substantive PSA law. Langlois believes that more could follow under the substantive PSA law, “provided that agreement is reached on implementation of the normative acts [statutory instruments covering VAT, cost recovery and other details]”.
The succesful negotiation of the sale was itself an achievement, say all the parties. ONGC-Videsh’s dynamic md, Atul Chandra, led efforts to ensure political support and negotiate the bureaucratic rapids in New Delhi. In Moscow, where not so long ago PSA was routinely denounced by politicians as “selling out the motherland”, paths were smoothed for the foreign interest in Sakhalin I to rise to 80%. And ExxonMobil, who provided a data room in Houston for parties to examine technical and financial documentation, had to be kept on board.
Jeremy Wilson, head of global energy at JP Morgan Chase, who advised ONGC, said it was the most complex deal he had seen. “There were so many parties who had to feel comfortable with this. To be honest, when we started I thought our chances of success were about 5%.”
For Frank Kujliaars, head of integrated energy (Central Europe, Middle East & Africa) at ABN Amro, who advised Rosneft, the ONGC sale is “unique for being the first and biggest fully non-recourse transaction in the Russian market. He said: “The buyers have taken a very strategic, long-term view.”
More strategic and long-term than some western oil companies managed to take, say some market sources. By the time BP Amoco talked to Rosneft in October about Sakhalin I, the Russian company’s talks with ONGC were already far advanced. Dick Olver, BP Amoco’s head of exploration and production, admitted at last month’s results presentation that it was a “missed opportunity”.
Wilson at JP Morgan Chase believes that, going forward, oil majors must add to their reserves – 30% faster in the next five years than in the last five, by recent estimates. “To achieve optimum production levels they must go to difficult places, including Russia,” he said. “ONGC had fewer hesitations about Russian risk than the western majors have, and benefited as a result.”
In Moscow business circles, the Sakhalin I sale was unanimously welcomed – but not seen as indicative, yet, of a sea-change.
Edwin Tham of Allen & Overy, a member of Rosneft’s legal team, said: “A deal such as this, involving a large-scale commitment by a foreign investor, could hardly have happened outside of PSA legislation. The Russian environment is still too uncertain.”
Just contrast the Sakhalin I sale and the biggest non-PSA Russian M&A deal so far – the creation last year of Russian Aluminium, now the world’s no.2 producer of the metal with $5 billion annual turnover, from the merger of Siberian Aluminium with assets believed to be controlled by oil magnate Roman Abramovich.
This bold move could never have been made by foreign investors; it is unlikely they would have wanted to try. Knowledge of Russian conditions, and the confidence to confront the criminality and bad corporate governance with which the aluminium industry in Russia has become synonymous, were vital prerequisites.
James Fenkner, chief strategist at Troika Dialog investment bank, said: “The M&A environment is certainly better than last year.
“Russian companies are consolidating, as in aluminium, or, in the natural resources’ companies case, seeking to go up the value chain – buying manufacturing assets, like [leading steel producer] Severstal, or downstream oil assets in eastern Europe, like [no. 1 oil producer] Lukoil. The foreign companies are concentrating on the asset part of the value chain, such as the Sakhalin project.
“But we are still a good few steps away from a mature M&A environment.”
A version of this article appeared in Corporate Finance, March 2001
Posted 27.3.01; © 2001 Simon Pirani