A Russian Bear Meets a Financial Lion

Morgan Stanley seems closer in negotiations to sell its two crude oil transportation units to Rosneft. Morgan Stanley's commodity trading exposure has worsened in recent years to the point of eroding its otherwise strong ROE. 

Many physical oil traders like Morgan have been curtailing their long capacity options for several reason, all tied to weakening global oil prices. Global oil and credit demand will drive deals like this one for banks and integrated oil.

First, Rosneft and Morgan
Rosneft lifts 40% of Russia's crude oil and produces 32% of Russia's refined products. Rosneft lifts enough crude each day to cover China's 4 million barrel per day oil shortfall. Low lift costs of about $5/bbl are offset by higher transportation and other midstream oil costs.

Rosneft has worked hard to keep capital expenditures lower through greater use of strategic partners such as Fortum and Enel. It just signed a deal with KazTransOil to move crude to China through Kazakhstan with subsidized export duty provisions to help control burgeoning transportation costs.

Morgan's commodity operation has been a drag on its returns. This is consistent with other banks and investment companies that have seen commodity profits drop by 15% this year.

On top of commodities depressing Morgan's fixed income, currency, and commodity margins is the looming danger of regulator crackdown on bank commodity businesses. Both pressures would be enough to cut the commodities unit loose. JPMorgan Chase just began the $3.3 billion sale of its crude trading unit to interested bidders. 

Now, a deal
In the deal, Morgan could sell two units: Transmontaige and Heidmar, both in the midstream oil transportation and storage business.

Rosneft is just beginning to enter the U.S. liquids markets with its Neftegaz America Shelf LP acquisition of 30% interest in 20 Gulf of Mexico blocks held by ExxonMobil .

Heidmar operates VLCC, Panamax, Suezmax, Aframax, and Suezmax ships globally. Significantly for Rosneft's relationships with China National Oil, China National Petroleum Company, and Sinopec Group, Heidmar partners with Dalian Ocean Shipping Company, a wholly owned subsidiary of China Ocean Shipping Company. 

Why this deal is important
The core of this deal is what commodity traders call basis. There are three species of basis they work with. One is the difference between oil futures and oil physicals. Another is the difference between FOB oil prices at various locations on the planet. Yet another is the difference in prices between grades of oil and refined products.

All basis trading requires in-depth knowledge of storage and transportation. This means ships, barges, pipes, tank farms, quays, and all of the liabilities associated with these environmentally challenged assets. However, lack of profitability and regulatory risk are ganging up to move physical trading away from financial houses and back into integrated oil companies and their physical partners.

In short, Morgan Stanley stands to improve its ROE, focus on oil dry trading and derivatives, and skirt looming regulatory issues with banks that have physical commodity operations.

However, Morgan Stanley loses its window into the underlying value of an oil trade, and equivalently the value of oil in a structured debt offering.

On the other hand, Rosneft gains transportation efficiencies, access to U.S. markets, and a transportation hedge with its global shipments, especially to China. Rosneft can also begin to build a commodity trading business of its own.

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