The physical oil barrel trading unit of Morgan Stanley (MS, Financial) has been facing the storm of regulatory pressure for a very long time. The business in question trades in actual barrels of oil instead of just paper contracts linked to the price of crude, which is quite rare for a banking enterprise. Morgan Stanley is under immense U.S. pressure to sell the unit because regulators regard physical oil trading as too risky for a major banking unit to own because unpredictable events like oil tanker leaks could expose it to billions of dollars in liability — thus putting the banking system and public money at stake.
The street buzz
Rosneft, Russia's biggest crude oil producer, may back out of a deal to buy Morgan Stanley’s oil trading unit because Western sanctions make it virtually impossible to finance day-to-day operations, three sources close to the state-controlled company said on conditions of anonymity.
Though no one wants to issue any official statement, the buzz is that Rosneft agreed to buy the unit in December. Since then, the United States and the European Union have slapped wide-ranging sanctions on Russia's energy and military sectors to protest against Moscow for its incursion into Ukraine. Rosneft's chief Igor Sechin, a close ally of Russian President Vladimir Putin, has been on the U.S. sanctions list since April. Rosneft itself was added to the list in July.
A spokesman for Morgan Stanley declined to comment on the issue. Ruth Porat, the bank's chief financial officer, said she expected the deal to close later this year. Rosneft declined to give any official comment.
Rosneft has enough cash capital to fund the acquisition of the Morgan Stanley unit, which sources said sports a price tag of something between $300 million to $400 million. But to operate daily, the business requires billions of dollars of bank lines of credit — funding that's difficult to secure given the sanctions. Due to the ongoing sanctions, the operational credit required to operate the unit is becoming increasingly high, and no western bank can enter into a deal with the Russian crude oil major, as the U.S. government continues tightening the sanction noose on Russia, thus affecting the bilateral business fraternity adversely.
Though the precise sizes of these credit lines are undisclosed, trading houses that compete with Morgan Stanley such as Vitol, Mercuria and Trafigura have $30 billion to $40 billion worth of credit lines with dozens of banks.
To quote a Russian source with direct knowledge of the matter, he said, "This deal just cannot go through. It is not an issue of finding $300 million to buy the business. Rosneft has the money. But it won't be able to operate it."
Another hurdle for the deal to go through is the approval from the Committee on Foreign Investment in the United States (CFIUS), a regulatory group that scrutinizes mergers and acquisitions that may affect U.S. security, which makes the Russian oil giant more vulnerable in the face of the ongoing sanction. CFIUS has asked Rosneft and Morgan Stanley to furnish more information about the deal, without approving it or rejecting it, a step that lawyers said is not unusual for a transaction under review.
One of Rosneft sources said talks with CFIUS were still continuing: "The U.S. bureaucracy has simply asked for more information. We are still in the game."
The street does not seem very optimistic about the fate of the deal. A Western banking source who works with Rosneft said the company believes it could not do much with assets of a U.S.-regulated bank — even if it was allowed to buy them — because of sanctions.
Both parties leaving no stone unturned
In the month of August, Rosneft applied for a $42 billion loan from a Russian state-owned wealth fund to help it fight the effects of the sanctions. Last week, the Russian deputy prime minister said the government is considering the applications.
Rosneft, which generates $30 billion in cash flow annually, is meeting its funding requirements from its internal resources. Another option would be borrowing from China, which already has its presence in making billions of dollars of credit lines available to Russian enterprise.
Morgan Stanley has been trying to sell off its crude oil unit since the last couple of years. Previous attempts to sell it to buyers in the Middle East and Asia failed due to price constraints and operational differences.
The outcome
The failure to sell the unit may benefit the bank to an extent as of now, because revenue in commodity trading businesses has been rising this year as markets have spiraled up, though the regulatory pressure on Morgan Stanley to get rid of this unit stays intact.
After trying to do away with the commodity-based unit for more than a year, Morgan Stanley has started expanding its commodity division again with plans to hire traders, sales staff and other professionals in the United States. Whether this new stance of Morgan Stanley is a temporary move to cash in on the current upswing in the commodity trading business or a permanent move is still to be seen. This is because even though it might benefit from the ongoing upsurge, but since it is into physical crude trading, the uncertainties of the trade will still loom large on it and would make the U.S. banking regulators reconsider the move. Sooner or later, this would escalate the pressure for sell-off to some other entity if the deal with Rosneft does not stand a chance due to the sanctions.
