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. Last Updated: 07/27/2016

Oil Firm Investors Burned by Republic

When Sakhaneftegaz floated share this past February, Russian and foreign investors were impressed enough by the firm's prospects to snap up sizable stakes in the company.

Although Sakhanefetgaz is far from being a major oil and gas firm, it does have an effective monopoly in Sakha, a resource-rich semi-autonomous region in the Far East that is five times the size of Texas. It is also a highly inhospitable area where temperatures can range from 40 degrees Celsius in summer to minus 60 degrees in winter.

Despite producing just 60,000 metric tons of oil last year - less than 1 percent of total Russian oil production - Sakhaneftegaz's local monopoly on oil products alone was potentially worth a cool $500 million a year, according to Gerd Jakobs of ECM Security. Combined with the prospect of healthy export earnings from a likely deal to supply gas to China, that made the investors he represents willing to stump up an average $15 a share for a stake in the firm.

Those investors' chances of reaping a decent return on their cash may have gone down the tubes last Friday thanks to the heavy hand of Sakha's government.

Even though the government only retains a 33 percent stake in Sakhaneftegaz, it succeeded in having a 3.2-million share float voted through at a closed door board meeting. The shares - equivalent to 30 percent of current equity - are to be sold to the regional government by closed subscription for 8.5 rubles ($0.34) per share.

That's a massive discount on the $1.50 a share that the stocks went for on May 25, the last time they were traded, said Alexander Klimentev of Sakhainvest, an investment group with the largest private stake in Sakhaneftegaz of a little over 20 percent.

When added to the regional administration's current stake, the float would be enough to restore to the government a majority stake in the firm.

Minority shareholders were outraged by the move.

"I would not have invested in Sakhaneftegaz if I had known that the regional government was going to be running it," said Jakob of ECM Security.

The share dilution was authorized after Mikhail Nikolayev, president of the Sakha Republic, asked the company's board of directors to postpone the annual general meeting that had been set to take place last Friday in Yakutsk, the Sakha capital.

The official reason for this request was that Nikolayev would be out of the republic on business and asked for a month's postponement.

However, the government-controlled board of directors instead held a meeting of their own behind closed doors and voted through the share dilution measure, riding roughshod over the objections of some members of Sakhaneftegaz's top management, who were present at the meeting.

"I was not a supporter of this measure, but those who wanted this had a stronger hand than we did," said Piotr Yegorov, Sakhaneftegaz vice president.

Sakha government officials were unavailable for comment regarding Sakhaneftegaz.

In addition to the regional government's 33 percent stake in Sakhaneftegaz, foreign portfolio investors hold from 12 percent to 15 percent, with ECM Security representing about a third of this investment. Sakhainvest holds 25 percent, Russian regional pension funds hold 10 percent to 12 percent. The rest is split between some 3,500 individual shareholders.

However, the government had managed to effectively retain full control over the company because the old board was elected a year earlier when the government still held a controlling stake in the company, Yegorov said.

Until early this year, the regional government controlled more than 50 percent of Sakhaneftegaz, but it allowed that stake to be diluted when the company carried out a shareholder-approved share float that allowed the firm to consolidate its subsidiaries through a share swap.

That share issue was when many of the minority investors became involved, according to ECM Security's Jakob.

Those investors are likely ruing the day they ever heard of Sakhaneftegaz. They need the company's market capitalization to reach $180 million before they could recover their investments, Jakob said.

It is currently $9 million, and if the share float goes ahead that's likely to drop to $4 million.

The share dilution was most likely timed to take advantage of the recent signing of an agreement with China, said Klimentev of Sakhainvest.

The deal - signed in April by the Chinese national gas company, Sakhanefetegaz and the Sakha government - envisages building a 4,400 kilometer pipeline from the northern Sakha gas fields to Beijing. A feasibility study for the seven-year project is set to be completed before the end of this year.

Sakha has massive reserves of gas that have until now been going to waste for lack of a market. Sakha's demand for gas was 1.5 billion cubic meters last year, but Sakhaneftegaz has proven reserves of about 1.5 trillion cubic meters and projected reserves of 9 trillion cubic meters.

"If a production contract is signed, and Sakhaneftegaz begins supplying gas to China, the share price will shoot up to around $60 per share," Klimentev said.