What Petropavlovsk Says About Norilsk, Polymetal And Sanctions

Petropavlovsk (OTCPK:PPLKY) [LON: POG]

Petropavlovsk is a UK company, listed in London, that mines gold in Russia’s Far East. As far as anyone knows – including the company – there are no sanctions upon the company. The stock continues to trade (there used to be US trading of the London stock, also an ADR, but both are no more) in London. It should be OK. Well, as OK as anyone’s going to be in a war.

Except, as Petropavlovsk announced on Friday, there is a problem. The company’s banker is Gazprombank, and Gazprombank is sanctioned. Which means that a UK company cannot deal with Gazprombank.

Well, that’s simple enough, go find another bank that isn’t sanctioned. Ah, but….

Market structure

For a couple of decades now good miners in Russia have been able to use a bank to do the export of their finished gold. It used to be, back in the mists of time, only the central bank but that was expanded. In the last couple of years it has become possible for a miner to export directly – if they cared to. Near no one did for the banks were pretty efficient and the charge for making the export was probably less than the costs of insuring directly, running one’s own security and so on.

So, Petropavlovsk mines and refines gold up to good delivery bars and Gazprombank then does the export. Russian gold is now no longer good delivery at the London Bullion Market, nor at CMET, but that’s a minor inconvenience. Gold refining costs are low enough that not good delivery can be transformed into good delivery for a percentage point or two of value. There are many people who can do this as well.

But Gazprombank is sanctioned, meaning that Petropavlovsk cannot use this route because it cannot deal with Gazprombank. That’s possible to solve, use another bank with those export rights for gold.

Except now we get to something which often does work in tandem. The working capital for the mines is borrowed from Gazprombank. This is secured against those future deliveries of gold. We could think of it as invoice factoring if we like, in economic terms it’s not that far from it.

So, Gazprombank has the right to 100% of Petropavlovsk gold output. Up to and until that working capital loan is paid off.

Well, OK, now again that can be solved. Borrow the money elsewhere, from a non-sanctioned bank which can export gold and switch lenders. Except sanctions don’t allow paying off Gazprombank – that’s to do business with a sanctioned entity.

At which point. Petropavlovsk must deliver gold to a sanctioned entity, which it’s not allowed to do, or pay off the loan from a sanctioned entity, which it’s not allowed to do, or it stops producing gold. But not paying off the loan, nor delivery – or closing production – means that it rapidly moves into default on the loan from Gazprombank. At which point the mines themselves might become the security which has to be given up for the loans now in default.

No one knows

No one at all knows how this is going to turn out. They’re certainly backed into a considerable corner here. They’ve assets in Russia, but those might end up being the security against a default, but they can’t either deliver under their contract or refinance to avoid the default.

Umm, well, what?

As Petropavlovsk has really only been trading in London in the recent past it’s unlikely that there will be many here with a holding. So this isn’t really about Petropavlovsk itself. My best guess – and it’s entirely a guess – is that the authorities at this end will work out some way of threading this problem before default and confiscation. But that’s no certainty. Any position in Petropavlovsk would be a bet on the sensibility of politics, which is a risky thing. A few tens or hundreds of thousands of shares (at 2 pence and lower each) could be a fun bet but it really would be a bet on that sensibility of politics.

Which brings us to Polymetal which we’ve discussed a couple of times recently.

The situation here is different. Polymetal sells concentrate, not delivery bars. So it’s not having to sell through a bank which may or may not be sanctioned. There’s also some half – nearly half – of the business in Kazakhstan, which is outside all of these problems, have a look at those two other pieces for more detail on all of this.

But it is still a gold miner in Russia that could be affected by portions of the sanctions. They have working capital loans which need refinancing this year for example. We are, as with Petropavlovsk, looking at a UK (Jersey, which counts for UK in this sense) company that happens to do business in Russia. So far as anyone knows there are no direct sanctions which should affect the company. But what about indirect?

This is a significant risk.

We’ve also talked about Norilsk Nickel. This is legally entirely different. This is a Russian company, listed in Moscow. NILSY, what we might trade, is a Depositary Receipt. There are, so far at least, no sanctions against Norilsk itself. Nor against the controlling – or at least major – shareholder Potanin.

There is a worry being muttered around the market. That the bank which issues the depositary receipt might not be able to continue to hold the underlying shares. This is more of a worry with those Russian companies which have been directly sanctioned of course.

It’s not a particularly vivid worry just this week though. The Moscow exchange has opened again but foreigners aren’t allowed to sell out of their positions. So the depositary banks cannot dump those underlying thus making the receipts somewhat moot, or even closed out at whatever price before any chance of recovery. How long that ban on foreign selling is going to last is anyone’s guess.

On paper at least those who bought NILSY at the bottom have done very well. For that Norilsk price in the reopened Moscow market is holding up so far. Not that the position can be closed as yet.

The point of this

The point of this piece isn’t to make any recommendations either or any way on any of the three, Petropavlovsk, Polymetal or Norilsk. Rather, it’s to point out that sanctions is a much more complicated beast than we’ve been thinking it might be so far.

Petropavlovsk isn’t sanctioned and yet it is possible – please do note, only possible – that it will go bust if it adheres to the sanctions rules. It can’t sell gold to its secured lender, can’t refinance the loan because it’s not allowed to pay it off, so what is it to do without a relaxation of those sanctions?

What are the other ways in which the application of these varied sanctions rules are going to impact those who, seemingly, shouldn’t be affected as they are not themselves sanctioned?

My view

It’s not possible to trade NILSY at present – at least, I don’t think it is – so there’s little point in trying to pinpoint value. I remain with thinking that Polymetal is the most likely to survive given the Kazakh business and that is probably worth more than the current price. Petropavlovsk, as above it’s a penny stock bet, an option value almost, on the authorities making an exception to the sanctions rules.

But my proper point here is that there’s more risk than just who gets sanctioned. For as those sanctions work through the connections in the economy more folk will be affected.

The investor view

The real value to us as investors of the Petropavlovsk issue is as a window on how sanctions will play out. If the authorities insist upon the situation with Gazprombank playing out – you can’t meet the terms of the contract but also you cannot refinance out of it – then the future value of all of those Russian connected stocks is lower than we might think it is now. If, on the other hand, they agree that this is ridiculous and so change the rules enough to allow a solution here then that’s significantly positive for the value of the only other one we can trade, Polymetal.