Politics / Issue August 28, 2008 63

404 Putin And Gazprom

Politics

02.09.2008

In February 2008 the authors of this paper published an independent expert report titled Putin.Itogi (fittingly, Putin. Summing up.), where presented was their vision of the outcomes of activities and political heritage of the Second President of the Russian Federation. In that report we gave uncomplimentary, though fair, assessment of working by Vladimir Putin in various spheres of our life economy, army, pension system, health care, road infrastructure and other areas. The report was based on figures and facts concealed from Russian citizens by official propaganda.  

However, many readers have made a note that there is one issue we have touched too slightly. Thats about condition of the Russian energy industry in general and Gazprom in particular.   

That was not an accidental omission by us. We consider it that the situation about Gazprom requires special consideration which would not be possible to be fit in just a couple of paragraphs. First, this is because Gazprom and what is happening in this company is of special importance for the entire country. Second, this is because we have first-hand knowledge of Gazprom problems, having had direct relation to this company in our professional activities as a former fuel and energy minister and the deputy energy minister of Russia. Third, this is because Gazprom has been a kind of special and personal project by Putin. From the very beginning of his presidency he has cared for the company, appointing his people to the key posts and looking into all the details carefully. Gazprom is one of few projects where Putin can be considered personally responsible for the results, from the beginning of his office, and one of the projects to be taken as a criterion for assessment of Putins presidential activities.   

In this present paper we intended to develop analysis given in the report Putin.Itogi and to focus on what has been happening to Gazprom these years. If you are interested to learn about that, here is the Putin and Gazprom report for you.  

Gazprom as the main personal project by Putin 

Gazprom is a unique phenomenon in the Russian political and business life. In 2007 proceeds by Gazprom amounted over $93 Bn, which is 7% of the Russian GDP. This is 2.5 times as much as our defense spending. Gazproms share in the industrial production is over 12% and in the cost structure of the Russian export is about 16%. The company makes about 43% of the Russian production of primary energy carriers and has similar share within the structure of the national consuming the energy resources. Gas supplies by Gazprom secure up to 40% of production of electric energy in the country. In fact, Gazprom is an energy core of the Russian economy. Stability and prospects of our economy depend greatly on effective and reliable working by the Company.

The Company is also a key player in the world energy market. The volume of oil and gas extraction by Gazprom takes a share of 5% of the world production of the energy resources and about 8.3% of the world production of petroleum and gas. Supplies by Gazprom make for over 50% of the gas import by the EU countries.  

Its difficult to find another company of a similar scale and similar extent of political and economic influence in Russia. Significantly, Evgeny Yasin once called Gazprom a purse of the government, as the Company has no equals in terms of the degree of concentration of the financial means and opportunities of quick mobilization of those means for the purposes needed by the government.  

In the 90s the authorities used this resource from time to time for solving political problems, like it was in 1997 where the government dealt with the task of paying off the arrearage of pensions. Then President Yeltsin commissioned that Gazprom pay off major part of its arrearage to the Pension Fund in the amount of $2 Bn so that to finance the payments of pensions.     

Over the years of Putins presidency the Gazprom resources have been used for different purposes. This is what we are going to tell about within the framework of the given brochure.  

Gazprom has become the most important personal project by President Putin. Right after coming to power, he began to have an eye on the company. Even over the course of the presidential election campaign of 2000 it was clear that energy issues and Gazprom were the key elements on the Putins political agenda. In June 2000, just a month after his inauguration, Putin managed to make a prompt replacement of Viktor Chernomyrdin for his closest team-mate Dmitry Medvedev at the post of chairman of the board. And in May 2001 the head of Gazprom Rem Vyakhirev, who had managed the company since its foundation in 1992, was substituted with Alexei Miller.   

Gazprom is more than just a joint-stock company. The entire national economy is based to a significant extent on the gas industry. These words by Putin, spoken at a meeting held on 30 May 2001 in the Kremlin and dedicated to dismissal of Vyakhirev and appointment of Miller, have let understand clearly his attitude towards the Company at the very beginning of his presidential term.   

Gazprom was the first business structure where Putin began seizing systematically the key positions appointing his people to the commanding posts and ousting members of the old management team. The supreme leadership of Gazprom was soon filled with old acquaintances of Putins from the times of working in the St Petersburg administration. As of today, 11 out 18 board directors managing financial matters, property issues, corporate management, are people who in the 90s worked either in St Petersburg Administration or in OAO Sea Port of St Petersburg, or in some St Petersburg commercial structures, or in FSB.       

Such a practice is uncharacteristic of large global energy entities. Usually the leading positions there are taken by professionals having many-year experience of working in high-ranking posts in different energy corporations. As a rule, former minor regional officials, employees of ports and building companies are not appointed (particularly in such a big number) to fill the positions of top-managers in the leading oil and gas corporations.   

However, Putin, who made in person all the appointments, staked not on professionalism but on belonging to his St Petersburg clan.    

This is not only about seizing the management in the company. Putin dedicated significant part of his working time to solving the current problems of Gazprom functioning. Major part of the agenda of his international meetings and visits to abroad was related to lobbying various Gazprom projects.    

Putin stood for Gazprom interests over the course of consideration of questions related to regulation and development of the gas industry by the Russian government. When in 2002-2003 the cabinet of Mikhail Kasyanov attempted to include a question of reforming the gas industry and opening this sector for competition, the question was constantly dismissed under request from the Kremlin. Recently, when reproofs to Gazprom have become more frequent (also from the governments officials side) regarding unacceptably low level of tax paying by the company, Putin has protected Gazprom from tax increase, and the government has undertaken to keep the previous level of taxation of the company till 2010.      

With Putins approval the government has signed the program of sharp increase of gas prices for the Russian consumers making it correspondent to European prices. Gazprom has been lobbying this decision for 15 years and it failed to get it in cabinets of Gaidar, Chernomyrdin, Kirienko, Primakov and Kasyanov. The program was finally accepted with the Regulation #333 of 28 May 2007, signed by Mikhail Fradkov. In accordance with this program, the gas prices for the Russian consumers are to have doubled by 2011 compared to todays level, and amount to at least $125 for 1,000 cubic meters (todays price is about $64). Probably, in reality the prices will be even higher, as the gas prices in Europe have been going up rapidly and unpredictably.     

Over the years of his presidency Putin has proved to be a very effective lobbyist and advocate for Gazprom interests.   

Has the country got any advantage out of that? Have Russian citizens got any benefits out of such undivided attention by the President to the main company in the country?  

Reliability of securing gas for the country getting worse 

The appointed by Putin management having been working for 7 years it seems reasonable to make it accountable for production and economic results of the companys activities over the mentioned period. The results are rather poor. Above all, Gazprom management has failed the main function by the company thats reliable gas supply to the Russian consumers. It is considered that exactly in exchange for this function performing Gazprom was given all the privileges, including the monopolist status and active support from the state.    

However, the volume of extraction by Gazprom has not grown over these years, and it even decreased in 2007 down to the level of 1999. Considering the exhaustion of the old gas fields, the stagnation of the gas extraction may turn into complete decline in the near future.    

Gazprom supplies to the Russian consumers have not increased either. In 2007 the volumes of gas supplies to the home market amounted only 307 billion of cubic meters, which is only 2% higher than the figure of 2001. In the meanwhile, the home demand for gas has increased for 18% or almost 67 billion cubic meters per year! 

Thus, the gap between home demand and supply is growing changing from 72 bn of cubic meters in 2001 up to almost 132 bn of cubic meters in 2007. Today Russia has to satisfy about one third of her need in gas through using the non-Gazprom products.   

This gap has been traditionally closed with supplies by independent Russian gas producers and with import of gas from the central Asia countries. However, at the moment the possibilities by independent producers being restricted, the rapidly growing dependency on importing the gas from Central Asia leads to the sharp growth of costs by Gazprom (this will be considered in more details below).  

The problem of insufficient gas supplies in the home market, getting sharper against the background of the export obligations by Gazprom, is turning into a real threat. So far Gazprom has been lucky with favorable weather conditions: two last winters have been relatively warm which helped smoothing the winter peaks of gas consummation. However, even considering the mild temperatures, the demand for gas increases in winter period.      

Indirectly, this may be seen at an example of the last winter season of 2007-2008 where under conditions of gas extraction stagnation the gas extraction from the underground storing facilities went up to a top record figure of 50.1 bn of cubic meters, which was 20% more than the average figure for the three previous winters! By the end of January, the underground gas storages of Gazprom had been exhausted almost completely. Along with that the daily output increased only for 2-3 % compared with the previous season, despite the fact of putting into operation the new relatively large Yuzno-Russkoe gas field.       

The winter of 2007-2008 was featured with a top record of daily extraction of the gas from underground storages thats 583.6 million of cubic meters per day, which is higher than the record of the really cold winter of 2005-2006.   

This shows how much the wintertime demand for gas has grown even under conditions of relatively mild winters. One may suppose the threatening consequences to affect Russia in case one of the next winters is really cold. One should expect large-scale cutting off of the vitally important facilities due to the gas shortage.  

Similar picture we could see in the winter 2005-2006 where mass restriction of gas supplies had to be imposed on the consumers. According to the RAO EES, the total restrictions of the gas supplies to the Russian electric power stations on the cold days of January-February 2006 was 12.5% against the target volumes for the entire United Energy System and up to 80-83% for the power stations of the central region and the North-West.    

In other word, there was almost complete turning off of gas supplies to power stations in the European part of Russia (should it be reminded that the gas is the dominating fuel used for producing electric energy in Russia?). 

In January-February 2006 there was a serious tension also about export gas supplies. According to information by the media, on 18 January 2006 Gazprom decreased voluntarily the volume of transit of the gas through Ukrainian territory from 390 to 350 million cubic meters per day due to shortage of the gas. Same day Gazprom informed its Italian partner, the ENI Concern, of its incapability to guarantee the gas supplies in the planned volume due to extremely cold temperatures, after which restrictions of Gazprom supplies were reported by Serbia (25%), Croatia (6-10%) and Hungary (20%).      

The reason for stagnation of the gas supplies in the home market against the background of the growing demand is a systemic shortage of investments into extraction. Russia possesses sufficient stock of the proved reserves of the gas, which should be enough for the next 80 years with todays level of the extraction. However, many of those fields are not explored. Significant part of the reserves is concentrated in the fields in the new unexplored areas where there is no developed infrastructure and this is why those areas are so difficult for exploration.      

For example, to explore the fields in the peninsula of Yamal situated at a distance of 500-600 km to the north of the standing regions of the gas extraction, it takes construction of a 540 km long railroad that is to pass permafrost areas and the lands waterlogged for 50-60%, featured with a lot of small rivers and streams. To deliver the gas from the peninsula of Yamal it is necessary to build a gas pipeline with the length of 1,100 km, underwater part of which is also to pass on the permafrost and waterlogged territories.        

According to licenses given, Gazprom was to put those fields in operation at the late 90s. However, nothing real has been done about that. In 2000 the former head of Gazprom Rem Vyakhirev asked for prolongation of the licenses. He was refused first, however, after appointment of Alexei Miller to be the head of the company, the license terms were postponed for 8-12 years in a quiet way and without any explanations given. And now even those terms are going to be unmet.   

Against the background of declining volumes of extraction at the old gas fields, put into operation as far back as 1980s, Russia is going to face a threatening problem of the gas deficit. The Yuzhno-Russkoe field is the last relatively large field remaining in the standing area of the extraction where the infrastructure is rather well developed and conditions of extraction are more favorable. The new gas will have to be taken from unexplored fields, one of the most complicated in the world, where exploration and making the necessary infrastructure will require vast investments. According to fresh estimation by Gazprom itself, the cost alone of the construction of the Bovanenkovo-Ukhta pipeline will be $80-90 Bn, while the entire project of exploration of the Yamal may take an amount of up to $200 Bn, which is more than all the Russian Stabilization Fund!      

Why all those investments havent been done so far, considering it was planned that the gas from Yamal gas fields was to be delivered to the continent at the late 90s?  

The problem is that over all these years Gazprom intentionally has spent only relatively minor means on investments into its profile business, i.e. gas extraction. The vast super profits, gained out of rapid growth of the export and domestic gas prices, Gazprom has spent on buying up the assets and on financing the rapidly growing costs.    

That way, within the period from 2001-2007 only slightly over $27 Bn have been spent by the Company on the capital investment of its main business, the gas extraction.  

Just compare: in 2003-2007 Gazprom has spent $44.6 Bn on buying the assets. Over $30 Bn in that amount were assets having no relation to the gas industry. Thats mainly oil companies (Sibneft, Tomskneft) and electric energy companies (RAO EES, Mosenergo, wholesale and territorial generating companies), also Rosukrenergo trader.  

If those means had been spent on exploration of the new gas fields, Russia would not be posed a threat of the gas supplies crisis.  

While the fields in Yamal are not getting explored yet, Gazprom has got into dependence on the gas import from the Central Asia. If in 2002 the share of the Central Asian gas was slightly over 4% in the Gazprom balance, now the figure is 8%. In the meantime, this gas is going up rapidly. In 2003 a thousand cubic meters of the Turkmen gas cost to Gazprom $30. Today the price is $150. And since 2009 on, the figure may become $250 or even higher. 

No wonder that the financial report of Gazprom for 2007, made in accordance with the international standards, has shown a paradoxical result: with the growth of proceeds of more than 8% out of the gas selling, the profits out of selling have reduced for 11%. And this figure appeared against the background of steady growth of gas sales in 2007, including 22.5% for the Russian consumers and the average 25.2% for the CIS countries.   

How can it have been shown reduction of profits out of sales with the rapid growth of prices? The Gazproms management makes no secret out of the fact that the reason is the growth of costs, where the main article is buying up the gas from the third persons (cost of such buying has increased for 36%). If in 2003 the expenses for bought oil and gas were less than a billion dollars, in 2007 the figure was $15 Bn or more than a quarter of all the operational costs by the Company!        

The biggest share of those costs is rapidly growing costs for buying the gas in the Central Asia: a bit over $ 1 Bn in 2006; $7.5 Bn in 2006; $11.7 Bn in 2007.

In March 2008 the heads of the petroleum companies from Kazakhstan, Uzbekistan and Turkmenistan advised Gazprom that since January 2009 they are going to change for the new tariffs of the gas supplies, making it proportionate to the European prices. That means, the purchasing prices may reach the limit of 250-300 dollars per one thousand cubic meters. Thus, the costs for buying the Central Asian gas will increase to $17-21 Bn per year.     

There is another problem hindering the increase of investments into gas extraction, thats a very low economic effectiveness of the activities by Gazprom. The operational costs of the Company (with taxes excluded) have increased as many as three times compared to the year 2003: from $4.9 to $14.8 per barrel.      

Besides the growth of costs for the bought gas, the rising figure of the wage payment is another article of the expenses increased. The figure has gone up from $3.7 Bn in 2003 to $9.7 Bn in 2007, or counting it in barrels of the extracted oil equivalent this is the change from less than $1 per barrel in 2003 to $2.5 in 2007.   

Gazprom headcount has been constantly increasing, going from 391,000 in 2003 to 445,000 in 2007.   

To be able to finance its growing appetite on buying the assets and to pay the growing costs, Gazprom has got indebted greatly. The Companys debt that was $13.5 Bn at the end of 2000 reached the figure of $61.6 Bn or 66% (two thirds) of the annual proceeds. It should be noted that with the international petroleum companies the normal figure of proportion of the debt to the annual proceeds is considered to be no more than 10-15%.   

Vast payments for servicing the debt hinder the investments. Moreover, there is a risk that in case of aggravation of the export price conjuncture Gazprom would have to reduce investments or even go bankrupt.

Possible consequences then would be accelerated price rise for gas for the home consumers, worsening the crisis in the gas extraction and probable spending of the state financial resources made for getting Gazprom avoid the bankruptcy. 

So it turns out that the gas resources lying in the depths and allegedly belonging to people, in reality are disposed of by a narrow circle of persons who are close to the countrys leadership.   

(Published with abridgements. To be continued.)

  








Reference: Gazprom, Explanations to the financial report under international standards


Boris Nemtsov
Vladimir Milov 


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