Is the US relaxing its sanction regime against Russia?
A Russian state bond for $750 million is such an obvious target, European bankers are asking why didn’t US government warfighters against Russia shoot down last month’s Sovcomflot issue. This followed by just four weeks the campaign by the US Treasury to stop US investment banks and the international security clearance companies, Euroclear and Clearstream, from trading the bond issued in May by Russian state bank, VTB.
Sovcomflot, Russia’s state-owned shipping company and one of the world largest oil tanker groups, successfully placed $750 million in 7-year bonds at 5.735% on June 23. VTB and Sberbank were the Russian underwriters, JP Morgan and Citigroup were the American bank underwriters. Sovcomflot’s prospectus confirms its bond has been cleared to trade with all three global clearance agencies -- Depository Trust Company (DTC) of New York, Euroclear of Brussels, and Clearstream of Luxemburg. Says a London bond trader: “The DTC is dominated by Citi, Morgan Stanley and J P Morgan. Euroclear is owned by J P Morgan. These Americans can hardly be sanctions busters unless the US Treasury has all of sudden decided to go soft on the Russian oil and gas business, and on Russians who have been on the sanctions lists for two years. Is the war petering out, like the Obama Administration?”
Sovcomflot is a 100% state-owned shareholding company. A decade of schemes to privatize its shares on stock exchanges in New York, London, Frankfurt and Moscow have so far come to nothing.
Its board is appointed by the state, and is chaired by a state official. Its chief executive, Sergei Frank (below, left), is a former federal Transport Minister and protégé of Mikhail Fradkov, a former prime minister and currently head of Russia’s Foreign Intelligence /Service (SVR). An English appointee on the Sovcomflot board, David Moorhouse (right), is not listed as an independent. He used to run the shipping classification and inspection company, Lloyds Register. In the past he and the Register serviced Sovcomflot’s fleet safety and insurance requirements. Moorhouse also helped Frank respond to critical reporting of Sovcomflot’s affairs in the London maritime press.
Sovcomflot operates a fleet of 140 vessels, with capacity of 12.3 million deadweight tonnes (dwt). Many are mortgaged to secure short-term debt of $316.2 million and long-term debt of $2.7 billion. On the company’s balance-sheet, revenues have stuck between $1.3 billion and $1.5 billion since 2013. But a reduction in operating costs and a modest recovery in tanker rates have erased the company’s loss of $39.2 million in 2013, and turned a profit of $354.5 million in 2015. In the first quarter of this year, Sovcomflot is reporting profit is up 9.2% on the same period of last year.Sovcomflot’s primary business is carrying crude oil and petroleum products to consumer markets far from the production fields.
Gas in the form of liquefied natural gas (LNG) and liquefied petroleum gas (LPG) is a much smaller, though growing line of business. On the latest figures published by Sovcomflot, crude oil accounts for 49% of earnings; petroleum products, 17%. Suppling, servicing and shuttling oil from offshore platforms comprises 22%; gas tankering, 14%.
This is how the fleet is distributed at the moment.
Although it has been the Russian government’s policy to put oil and gas exports on Russian ships for economic and maritime security reasons, reducing dependence on foreign-owned vessels, Sovcomflot admits that only one barrel in five of its oil cargoes is Russian.
In its prospectus to investors last month, Sovcomflot said its strategy is to grow in fleet numbers and profitability as oil production grows around the world. In Russia, the company sees itself as “a seaborne extension of the Russian pipeline infrastructure”. So its growth depends, not so much on Russia’s new onshore fields whose output is piped east to China and west to Europe, but at the offshore fields, both oil and gas, being developed in the Arctic and Sea of Okhotsk. “The Group”, says the prospectus, “provides supply vessel and shuttle tanker services to projects such as the Sakhalin-1, Sakhalin-2, Prirazlomnoye, Novy Port and Varandey. These projects require highly specialized vessels and specifically trained crew to operate supply vessels and shuttle tankers, particularly in the extremely harsh ice-water conditions of the Arctic and Far Eastern regions. As a result, the vessels in this segment earn a significant premium over traditional tankers and offshore supply vessels, and this specialized expertise provides a significant barrier to entry for potential competitors.”
In the polar region, and also in the Sea of Okhotsk off the Russian east coast, these are the new sources of oil and gas production which have been targeted by the US and the European Union (EU) for sanctions to prevent borrowing of the large sums required to finance the projects, and halt the flow to Russian companies of the technology needed. Sanctions and political operations at the European Commission in Brussels have also aimed at curtailing land and undersea pipeline deliveries of Russian oil and gas.
Two of Sovcomflot’s biggest Russian customers, Gazpromneft and LUKoil have been sanctioned, along with Rosneft, Russia’s leading oil producer; Gazprom, the leading gas producer; and Surgutneftegaz, another oil major. The state-owned shipyard group, United Shipbuilding Corporation, which works on Sovcomflot’s vessels, and Transneft, the pipeline company delivering oil to tanker port terminals, are also listed. The two Russian underwriters of the Sovcomflot bond, Sberbank and VTB, are sanctioned. Individuals close to Frank, who are proscribed, include Gennady Timchenko (lead image); Igor Sechin, Rosneft’s chief executive; and SVR chief Fradkov.
The US war strategy, aimed at sabotaging the development of Russia’s Arctic fields and the shipping lanes for moving the oil and LNG to market, can be followed in this Washington think-tank version.
In the Sovcomflot prospectus the risk that the company’s future may be targeted in the sanctions war is acknowledged. “No individual or entity within the Group has been designated for sanctions under any of these authorities. Additional designations may be made, or additional categories of sanctions may be created, at any time, and the Group can give no assurance that any member of the Group, or individuals holding positions in the Group, will not be affected by future sanctions designations. U.S. law provides that persons that ‘have materially assisted, sponsored or provided financial, material or technological support for, or goods or services to or in support of’any targeted person or activity may be designated for sanctions. The Group, like a large number of Russian companies, has commercial relationships with entities that are subject to U.S. sanctions.”
The prospectus also concedes that the US capital sanctions, though not formalized, may strike at Sovcomflot’s bonds. “Investors in the Notes may be restricted in their ability to sell, transfer or otherwise deal in or receive interest payments with respect to the Notes because the investor is subject to the jurisdiction of an applicable sanctions regime, which could make such Notes partially or completely illiquid and have a material adverse effect on their market value.”
This is a reference to the de facto sanction which between February and May of this year prevented banks like Goldman Sachs from underwriting the VTB bond. It is also a reference to the way in which the US Treasury’s Office for Foreign Assets Control persuaded the clearing companies which make bond trading possible not to allow the VTB placement to be registered. For the full story on how Washington targeted the VTB bond, reducing $7 billion in bids to just $1.75 billion in placements, read this.
According to a Sovcomflot insider last week, “it is fortunate that Sovcomflot managed to refinance its debts [with the new bond]. Otherwise we all could be in [expletive deleted] with our ratings.”
On June 8 the Moody’s ratings agency issued its endorsement of the $750 million bond issue on the grounds that the new debt is in effect guaranteed by the Russian government; and that the timing relieves the repayment pressure for the company’s $800 million bond due in 2017. Moody’s also noted in Sovcomflot’s favour: “material improvements in time charter equivalent (TCE) revenue and margins thanks to higher rates and lower bunker fuel costs; good cash flow visibility as two-thirds of revenue originate from long-term charters as opposed to the spot market; and revenue growth potential from fleet additions and growing diversification into the liquefied natural gas (LNG) shipping and offshore services.”
Moody's report omitted to mention the sanctions against Russian offshore oil projects, or the ban on underwriting and trading the VTB bond.
Sovcomflot ‘s prospectus devotes several pages to assuring bond buyers they will be able to buy and sell the Sovcomflot paper through all three global clearing houses, starting with the US market leader, DTC. This company is dominated by the big New York banks, including Citi and J P Morgan which are lead managers of the Sovcomflot issue. Chairman of DTC is Robert Druskin, from Citi (below, left). Chief executive of DTC is Michael Bodson (centre), a Morgan Stanley veteran.
The executive at DTC supervising the Sovocomflot bond is Phil Davies (right), managing director and global head of operations. He too is a Morgan Stanley veteran.
US Sanctions Busters?
Bond market sources say these executives, like their counterparts at Euroclear and Clearstream, checked in advance with the US Treasury, and were given the green light to accept the Sovcomflot bond. The sources add that the perception Washington is relaxing its financial warfare against Russian state entities has helped to lift trading volumes and pricing for the Sovcomflot bond in the first month of trading.
Russian market sources and Sovcomflot insiders say they have been surprised by the readiness of bond buyers to accept the privatization risk at Sovcomflot. A maritime industry source who knows Frank well adds: “the Sovcomflot business model is based on an offshore structure. Kremlin policy is in favour of deoffshorization. There is practically nothing in the prospectus about the government’s plan for selling Sovcomflot shares, and the probable change of ownership. If and when that happens, are investors prepared for the new owner or shadow owner to use the offshore model to help himself?”
Frank has been trying to secure Finance Ministry and Kremlin backing for a management buyout of the shipping company. The scheme Frank proposed to Alexei Kudrin, the former finance minister, required state bank financing for Sovcomflot’s managers, led by Frank, to buy small blocks of shares, which, in aggregate, would add up to 25% . Last month it was officially confirmed that VTB has been awarded the government’s mandate to arrange the sale of 25% less one share. The date and the exchange have not been decided yet.
Insiders say they do not believe Frank’s scheme will be adopted. They add that the oil company Surgutneftegaz has the cash to make the purchase without state bank financing. Timchenko has also been a candidate for preferment in the privatization, though he would need state bank funds. Timchenko (lead image) has been closely connected to Frank for many years. His daughter, Ksenia (below, left) is married to Frank’s son, Gleb (right). They both work in Timchenko businesses. They are not on the US or EU sanctions lists as individuals; but their businesses, including Transoil and Aquavita, are sanctioned. For more details of the family business, read this. For the archive on Frank’s management record at Sovcomflot and his business relations with Timchenko’s oil, port, and transportation interests, start here.
According to Sovcomflot’s prospectus, privatization is a risk for investors in bonds because “it may adversely affect the price”. For the time being, the document adds, “Sovcomflot’s privatization structure contemplates issuance of new shares along with concurrent sale of the existing shares held by the Russian Federation, with the Russian Federation retaining ownership over 75% plus one share. In addition, Sovcomflot’s privatization structure and company laws provide for a placement of depositary receipts representing a portion of the relevant shares in Sovcomflot under foreign law…
On December 17, 2014, the Board of Directors approved an additional issue of shares to be placed.
by open subscription along with respective Prospectus. The issuance decision and Prospectus were registered with the Central Bank of Russia on March 12, 2015. Since the additional shares were not placed within one year from the date of the registration of the issuance decision, on January 27, 2016, the Board of Directors of Sovcomflot extended the term for the relevant placement of additional shares through March 12, 2017. The statutory deadline for placement of the additional shares is three years from the registration of the issuance decision. As of the date of this Prospectus, no additional shares have been placed.”
Insiders say that until the Kremlin decides who should end up controlling Sovcomflot, there can be no decision on when, where, or at what price the shares can be issued. “Surgutneftegaz and Timchenko are sanctioned at the moment,” according to one of the sources close to the company. “But the US seems to have shut its eye to the bond, so who knows what will happen if either one or both of those names are selected for the privatization? Right now there’s no crowd of investors for the share sale.”