Should you buy into Rosneft?

The flotation of Russian oil giant Rosneft will be one of the most-hyped in recent corporate history. Why? Ostensibly because Russia’s vast oil reserves are the answer to the world’s impending energy crisis - but more likely because investment banks are set to make over £250m in fees from the exercise, say Bedlam Asset Management...

Assuming a successful flotation in July, most readers will unwittingly find themselves shareholders in this giant Russian company; unwitting because it is so large it will leap into a variety of indices. As a consequence it becomes a "good" investment, according to current fund management credos. Moreover, the great investment banking publicity machine is about to go into Rosneft overdrive, for the total fees from a successful flotation could exceed $250m, more than the annual GDP of small African country.

The Rosneft flotation: Remember Yukos Oil?

Investors with a memory span longer than a goldfish might think they had already bought Rosneft a few years ago, so are curious why they have to buy it for a second time at a much higher price. This recall is correct. For Rosneft is little more that Yukos Oil, Mk II. In its current form the company has been in existence for barely a year. Its principle asset, Yuganskneftegaz, was bought at an auction conducted by the Russian government in December 2004, and was the result of the federal tax authority suddenly deciding in 2003 that Yukos owed them $28 billion in back taxes. Such a bill was a bit of a surprise to Yukos' management, for at international presentations two years before, senior government apparatchiks happily extolled the company's virtues. H

However, the then controlling Jewish (the relevance being Russia's chronic anti-semitism) shareholder, Mikhail Kordokovsky, unwisely decided to finance political opposition to President Vladimir Putin and his Duma nominees. To be fair to Vlad the Impaler, Kordokovsky (and other Robber Barons) posed a serious threat to the new Russia by creating states within a state' which no Government can ever allow. Yet the destruction and dismemberment of Yukos had, at best, a very weak legal foundation. Hence foreign shareholders, who held Yukos as a once in a lifetime opportunity, watched in horror as the value of their asset was destroyed.

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As skimming goes this was a cracker, given that 99.6% of Yukos' value was lifted by the government. Excluding the three "independent" non-executive directors, Rosneft's board are all placemen of the current regime. So even investment bankers have felt compelled to include in the prospectus perhaps the lengthiest risk factors we have ever seen. However, we feel an urge to write to the FSA, as a key one is missing, namely; "the President and his appointees on occasions have facilitated the transfer of corporate assets from one group of their friends to another without any warning. This risk may recur upon the demise or retirement of the current regime, as it did with the previous one".

The Rosneft flotation: why you investors shouldn't believe the hype

We have established that most readers will become involuntary shareholders. Others may be voluntary shareholders for even simpler reasons. For apart from a value post flotation of up to $80 billion, triggering a big = safe' knee-jerk reaction, the hype will be awesome. There will be acute emphasis on the vast reserves valued at a mere $7 per barrel and a looming world energy shortage'. Even the thickest investor can take seven from the current price of $70 per barrel, leaving $63 of 'untapped value'.

However, the hype is making many assumptions: that local and world prices are the same (they are not); that Russian reserve data is as good as, or better than Shell (sic); or that the pipelines don't leak continuously (they do). It also ignores the fact that drilling in Russia can be very expensive, transport worse and theft impressive. Critical is the assumption that the oil price remains at the current record high level for ever, even though daily world production in 2006 has exceeded demand. But this is all nit picking. President Putin now controls 60% of all Russian energy and he wants the money, so expect a spate of bullish announcements very soon. Whether,

like many new issues, it trades below its offer price within a six months remains unknowable for now, although the book building process tends to make this a rising possibility.

If you do choose to buy, be aware that of the mere $11.6 billion of paper being sold, $8.5bn goes straight to the Russian government; not much is being raised for this highly borrowed company so there is little balance sheet improvement. Note also that emerging market governments tend to

dump further paper onto unwitting foreign investors at the most opportunistic moment.

First published as Bedlam Asset Management's 'Pick of the Week'. If you'd like to read the rest of this article, you can read it on their site by clicking here: Careers Advice from Bedlam.