What Petropavlovsk says about Norilsk, Polymetal and sanctions

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Petropavlovsk (OTCPK:PPLKY) [LON: POG]

Petropavlovsk is a British company, listed in London, which extracts gold in the Russian Far East. As far as everyone knows – including the company – there are no sanctions against the company. The stock continues to trade (there used to be US exchanges on the London stock, also an ADR, but both are no longer) in London. It should be fine. Well, as OK as anyone is 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 a UK company cannot do business with Gazprombank.

Well, it’s pretty simple, go find another bank that isn’t sanctioned. Oh, but….

Market structure

For a few decades, good Russian miners can use a bank to export their finished gold. It used to be, in the dawn of time, only the central bank, but it has been expanded. In the last couple of years it has become possible for a miner to export directly – if they wish. Hardly anyone did as the banks were quite efficient and the export charges were probably less than the costs of insuring direct, managing one’s own security, etc.

So, Petropavlovsk mines and refines the gold to good delivery bars, and Gazprombank then does the export. Russian gold is now not well delivered to the London Bullion Market, nor to the CMET, but this is a minor inconvenience. Gold refining costs are low enough that a bad delivery can be turned into a good delivery for one or two percentage points of value. There are many people who can do it too.

But Gazprombank is sanctioned, which means that Petropavlovsk cannot take this route because it cannot deal with Gazprombank. It is possible to solve, use another bank with these export rights for gold.

Except now we come to something that often works in tandem. Mine working capital is borrowed from Gazprombank. This is guaranteed against these future deliveries of gold. You could think of it as invoice factoring if you will, in economic terms it’s not that far off.

Thus, Gazprombank is entitled to 100% of Petropavlovsk’s gold production. Until and until this working capital loan is repaid.

Well, OK, again, this can be fixed. Borrow the money elsewhere, from an unauthorized bank that can export gold and change lenders. Except that the sanctions do not allow reimbursing Gazprombank – that is, doing business with a sanctioned entity.

At what point. Petropavlovsk must deliver gold to a sanctioned entity, which it is not allowed to do, or repay a sanctioned entity’s loan, which it is not allowed to do, or it stops produce gold. But failing to repay the loan or deliver – or stop production – means it quickly defaults on the Gazprombank loan. At that time, the mines themselves could become the collateral that must be pledged for loans currently in default.

Nobody knows

No one knows at all how this will turn out. They are certainly backed in a considerable corner here. They have assets in Russia, but these could end up as security against default, but they cannot deliver under their contract or refinance to avoid default.

Uh, well, what?

As Petropavlovsk only traded in London in the recent past, it is unlikely that there will be many here with a stake. So it’s not really about Petropavlovsk itself. My best guess – and it’s entirely a guess – is that the authorities on this side will find a way to solve this problem before default and confiscation. But this is not a certainty. Any position in Petropavlovsk would be a gamble on political sensitivity, which is risky. A few tens or hundreds of thousands of shares (at 2p and under each) might be a fun bet, but it would really be a bet on that political sensibility.

Which brings us to Polymetal which we have discussed several times recently.

The situation here is different. Polymetal sells concentrate, not delivery bars. It is therefore not a question of selling through a bank which may or may not be sanctioned. There is also about half – almost half – of the business in Kazakhstan, which is outside of all these issues, take a look at these other two pieces for more details on all of this.

But it’s still a gold mine in Russia that could be hit by some of the sanctions. They have working capital loans that need to be refinanced this year for example. Similar to Petropavlovsk, we are looking at a UK company (Jersey, which counts as UK in this sense) doing business in Russia. As far as we know, there are no direct sanctions that should affect the company. But what about the indirect?

It is a significant risk.

We also talked about Norilsk Nickel. It is legally quite different. It is a Russian company, listed in Moscow. NILSY, what we could exchange, is a certificate of deposit. There is, so far at least, no sanction against Norilsk itself. Nor against the controlling shareholder – or at least the main one – Potanin.

There is a concern that is whispered in the market. That the bank issuing the certificate of deposit may not be able to continue to hold the underlying shares. It’s more of a concern with the Russian companies which were directly sanctioned of course.

It’s not a particularly strong concern this week though. The Moscow stock exchange has reopened but foreigners are not allowed to sell their positions. Thus, the custodian banks cannot empty the underlyings, thus making the receipts somewhat theoretical, or even closed at any price before any chance of recovery. No one knows how long this foreign sales ban will last.

On paper at least those who bought NILSY downstairs did very well. For this price Norilsk in the reopened Moscow market is holding up so far. Not that the position can be closed just yet.

The point of this

The purpose of this article is not to make recommendations on any of the three, Petropavlovsk, Polymetal or Norilsk. Rather, it’s to point out that sanctions are a much more complicated beast than we so far thought.

Petropavlovsk is unsanctioned and yet it is possible – mind you, only possible – that it will go bankrupt if it plays by the sanctions rules. She can’t sell gold to her secured lender, can’t refinance the loan because she’s not allowed to repay it, so what can she do without an easing of those penalties?

In what other ways will the application of these various rules of sanctions impact those who, apparently, should not be concerned since they themselves are not sanctioned?

My opinion

It is not possible to trade NILSY at present – at least I don’t think it is – so there is no point in trying to determine its value. I still think Polymetal is the most likely to survive given the Kazakh activity and is probably worth more than the current price. Petropavlovsk, as above, is a bet of a penny stock, almost option value, on the authorities making an exception to the sanctions rules.

But what I mean here is that there is more risk than knowing who is sanctioned. Because as these sanctions work through the connections in the economy, more people will be affected.

The investor’s point of view

The real value for us as investors in the Petropavlovsk issue is like a window into how the sanctions will unfold. If the authorities insist that the situation with Gazprombank plays out – you can’t meet the terms of the contract but you can’t refinance either – then the future value of all those connected Russian stocks is less than we might think. now. If, on the other hand, they agree that it’s ridiculous and change the rules enough to allow a solution here, then that’s very positive for the value of the only other we can trade, Polymetal.

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