After weeks of murky deliberations, Russian state oil company Bashneft could be privatised to the state, in the form of oil giant Rosneft. But while the government still says nyet, it is the Kremlin, the true seat of Russian power, that will call the decisive shots.

Government lawyers say they found no legal impediment to state-controlled Rosneft participating in the deal, thereby potentially enlarging its share in the country's total oil producing assets to more than half, gazeta.ru reported on July 28, citing sources close to the looming deal.

Rosneft, which was largely built on remnants of the independent Yukos oil company, dismembered by the state in the mid-2000s, is headed by Igor Sechin, an influential ally of President Vladimir Putin. A longstanding member of Putin's inner circle from St Petersburg, Sechin was dubbed the "oil Tsar" for spearheading the rapid consolidation of state oil assets during Putin's third presidential term.

As the sale of the 50.1% stake in Bashneft has been approved and fast-tracked by a separate decree, it is not regulated by other privatisation guidelines, and is therefore open to all buyers, including other state companies, the gazeta.ru sources explained.

But while the lawyers may have given the green light, government officials continue to dig in their heels. "A decision has been made to not allow companies controlled by the state to participate in the privatisation," Deputy Prime Minister Arkady Dvorkovich was also quoted as saying by Vedomosti daily on July 28.

And however it's dressed up, that this would effectively be a sale by the state to the state is not lost on people: "If Rosneft takes part in the privatisation, it will only be moving the same money around," an unnamed government official told the newspaper a day earlier.

He also noted how repeated reports of Rosneft's interest are undermining the broader privatisation campaign to raise some $15bn to shore up the federal budget. Also expected to go on the block in the coming months are state shares in Sovcomflot, VTB bank, Russian Railways, Aeroflot, and some of Rosneft itself. 

Inside job

The drive got off to a solid start with this month's SPO of 10.9% of diamond miner Alrosa in Russia's first successful privatisation since 2013. But uncertainty around the Bashneft sale raises concerns that the privatisations can be compromised by Kremlin reluctance to release key assets from the grip of a clique of "stoligarchs", loyal business leaders ranged around the seat of state power.

Despite the reported sending of more than 50 invitations to buy into Bashneft to foreign oil majors, sovereign wealth funds, and the usual band of industrial tycoons, all four leading bidders so far appear to be domestic: state-controlled Rosneft, independent oil major Lukoil, and lesser-known players NNK and Antipinsky Oil Refinery. 

The latter two are controlled by ex-head of Rosneft Edward Hudatainov and an ex-classmate of Putin's, Nikolai Yegorov, who reportedly controls 20% in Antipinsky.

Line to the top

The strong interest in Bashneft is not accidental, as it is one of the most attractive assets in the oil and gas sector, steadily increasing output despite the decline in oil prices seen since 2015.

Bashneft's market value has been growing as it basked in the spotlight in recent months, currently reaching RUB466bn ($7.1bn), which makes a controlling stake worth just over $3.5bn.

Even despite the recent rally on Bashneft shares due to privatisation talks, Gazprombank in June argued that the valuation is justifiable, with the company being "probably the best [acquisition] target in the Russian oil and gas sector".

"There's a line from here to the Kremlin to buy Bashneft," a person familiar with the privatisation process told the Financial Times on July 27.

The company remains doggedly attractive despite its turbulent recent history. Bashneft was privatised in the early 2000s by AFK Sistema by consolidating oil and gas assets of Russia's Republic of Bashkortostan, and was effectively renationalised in 2014 by court order after Sistema chief Vladimir Yevtushenkov was placed under house arrest.

As the controversial case of re-nationalisation was unfolding, many commentators feared that extracting Bashneft from Sistema was the new "Yukos case", referring to the jailing of oligarch Mikhail Khodorkovsky and the ensuing firesale of the company's assets, said to have been orchestrated by Sechin and marking the rise of Rosneft's domination of the sector.

Rosneft's shadow was already hanging over Bashneft in 2011 when the state behemoth was reportedly competing for the major Trebs and Titov oil fields, auctioned to a joint venture of Bashneft and Lukoil.

In 2013, after acquiring Russia's third largest oil producer TNK-BP for $44.4bn in cash and 12.84% of its own shares, Rosneft was said to have set its sights on Bashneft next.

"They've had their eye on Bashneft since 2013. It's not a shock to hear they're interested," James Henderson, Russian oil specialist at the Oxford Institute for Energy Studies, told the Financial Times.

Kremlin at the reform fork

"We are categorically opposed to the idea [of Rosneft taking part in the deal], that would not be true privatisation," an unnamed government official told the Vedomosti business daily earlier. 

Indeed, preferring Rosneft to a group of anchor investors or privately owned Lukoil, which is regarded as having great synergy potential with Bashneft, would undermine the image of the privatisation efforts.

Gazeta.ru on July 27 reported claims that a separate decree by Prime Minister Dmitry Medvedev could now rule out the participation of Rosneft or any other state company.

However, the Kremlin's position is what ultimately counts, and it is apparently increasingly shifting in Rosneft's favour.

Presidential spokesman Dmitry Peskov recently cited "an understanding" in the government and the Kremlin that state-owned companies should not participate in the privatisations. But on July 27, Peskov took a new tack, saying that Rosneft "formally speaking, is not a state company" since it is owned indirectly via a holding company. Indeed, a 69.5% stake in Rosneft is held by Rosneftegas, chaired by no other than Sechin.

Since spring 2016, Kremlin-initiated policy discussions and brainstorming have been seeking new ways to fuel Russia's economic growth in the aftermath of recession and transition to lower oil prices. This has made analysts hopeful that long-overdue reforms could be around the corner.

But the path the Kremlin takes on the Bashneft deal will shine more light on its readiness to embrace genuine structural reforms and market instruments, rather than rigid control of hydrocarbon rents and state company domination.