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. Last Updated: 07/27/2016

Rosneft Looks to Beat Debt Crunch

Standing just across the river from the Kremlin, Rosneft's headquarters is shrouded in scaffolding.

The building's upgrade reflects the changes within as Rosneft acclimatizes to its new status as the country's largest oil company, following its purchase earlier this year of the remaining fields and production units that once belonged to bankrupt oil firm Yukos.

The shopping spree boosted its production to more than 2 million barrels per day but also left the company heavily in debt, potentially affecting its capacity to undertake future projects as it approaches a debt market reeling from the global liquidity crunch.

"The markets have been difficult," Peter O'Brien, Rosneft's vice president for finance, said in a recent interview in his second-floor office, as yet untouched by the renovation work.

Rosneft's attempt to pay down part of its $25 billion debt to financial institutions through a $5 billion bond issue was postponed in July due to volatility on global markets.

"When we went out, it was the start of it," O'Brien said, referring to the instability that shook global markets as the U.S. subprime mortgage crisis began to bite. "It's been very difficult, and it's starting to look a little bit better now, but [the dollar bond] is one of many options we intend to choose from."

State-owned Gazprom, laden with over $40 billion in debt, also postponed a bond sale in its Gaz Capital unit in August amid market jitters.

The lack of cash in international markets has in part prompted Rosneft to look closer to home, opting to issue ruble-denominated bonds by the end of the year, O'Brien said.

The issue, rumored to be for 45 billion rubles ($1.76 billion), has yet to be approved by the company's board.

"These [global] market conditions are bad, and they're not that desperate," said Al Breach, chief strategist at UBS, referring to Rosneft. "Now they have to look for other sources of funding. Going local will partially enable that.

"They're a very singular case, with sponsorship [from] the state that has helped them be able to raise capital," Breach said.

Rosneft raised $11 billion through an initial public offering in July 2006, reducing the state's share to 75.16 percent.

Rosneft has no plans to issue additional shares anytime soon, O'Brien said. "We view that as something we can do between now and 2010, if we feel the share price is more properly valued," he said.

Rosneft aims to have a ratio of debt to EBITDA -- earnings before interest, tax, depreciation and amortization -- of 1:1 by the end of 2010.

The company spent more than $25 billion acquiring Yukos assets in a recently concluded round of bankruptcy auctions that effectively dismantled what was once the country's largest oil company. It took huge loans from a consortium of Western banks to cover the cost.

But with Yukos' court-appointed receiver declaring Rosneft the bankrupt firm's largest creditor after the Federal Tax Service, it also recouped about $11 billion from the proceeds of the auctions.

And it also won back a 9.44 percent stake that Yukos formerly held in the firm, which, at Rosneft's current $80 billion market capitalization, is worth around $8 billion.

O'Brien said Rosneft would likely use most of the stake to fund further mergers and acquisitions, saving some of it to pay off more debt, potentially in the form of convertible bonds.

Chris Weafer, chief strategist at UralSib, said Rosneft would likely prefer to put the stake on international markets, enabling them to increase their free float and thus list on the MSCI emerging market index, allowing them to attract a broader range of investors.

"If they can't do that because of market conditions, they could turn to plan B -- selling equity to a strategic investor, possibly someone like Surgutneftegaz, who could afford it," Weafer said.

O'Brien denied recently revived speculation that Rosneft was seeking to take over Surgutneftegaz, the country's fourth-largest oil producer, which is estimated to be sitting on $16 billion in cash.

"It's not being discussed," O'Brien said.

Yet Weafer said some sort of hook-up with Surgutneftegaz was not out of the question, either through an equity sale or a joint venture that could avail Rosneft of Surgut's impressive cash pile.

"Lots of very cash-rich, Kremlin-friendly companies are using their better financial positions to help state companies, both strategically and in terms of liquidity," Weafer said.

Some analysts have speculated that Kremlin-friendly oligarch Oleg Deripaska was roped in by the state to buy the country's seventh-largest oil producer, Russneft, which is currently struggling under the weight of hundreds of millions of dollars in tax claims. Its former president, Mikhail Gutseriyev, was recently placed on an Interpol wanted list after fleeing the country to escape what he has called politically motivated charges against him.

The campaign against Gutseriyev and Russneft has prompted comparisons with Yukos, which was felled by over $30 billion in back tax claims and the jailing of its founder, Mikhail Khodorkovsky.

Khodorkovsky accused Igor Sechin, Putin's deputy chief of staff and chairman of Rosneft's board, of launching the campaign against him.

Rosneft has now gobbled up the lion's share of Yukos' assets, growing from a middling oil concern into the country's largest oil firm, mainly through its purchase of Yukos' largest production units, Yuganskneftegaz, Tomskneft and Samaraneftegaz.

Absorbing those acquisitions will take up much of Rosneft's attention as it prepares to go global and challenge the likes of Shell or BP.

"It's clear to us that we need to spend the next year or two focusing on successfully integrating recent acquisitions and improving efficiency," O'Brien said.

The company is drawing up a new investment strategy, due to be approved at a December board meeting. CEO Sergei Bogdanchikov said Sunday that part of the plan would see the firm extracting 140 million tons of oil per year by 2012, up from 100 million tons now.

Analysts said that while Rosneft's current debt reduction strategy seemed manageable, it could run into trouble when it seeks to boost production at existing and future units.

The company is due to start production from its Vankor field in the Arctic next year, and is expected to win licenses to some of the fields in east Siberia and on Sakhalin Island that the Kremlin will soon dole out.

The company will likely follow the new state model set out through Gazprom's acquisition last year of a majority stake in the Sakhalin-2 gas project from Shell, analysts said, with a state-run company holding a 51 percent stake alongside international energy firms.

International firms will likely front most of the funding, they said.

And in a sign that Rosneft hopes that it has put concerns about possible international legal action by Yukos' former managers behind it, in July it signed a memorandum of understanding with Shell to start looking into joint oil projects in Russia and potentially abroad.

"We expect Russia next year to move to a more proactive state phase -- out of the acquisitions phase and into the exploration phase. The state companies will be leading that," Weafer said.

"Rosneft is going to have to raise a lot more cash," he said.