Get the latest updates as we post them — right on your browser

. Last Updated: 07/27/2016

Gazprom, Rosneft Merger Scrapped

The government on Tuesday jettisoned plans to merge state oil company Rosneft with Gazprom in what industry watchers largely cheered as a breakthrough.

The announcement by Gazprom ends months of uncertainty over the deal and clears the way for the lifting the so-called ring fence, the restrictions on foreign ownership of Gazprom shares.

Instead of merging the two companies according to the original scheme to give the state control over Gazprom, the government will now pay cash for a 10.7 percent stake held by the gas giant's subsidiaries, the Economic Development and Trade Ministry said Tuesday. At Gazprom's current market capitalization, the stake will set the state back some $7 billion, a sum the ministry said will be raised from international lenders.

"The purchase of the required number of shares from companies in the Gazprom group will be carried out in line with the market price, in cash," Dmitry Medvedev, chairman of Gazprom's board and the Kremlin's chief of staff, said in a Gazprom statement. The deal will be completed before the company's annual shareholder meeting set for June 24, the statement said.

Gazprom attributed its altered course to changes in Rosneft's assets and debt levels since September 2004, when President Vladimir Putin gave his public blessing of the planned merger.

Those changes include Rosneft's acquisition of Yuganskneftegaz, Yukos' former key production unit, which was sold off in December in an opaque auction that could still be challenged in international courts.

In its statement, the Economic Development and Trade Ministry said that Rosneft shares would be floated to attract funds to settle the company's towering debts and boost its capitalization.

In a complex scheme, the ministry said that Rosneft would be transferred into a new entity called Rosneftegaz, which would be a vehicle for raising the funds to buy the Gazprom shares necessary for a controlling stake.

Ministry officials contacted Tuesday evening said they had no additional information.

Gazprom board member Boris Fyodorov said that the mechanism for lifting the ring-fence could be drafted by September, Interfax reported.

A Rosneft spokesman refused to comment.

The announcement puts a decisive end to months of Kremlin infighting about the merger. The uncertainty prompted weary investors to begin selling off Gazprom shares.

"It is a massive breakthrough from the political perspective, as the removal of the ring fence in trading Gazprom shares and the privatization of Rosneft imply the government is loosening its hold on the oil and gas sector and further opening it to foreign investors," said Michael Heath, a political analyst with Aton brokerage. "It flies in the face of the consensus view that the government is determined to assert an iron grip over the oil and gas sector."

Local Gazprom shares leaped 6.8 percent to 78.99 rubles on the MICEX, the largest jump in the stock since Putin announced the merger in September.

Some analysts warned the deal looked highly complicated and could be hard to pull off. Dmitry Mangilev, an oil and gas analyst with Prospekt brokerage cautioned that the scheme described by the Economic Development and Trade Ministry had not yet been finalized to appreciate all the risks of the deal.

"It is not yet clear how they will cover the bank loans that the government is going to get for purchase of the Gazprom stake," Mangilev said. "And if they sell less than 50 percent of Rosneft it will not cover all of its debts, which stand at $17 billion."

Chris Weafer, chief strategist at Alfa Bank, said that floating Rosneft may not happen in the foreseeable future and had only been announced to make the scheme look more plausible. Moreover, the deal could prove negative for Russia in the long-term, Weafer said.

"It is a crazy proposal. The original plan made perfect sense: The state would transfer [Rosneft] assets that it already owned for the 10.7 percent stake in Gazprom," he said. "Now it will effectively increase state borrowings by $7 billion to acquire this stake. ... This event also marks the end of the prudent fiscal management of the economy that has helped Russia recover from the crisis of 1998."

Weafer said the deal signals a victory for people at the top of the government who are following personal agendas to keep Rosneft independent to control its cash flow. Those interests have defeated "statists" like Deputy Prime Minister Alexander Zhukov and Industry and Energy Minister Viktor Khristenko, who supported the merger as a way to close the state's grip on key industries, he said. "It has appeared that Putin sided with the statist economists, and therefore investors will see [the abandoned merger] as a possible defeat for Putin. That will keep the investment risk premium high."