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The world s biggest gas-producer is ailing. It should be broken up
Mar 23rd 2013 | MOSCOW |From the print edition
THE good times for Gazprom once seemed like they would never end. The world s
largest natural-gas producer, founded out of the old Soviet gas ministry,
enjoyed sky-high gas prices for years. The gas flowed along pipelines into
Europe; the profits flowed back. Gazprom began work on a $1.9 billion
headquarters in St Petersburg and acted as a bottomless wallet for Russia s
rulers. Whatever problems it encountered, it could drown with money , as
Natalia Volchkova of the New Economic School in Moscow puts it.
All this is now under threat. Its ageing gasfields are in decline. Thanks to
America s shale boom, gas is more plentiful on the world market. Gazprom s
European customers are realising that they have other choices. The prices it
can charge are falling, and with them the firm s prospects.
Years of easy money have made Gazprom fat and slow. It dominates its domestic
market, producing 75% of Russia s gas. It enjoys a monopoly over exports of the
stuff. Until recently, it had a tight grip on western Europe, where it supplies
around 25% of gas. It retains an even tighter grip on former Soviet-bloc
countries in eastern Europe. For a long time, this insulated Gazprom from
shifts in global gas markets.
Gazprom is not a normal company. It serves two masters. As a firm that issues
shares to outside investors, it should in theory strive to maximise profits in
the long run. But since it is majority-owned by the Russian state, it pursues
political goals, too.
In practice, it serves one master more assiduously than the other. As President
Vladimir Putin consolidated his power in the early 2000s, he built Gazprom into
a main instrument of Russia s new state capitalism. He appointed allies to top
positions. He used Gazprom as a tool of foreign policy, for example by cutting
off gas supplies to Georgia, Ukraine, Belarus and Moldova during political
rows.
Gazprom s deep pockets have helped Mr Putin at home, too. It sells gas cheaply
in Russia, so that the poor do not freeze in winter. Oddly for an energy
company, it has bought television stations and newspapers, all of which are now
friendly to the Kremlin. Mikhail Krutikhin of RusEnergy, a consultancy, says,
Gazprom has one manager: Putin.
With friends in high places, Gazprom has enjoyed low taxes and privileged
access to gasfields. But its costs are startlingly high. It treats its
executives generously: a 2008 tender, for example, included a solarium and a
special bath for horses. It buys supplies in an idiosyncratic fashion, too. The
Peterson Institute for International Economics, a think-tank, reckons that
although Gazprom posted nominal profits of $46 billion in 2011, it lost $40
billion to corruption and inefficiency.
And some projects favoured by Mr Putin are of questionable economic value. For
example, he is dead set on building a $21-billion South Stream pipeline between
southern Russia and Austria via eastern Europe. This project has political
appeal because it would bypass troublesome Ukraine as the main transit route
for gas to Europe. But given weak prices and demand, it is commercial idiocy ,
says Mr Krutikhin. The opening in 2011 of Nord Stream, an offshore pipeline to
Germany, was a diplomatic coup for Mr Putin, but it is still running far below
capacity.
These days, Gazprom is finding itself in an unfamiliar situation: it has more
problems and less money with which to drown them. On March 4th its shares hit a
four-year low. Investors reckon Gazprom is worth only a third as much as it was
in 2008. By one broker s calculation its market capitalisation of $110 billion
is barely half the value of its assets.
And this is where you ll bring me a coffee
Of pipes and power
The central battleground for Gazprom is Europe, its traditional stronghold and
the source of 40% of its revenues. Gazprom is fighting to preserve its old
pricing system, whereby big European customers sign long-term contracts linked
to the price of oil. But those customers now have the option of buying
liquefied natural gas (LNG) that America no longer needs to import.
Gas on the spot market is often much cheaper than Russian gas delivered under
long-term contracts. Norway s Statoil, a nimbler state-controlled energy firm,
has cut its prices and grabbed market share. Gazprom has slowly and reluctantly
offered price cuts too, which it expects will cost it $4.7 billion this year.
Citi, a bank, calculates that every drop in European gas prices of $1 per
million British thermal units reduces Gazprom s profit by $4 billion. Gazprom s
managers act as if this is a temporary inconvenience. They insist that the old
system of oil indexation is here to stay.
Because so many of its customers are tied to contracts, the full effects of the
global gas glut on Gazprom s bottom line will not be felt straight away. But it
is already cramping investment. Last August Gazprom and its partners, France s
Total and Norway s Statoil, decided to freeze a colossal offshore project in
the Barents Sea, which was intended to produce gas destined for export to
America.
The final threat to Gazprom s old way of doing business is legal. An antitrust
probe launched by the European Commission alleges that Gazprom is using its
dominant position in central and eastern Europe to restrict competition and
hike prices. If it loses the case, it could face a fine of up to $14 billion
and lose the mighty lever of being able to charge some European countries more
than others.
An adverse ruling might also threaten its strategy of trying to dominate the
European gas market by owning both the supplies and the means of distributing
them. Gazprom has quietly bought gas pipelines and storage facilities. It has
tried to strike deals whereby it lends money to impoverished European utilities
in order to secure their custom. If this strategy stops working, Gazprom will
no longer be such a potent foreign-policy tool for the Kremlin.
The Miller s tale
For years, Gazprom s bosses were in denial about threats to its business model.
Alexey Miller (pictured), the chief executive, called the shale-gas boom a
myth . Of late, however, Mr Putin appears to have woken up. He admitted last
year that there has been a real shale revolution and said Russia must find
mutually acceptable forms of co-operation with consumers.
Gazprom s future may involve more robust competition even at home. Two domestic
rivals have emerged: Novatek, a gas producer part owned by Gennady Timchenko,
an old acquaintance of Mr Putin s, and Rosneft, a state-owned oil firm led by
Mr Putin s trusted adviser, Igor Sechin. Put together, non-Gazprom firms now
account for a quarter of all Russian gas production. The rise of Novatek and
Rosneft do not suggest that the Kremlin set out to create competition , says
Ms Volchkova, but rather that it decided not to block it, as it might have
earlier.
Novatek, which is developing a vast gasfield in the Yamal peninsula with France
s Total, wants the Kremlin to revoke Gazprom s export monopoly. No decision
has been made yet, but the Kremlin could decide to loosen the monopoly by
liberalising LNG exports while keeping Gazprom as the only exporter of piped
gas.
In the short term, Gazprom s troubles in Europe could protect it from its
rivals at home. The Kremlin is likely to react defensively to pressure from
hard-bargaining European customers and regulators. It may opt to shelter
Gazprom at the expense of Novatek and others. But the overall message is clear:
Gazprom cannot count on its gilded position lasting forever.
That means it must think about what sort of company it will be in the years to
come. If things don t go Gazprom s way, it can still threaten to withhold
supplies. It hopes to avoid such a scenario, says Sergei Komlev of Gazprom s
export division, but the company has the right not to deliver gas if we don t
like the price.
Act too much like a bully, however, and customers will shop around. Besides
buying more LNG, some EU countries are keen to start fracking on their own
territory. Exploratory drilling proceeds apace in eastern Europe, though
fracking is still banned in France, Bulgaria and the Czech Republic.
Gazprom badly needs to find two things: new sources of gas, and new markets.
Neither will be easy. Its gasfields are running down. The International Energy
Agency, a rich-world energy club, reckons Russia s gas producers must spend
$730 billion by 2035 merely to replace most of their current production of 655
billion cubic metres a year. But much of Gazprom s 35 trillion cubic metres of
reserves are in barely accessible places such as the Yamal Peninsula, the Far
East and Eastern Siberia. Gazprom will have to pay much more to get this gas
out of the ground. Can it do that? The omens are not good.
In 2011 it invested $40 billion with little to show for it. Production has not
grown since 2001. Meanwhile Gazprom is losing its technological edge. Some
insiders predict that the company will be able to sell gas at high prices to
Europe for long enough to raise the necessary cash to invest in developing new
gasfields. That sounds optimistic. If the firm were better run, it would have
found ways to move more gas to Asia, where prices are much higher than in
Europe (let alone America).
One way would be to liquefy the gas and ship it. But Gazprom has been slow:
despite pumping a sixth of the world s gas, it has just a 20th of the LNG
trade. A planned $7 billion LNG facility in Vladivostok will help, but Gazprom
will need to invest billions to ramp up production.
The other way to get gas to Asia would be via pipeline. The obvious destination
is China, which sits on Russia s doorstep and is potentially the world s
biggest market for gas. The two countries have haggled unsuccessfully for a
decade. In February they revealed they had agreed to everything related to
pipeline exports apart from the price. China has signed up to import gas from
Central Asia, Australia, the Middle East and west Africa; almost everywhere, in
fact, except Russia. China refuses to pay Asian prices; Gazprom won t budge.
Creating a more nimble, commercially minded Gazprom would require massive
political will. The firm has traders around the world who could take advantage
if Gazprom started producing lots of LNG. It has built-in advantages, like
access to once-frozen Arctic routes for shipping LNG. It might even try to woo
more investment from the world s big oil firms, though they may prefer to
invest in easier countries than Russia.
The rational approach, many analysts agree, would be to split Gazprom s
pipeline business from the production and sale of gas. This would ensure that
economically senseless pipeline projects are not subsidised by exports. Beyond
that, Gazprom would probably benefit from being split into a handful of
separate gas producers which would then compete to extract and market smaller
corridor gasfields close to existing ones or pipelines. These fields have
plenty of gas but are too small for Gazprom to bother with. A bit of
competition might help to control runaway costs.
Gazprom still has many advantages, from vast gas reserves to gas-hungry
neighbours. But it has exploited them so ineptly that one analyst likens the
firm to a dinosaur on jet-powered rollerblades . For now, only Mr Putin can
change that. If he waits, soon neither he nor Gazprom will have much choice.
From the print edition: Business