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. Last Updated: 07/27/2016

Chinese Buy Udmurtneft for Rosneft

bloombergStorage tanks at Udmurtneft, which is being acquired by China's Sinopec.
Chinese state oil company Sinopec has agreed to buy TNK-BP's Udmurtneft, giving Beijing its first stake in Russian oil and paving the way for a strategic partnership with Rosneft.

Once Sinopec buys the medium-sized oil unit, Rosneft will acquire a 51 percent stake in Udmurtneft; Sinopec will hold the remaining 49 percent.

According to the terms of the deal, Rosneft will get its stake without paying up front. Sinopec will be paid for financing the deal out of Udmurtneft's oil revenues, Rosneft said in a statement Tuesday.

The deal comes amid burgeoning energy ties between Russia and China and growing speculation that a Chinese oil major could buy a small stake in Rosneft in its upcoming share issue.

"Rosneft has announced its intention to exercise its option to acquire 51 percent of shares" in Udmurtneft, Rosneft said. Rosneft said it agreed to the deal with Sinopec in May.

TNK-BP spokeswoman Marina Dracheva declined to say how much Sinopec would pay for the unit. Analysts valued the 120,000-barrel-per-day unit at $3 billion to $4 billion. Udmurtneft is located near Perm.

The deal shows Rosneft's dominant position at the center of Russia's oil industry just weeks before it issues shares to investors in the country's biggest-ever IPO. Under the terms of the deal, it is winning a majority stake in Udmurtneft without having to take on any risk, said Kakha Kikhnavelidze, an oil and gas analyst at UBS.

The agreement underlines energy-hungry China's eagerness to win a stake in production assets in Russia after years of mutual suspicion and Chinese bids being rejected.

"This is Sinopec's ticket to Russia," Kikhnavelidze said.

Rosneft, which became the Kremlin's flagship oil major after acquiring Yukos' main production unit in late 2004, is seen to be in a strong position to win new licenses and other assets amid a government drive to win back control of the strategic oil sector.

Rosneft heralded the deal as the start of a beautiful friendship.

"Management at Rosneft and Sinopec believe that this is a significant step toward closer collaboration between the two companies and toward the development of strategic relations with China's leading industrial corporations," Rosneft said in the statement.

"This will enable Sinopec to realize its strategy of entering international markets, including oil and gas production in Russia."

The deal comes amid mounting speculation that a Chinese oil major such as Sinopec or CNPC could buy up to 5 percent of Rosneft's shares in this July's IPO, a move that could save the offering from potential failure as markets fall.

Rosneft spokesman Nikolai Manvelov on Tuesday declined to comment on whether a separate stake could be offered to a Chinese firm as part of the IPO.

"If international companies want to take part in the IPO, they're welcome," he said.

A banker involved in the transaction said CNPC or Sinopec could take a small stake if investor appetite for the Rosneft offering waned as emerging markets took a hammering and investor concerns grew over the potential legal risks.

Yukos majority shareholder Group Menatep, now renamed GML, promised a "lifetime of litigation" after the oil major's biggest oil unit was taken over by Rosneft for a knockdown price following a forced government auction over back taxes.

"If the price Rosneft wants is considered too much by portfolio investors, then it needs someone to come in and make sure the offering is successful. That could either be the Chinese or India's ONGC or state banks," the banker said on condition of anonymity. "I think it's going to go down to the wire."

Investors have indicated they do not want to pay a premium for the Rosneft shares.

Valuations of Rosneft by banks taking part in the deal ahead of the IPO have ranged from $63 billion to $120 billion. LUKoil, the country's leading oil major, is worth $69.6 billion.

Rosneft needs to raise at least $8 billion in the IPO to pay off loans from Western banks.

A Chinese company appearing as a white knight in the Rosneft IPO would not be the first time China has helped bail out Rosneft. Chinese banks financed Rosneft's $9.4 billion purchase of Yuganskneftegaz in a hastily arranged $6 billion loan deal in early 2004.

Ever since that transaction, energy ties between one of the world's biggest energy producers and one of the world's biggest energy consumers have blossomed. As Russia sought to diversify markets and win financing for its controversial drive to regain control of the oil sector, relations took off.

The new relationship was crowned during a summit in Beijing in March. During the summit, more than 20 agreements were signed, including major oil and gas pipeline deals, which made Western governments worry that Russia was redirecting energy supplies to the East.

"Russia and China have reached a new level of understanding," Sergei Sanokoyev, head of the Russo-Chinese Center for Trade and Economic Cooperation, said Tuesday."Our relations have grown very quickly over the last 1 1/2 years. We are now considering our business relations in terms of strategic partnership."

He said the possibility of CNPC or Sinopec buying a small stake in the Rosneft IPO had been discussed by President Vladimir Putin and his Chinese counterpart, Hu Jintao, during the Beijing summit. It was unclear whether the topic came up at the recent Shanghai Cooperation Organization meeting, he said.

"The possible participation of Chinese companies in the Rosneft IPO has been talked about at the highest level," said Sanokoyev, who helped organize the summit.

"There is an understanding on the Russian and Chinese sides that such an interest is mutual and would be mutually beneficial."

The details -- for example, which Chinese oil company will take part -- were to be hammered out by other officials, Sanokoyev said.

"If two years ago the Chinese did not discuss the question of acquiring less than a blocking stake, now they are willing to take it stage by stage and not aim for a big step immediately in the development of relations.

"I consider there is the possibility for such a deal," he said.

Kikhnavelidze, however, said he saw no sense in a Chinese firm or any other strategic investor buying a stake of up to 5 percent in Rosneft.

"This would only be a financial investment," he said. "Buying a small percentage of Rosneft will not give any strategic influence unless there is a separate agreement on energy partnership."

A banker involved in the transaction, however, said the Chinese would only stand to gain from taking part in the offering.

"This would be a sign of goodwill. If they buy 3 percent, they would have a bigger chance of winning the next asset that comes up," he said.