Russia: Gazprom -- A Troubled Giant

Gazprom HQ in Moscow (AFP) Gazprom, the largest gas company in the world, is the jewel in the crown of Russian business. It employs over 300,000 people and its tax contributions account for more than 25 percent of the Russian budget.

Gazprom owns the entire gas-pipeline infrastructure in Russia -- all 144,000 kilometers, along with the compressing stations. Not only is the company the largest producer of gas in Russia, it also controls the sole means of getting gas to domestic and export markets.

By Russian law, Gazprom is obligated to allow other entities to use its pipelines for domestic needs, although not for foreign exports. However, it is allowed to refuse to do so in the case of pipelines being filled to capacity -- the company often does so without offering any evidence.

Gazprom, among other holdings, owns its own bank, Gazprom Bank; an insurance company, Sogaz; a media holding company, Gazprom Media; and recently it purchased the Zenit football team in St. Petersburg.

The company has close ties with the Kremlin. The chairman of the board of directors is Dmitrii Medvedev, Russian President Vladimir Putin's former head of administration. The president is Aleksei Miller, a close friend of Putin's from St. Petersburg.

Gazprom controls 25 percent of the world's gas reserves and 94 percent of Russia's natural gas. It is the only company in Russia legally allowed to sell gas outside the borders of the former Soviet Union -- a factor that largely contributed to the recent gas conflict between Ukraine and Russia and placed European gas supplies in danger.

Brief History

Gazprom traces its origins to the Soviet Gas Ministry, which was created in 1965 when the USSR first decided to place a greater emphasis on gas production and consumption.

In 1989, the ministry became Gazprom and its first head was Viktor Chernomyrdin, presently the Russian ambassador to Ukraine, who earlier had been appointed by Soviet leader Mikhail Gorbachev to be gas minister.

In 1993, the corporation was reorganized into the Russian shareholding company RAO Gazprom, which in 1998 was renamed OAO Gazprom, the name it bears today. In 2005, the Russian state became the majority shareowner (51 percent) of Gazprom.

Production And Investment Problems

Despite its size and predominant position in Russia and the world, Gazprom is seen by many as a mismanaged giant unable to reform itself into a modern company and one with substantial problems hidden from the public inside its glass and steel headquarters in Moscow.

In its 2005 country brief on Russia, the U.S. Energy Information Administration (EIA) was downbeat about Gazprom's market position:

"Russia's natural gas industry has not been as successful as its oil industry, with both natural gas production and consumption remaining relatively flat since independence. Moreover, Gazprom's natural gas production forecast calls for only modest growth (about 1.3 percent) by 2008. Russia's natural gas sector has been stunted primarily due to aging fields, state regulation, Gazprom's monopolistic control over the industry, and insufficient export pipelines. Three major fields (called the 'Big Three') in Western Siberia -- Urengoy, Yamburg, and Medvezh'ye comprise more than 70 percent of Gazprom's total natural gas production, but these fields are now in decline; and the government and Gazprom each project steep declines in Russia's natural gas output between 2008 and 2020."

The EIA study reflects the views expressed in a Russian gas industry analysis prepared in 2004, which examined Gazprom's long-term prospects and its ability to supply domestic as well as European and Asian customers with enough gas to meet skyrocketing demand.

The study found that in order for Gazprom to meet its obligations in 2020 it will need to begin a serious revamping and expansion of its gas transportation system -- the trunk pipelines and compressor stations -- as well as develop new fields.

According to the Russian industry study this means:

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• The construction of 26,000 kilometers of 1420 millimeter diameter trunk pipelines between 2004-2020
  

  
  

• 137 new compressor stations
  

  
  

• The development of new major gas fields -- the most important being in Yamal and in the Ob-Taz shelf, both in western Siberia. As it stands today, the "big three" major fields in production will be producing only 23 percent of Gazprom's needs by 2020.

The Russian study estimates that, for new trunk pipeline construction alone, $3 billion per year is needed.

The study broke down the sectors where major investments are needed by the gas industry from 2001-2020:

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• Geological exploration: $25.5-33 billion
  

  
  

• Production costs: $44.4-52.5 billion
  

  
  

• Processing costs: $21-22 billion
  

  
  

• Transportation (pipelines etc.): $83-96 billion

That would mean investments totaling between $173 billion and $203 billion.

A recent study by the OECD notes that the development of the fields in the Yamal Peninsula and the Ob-Taz shelf will cost $25 billion, with the infrastructure costing another $ 40 billion.

Furthermore, the time lag of five-seven years between the start-up of work and the beginning of production suggests that no other super field outside of the Zapolarnoye gas field will be brought on-stream before 2010.

The recent Russian gas industry study further notes that Gazprom does not have the money for these investments. On 1 January 2003, its accumulated investment deficit had grown to $21.2 billion in addition to debts of some $10 billion. By 2005, this had greatly increased with the purchase of Sibneft for approximately $10 billion.

The recent liberalization of ownership of Gazprom shares is intended to raise the money needed for these projects and might indeed succeed in doing so -- or it might not, depending on how institutional investors react to the recent Russian-Ukrainian gas conflict and the price for Gazprom shares.

Gazprom has traditionally argued that much of its financial woes stem from artificially low domestic prices for gas. The OECD study shows that the current wholesale price for 1,000 cubic meters of gas for a Russian household in late 2003 was around $15.90, and to industrial users at around $24.20. By comparison, in the EU, household tariffs varied from $159 in Finland to $735 in Denmark for 1,000 cubic meters.

The OECD study of 2004 also reiterated the criticism made by the EU and other critics: "The reform of Russia's crucial and highly monopolized gas sector has repeatedly been postponed, and it is not clear that any substantial reform will be undertaken in the foreseeable future. Despite its enormous importance, the natural gas industry is perhaps the least reformed major sector in Russia."

Other critics, such as the Moscow-based Hermitage Capital Management, have contended that Gazprom is one of least transparent and wasteful companies in Russia.

Despite the less than rosy appraisal of Gazprom by industry experts, Russian Energy Minister Viktor Khristenko was quoted by Interfax on 5 January as saying that "Russia and Gazprom have been reliable partners for European consumers at all times. Gazprom has stood by its commitments since Soviet times, therefore Europeans do not have any doubts about Gazprom's reputation."

How Gazprom intends to remedy these wasteful and possibly corrupt practices is not known. However, what is known is that the Russian government does not intend to liberalize the gas industry in Russia and allow for competition.

The Gazprom monopoly on gas exports was reiterated by Khristenko on 5 November 2004, when he announced that it will continue at least until 2020. Europe will be forced to deal with Gazprom, the only gas company in Russia, if they want to buy Russian gas.