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July 12, 2007
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Plus Gasification of Entire Europe
All major Gazpromís projects have political underpinning. Sometimes, it makes them look contradictory. For instance, former Gazprom chairman Rem Vyakhirev said in 1998 that the North-European pipeline project was economically unfeasible. Ten years later, the same project, under the new name of Nord Stream, is considered one of the most promising routes to directly link Russia and the EU.
Subsidiary is to Return

Rem Vyakhirevís team was the successor of Viktor Chernomyrdinís team. Consequently, it carried on all drawbacks and advantages of the USSR Oil and Natural Gas Ministryís Soviet ways. Meanwhile, younger and more business-aggressive managers prevail in Alexei Millerís team. Vyakhirev, who headed Gazprom in 1992-2001, faced a strategic task: to create a competitive environment on the ruins of the post-Soviet oil and gas ministry authorized to do business. Vyakhirev implemented the task quite successfully. Beside numerous small private companies, several vertically-integrated corporations, such as NOVATEK, Itera, Nortgaz, Trans Nafta, were created. The new times set other tasks to Gazpromís new leader Alexei Miller. The general centralization of power in Russia required the consolidation of energy resources. Other management decisions became necessary for implementing that task.

Nowadays, Gazprom has 29.1 trillion cubic meters of natural gas in undeveloped deposits. Independent gas producers have 9.8 trillion cubic meters, and Russiaís undistributed fund is 11 trillion. DeGolyer & MacNaughton independent auditor examined 90.5 percent of Russiaís gas deposits, 89 percent of gas condensate deposits, and 67 percent of oil deposits. The auditor estimated the cost of all Gazpromís hydrocarbon resources at $87 billion, as of March 31, 2006. For a second year running, deposit increase exceeds extraction in Gazprom. The increase in 2006 made up 587.5 billion cubic meters in the S1 category. So, the replenishment of the mineral resources base in 2006 by means of geologic exploration works exceeded 100 percent (Gazprom extracted 556 billion cubic meters of gas in 2006). Three gas condensate and two oil deposits, two gas, six gas condensate, and 25 oil reservoirs were discovered by the exploration works. Meanwhile, almost no funds were being allocated for geologic exploration in Vyakhirevís times, and Gazpromís deposit increase was minimal, 81.7 billion cubic meters in the S1 category according to Gazpromís annual report for 2000.

In recent years, Gazprom built up gas extraction by means of bringing into development Pestsovoe and Etypurovskoe deposits, developing at full capacity Zapolyarnoe deposit (100 billion cubic meters annually), and increasing extraction at Vyngayakhinskoe and Enyakhinskoe deposits, as well as by means of returning and acquiring assets of independent gas suppliers and oil companies.

Over the last six years, Gazprom systematically took away from various companies the assets which had been given to them earlier either by additional issuing of shares of enterprises holding extraction licenses, or by giving licenses to subsidiaries and then changing the ownership pattern of the company-owner. For instance, in May 2006, Gazprom established control over Nortgaz, whose owner was British company REDI Holding, controlled by Farkhat Akhmedov, Senator for the Krasnodar Territory (since May 2007, for the Nenets Autonomous Area). Back in 1999, Urengoigazprom (100 percent belongs to Gazprom) lost control over Nortgaz, when it failed to buy out the latterís additionally issued shares (its share fell from 51 to 0.01 percent). It explains why Gazprom, during the court hearings in 2005, gained back Nortgaz almost for free (it paid $1 for 51 percent of shares). However, Senator Akhmedov (or, rather, his British company, owns 49 percent and can veto any strategic decisions of the company).

Speaking of another asset, Gazpromís deputy chairman Alexander Ananenkov said: ďThe subsidiary is to return.Ē Gazprom acquired Sibneftegazí controlling stock for $132 million. Gazprom says that is how much creating Sibneftegazí infrastructure costs. In the 1990s, the asset belonged to Gazprom, but was sold to Itera for $9 million.

By a similar scheme, Gazprom acquired 51 percent of Purgaz, which owns a license for developing Gubkinskoe gas deposit by extracting 18 billion cubic meters annually).

In summer 2006, Gazprom made another good bargain, buying Tambeineftegaz, which owned 100 percent of Yuzhno-Tambeiskoe deposit of 1 trillion cubic meters, for just $350 million. Gazprom undertook that step so as to prevent such a large part of resources from leaking abroad: Tambeineftegazí owner Nikolai Bogachev offered to sell the companyís controlling stock to U.S. and Spanish holdings: Shell, ConocoPhillips, and Repsol. Gazprom thus showed that foreign companies in Russia should reach agreement only with it, as the executive of the state policy in the sphere of gas extraction and processing.

Civilized Manners of the Russian Monopoly

Gazprom bought 72 percent of Sibneft oil company (now called Gazprom Neft) in 2005 for $14 billion from the structures on whose behalf acted businessman Roman Abramovich. The deal was to show to the world what market conditions are created in Russia for the resources business. However, it went during the international denouncing of Russia for destroying YUKOS.

Gazprom made another overbank when entering the Sakhalin-2 project. The formal pretext and the only argument of the PR support was that the Natural Resources Ministry discovered violations of the nature-protection laws by Sakhalin Energy company, which owned the license for developing. It remains a secret why Shell basically surrendered its chief project in Russia. Apparently, the upcoming years will uncover the reasons why Shell gave up its leading role in the project. Formally, Gazprom bought the companyís 51 percent of shares for $7.45 billion. It turned out later the spent $3.6 billion out of $19.4 billion of planned investments of former shareholders will not be returned to them.

Price Cataclysms

The key change that occurred in the last six years was that Alexei Millerís team managed to persuade the Russian government, with President Vladimir Putinís direct support, that it is necessary to liberalize prices at the domestic market. So, natural gas in Russia grew from $10 to $50 per 1,000 cubic meters on average in the last five years, and the price keeps growing. Five billion cubic meters is to be sold at the exchange in 2007 (the average price is $65 for 1,000 cubic meters). Gazpromís revenues from selling gas at Russiaís domestic market grew from 138 billion rubles to 366 billion rubles in the last six years. Although Gazprom declares losses from doing business at the domestic market, which is quite reasonable considering taxation, the corporationís profits in 2001-2006 grew by nearly seven times, from 70.6 billion rubles to 411 billion rubles.

The gas prices for industry and energy sector will reach $98 in 2010. It is a truly revolutionary decision, although it will be implemented already at the times of Vladimir Putinís successor. However, Millerís contract for chairing Gazprom was prolonged in autumn 2006 till 2010, and Miller has good chances to remain there till that period comes.

However, the growth of prices at the domestic market was helped primarily by Russiaís aspiration to join the WTO, and then by the growth of gas prices in the EU and the U.S., as a consequence of the absence of effective energy-saving policy. For instance, RAO UES of Russia consumed 6 million metric tons of fuel oil and over 100 billion cubic meters of gas in 2006. By the way, oil and gas consumption in Russiaís energy system was much better balanced at the times of the planned economy of the USSR and the 1990s. Moreover, Rem Vyakhirevís team was made up mainly of people with oil-and-gas education, who did not allow technologic excesses in the sectorís development. On the contrary, Anatoly Chubaisí and Alexei Millerís teams have financial and economy experts on key positions, instead of gas and energy professionals. Gazpromís deputy chairman Alexander Ananenkov is a deterrent for the numerous initiatives of his colleagues in the monopoly; he prevents the company from taking some abrupt steps.

One of the brightest periods of Gazpromís history was the transfer of gas contracts with CIS countries to European standards. For the sake of separating the contracts for gas transportation from those for gas supplies, Gazprom had to virtually declare war to transit countries Ė Belarus, Ukraine, Poland, and Bulgaria. From the commercial point of view, Gazprom won those wars, and increased gas prices from $65 to $130 per 1,000 cubic meters for Ukraine, and from $46.68 to $100 for Belarus. However, this tactic victory led to a serious exacerbation of Russia-EU relations. Let us hope, it will not end by the gas monopolyís Pyrrhic victory in Europe. Although Russia has already received certain negative consequences. Presidents of Turkmenistan and Kazakhstan, Gurbanguly Berdymuhammed and Nursultan Nazarbaev, signed an agreement with Gazprom on building the Caspian Shore pipeline, and then immediately supported the project of the Trans-Caspian seabed pipeline bypassing Russia.

Adoption of the law ďAbout natural gas exportĒ should be definitely noted among the achievements of Millerís team. In Vyakhirev times, Itera and other commercial traders dealt with export. Now, the law prohibited other export ways bypassing Gazprom Export (100 percent belongs to Gazprom). Consequently, Gazpromís export revenues have considerably grown in the recent years. By selling one third of the total amount of extracted gas (150 billion cubic meters annually), Gazprom Export earned $38 billion in 2006, compared to $26 billion in 2005. By the way, Gazprom doubled in 2001-2006 its earnings from selling gas to foreign non-CIS countries, and the net profits in this sphere of business tripled, growing from 164 billion rubles to 456 billion rubles.

Supplies to CIS countries became more expensive by nearly five times, growing from 40 billion rubles to 192 billion rubles. The profits in this sector of the market increased by 3.5 times, from 12 billion rubles to 42 billion rubles. Miller teamís questionable decision was raising the purchasing price on Turkmen gas in 2006, from $44 to $100 per 1,000 cubic meters. It was the first revolutionary step in Russiaís relations with Central Asian states. Until then, the gas prices were growing by $10 per 1,000 cubic meters a year. Since mid-2006, no Central Asian country would agree to sell gas for less than $100.

Despite the general opinion, Gazprom is carrying out a consistent policy abroad. It both consolidates assets by purchasing EU traders, and uses price policy. So, the Committee of High Trust, consisting of 14 gas-exporting countries, has been created in Doha (Qatar). It will work out and coordinate the formula of price formation between the major gas exporters.

Managementís Behavior Trends

Under Rem Vyakhirevís leadership, Gazprom actively sold gas through affiliated traders, legally independent from Gazprom. For instance, Itera worked at all CIS markets, with multibillion dollar contracts. Nowadays the situation is somewhat different. At the domestic market, Gazprom sells gas through Mezhregiongaz (100 percent belongs to Gazprom), at commercial prices as well. So, Gazprom actively uses the following instrument: it buys gas from independent producers at the drill hole at a price 10-15 percent higher than the prime cost, and thus puts all possible profits into its extra charges. This way, Gazprom was buying gas at 480 rubles for 1,000 cubic meters in 2006 from Nortgaz, and at 580 rubles from Sibneftegaz in 2007, while the selling price for industrial consumers of Russiaís first belt is 780 rubles for 1,000 cubic meters. On the other hand, all producers working with Gazprom for a long time gradually receive a higher price. For instance, LUKOIL sells gas of Nakhodka deposit at 1,000 rubles. Experts say this policy is much more honest to gas producers.

Direct subsidiaries have privileges in Russia, just like in any other country. For instance, all subsidiaries of Gazprom pipe gas through the unified gas-supply system at a lower tariff than independent gas producers. ďThis inequality is considered legal and quite logical,Ē said Troika Dialog analyst Valery Nesterov. ďThere are less popular examples of the managementís personal interestedness. For instance, Alexander Ryazanov brought into Gazprom ESN Energo company of businessman Grigory Berezkin. ESN Energo secured one third of the electricity consumption by all Gazprom enterprises. After Ryazanovís resignation in autumn 2006, ESN Energo began to be gradually replaced by Mezhregion-Energosbyt (100 percent belongs to Gazprom through Mezhregiongaz).

Despite that Stroitransgazí controlling stock was sold to external organizations, unofficial sources say, the construction company is still supervised by Gazprom managers. It became harder to join Gazprom now. The reputation of Miller teamís key players is quite high. I daresay that not a single project in Russia goes without the support of certain responsible officials. Yet, Gazpromís major projects follow the interests of the state.

Coal Strip Mine

The last news from the countryís chief newsmakerís camp: the monopoly begins developing coalmine methane in Kuzbass. Its total amounts in the region are estimated at 13 trillion cubic meters. That is, the gas monopoly has found new considerable gas resources. ďVery soon, already this year, the company will begin intensive works in coal strip mines in Kemerovo for developing methane deposits in coal mines,Ē said Gazpromís deputy chairman Alexander Ananenkov. According to the monopolyís estimations, the prognosis resources of coalmine methane in Russia are comparable to the traditional gas resources, and are estimated at 49 trillion cubic meters (15 percent of world deposits of coalmine methane). ďUnfortunately, all that methane is not so far used for good purposes,Ē said Ananenkov. ďSince 2002, we conducted works, and we have very good results.Ē

It is difficult and not very profitable to extract methane. In Russia, it is effective only together with coal extraction. So, experts think the project will be aimed not at gas extraction as such, but at obtaining quotas under the Kyoto protocol for Gazprom. Russia ratified the protocol in 2004. It stipulates exchanging quotas for harmful emissions into the atmosphere. Thus, by using coalmine methane, Gazprom, as a national producer, will obtain the right to trade quotas.

Politics and Gazprom

In the last five years, all major Gazpromís projects have political underpinning. For instance, former Gazprom chairman Rem Vyakhirev said in 1998 that the North-European pipeline project was economically unfeasible. Ten years later, the same project, under the new name of Nord Stream, is considered one of the most promising routes to directly link Russia and the EU. The pipeline worth $7.5 billion suddenly becomes more attractive for Russia than the second branch of the Yamal-Europe pipeline worth $2.5 billion. Politically, it sounds like the desire to bypass Poland and other transit countries. However, the exacerbation of the Russia-Poland economic relations (after 2010) will soon lead to the necessity to settle a serious political crisis between the two countries, whose positions on many issues drastically diverge. Nord Stream will not bring the desired political dividends to Russia. It is not bringing direct dividends to Gazprom shareholders already now.

In summer 2006, Gazprom, EON, and BASF signed the final agreement on Nord Streamís project, determining its legal and financial framework. Yet, the agreement does not contain the scheme of the projectís financing, and the certain sums due to be paid by the parties. It means the Nord Stream partners have not yet reached agreement on these issues. By the way, the terms of developing the Nord Stream financing scheme have already been repeatedly postponed, and remain unknown so far. The projectís feasibility study is not ready yet.

However, Gazprom will obviously make all efforts to launch the pipeline on time, because it has contracted nearly the entire amount of gas for 25 years ahead, beginning since 2011. The Russian gas monopoly is to supply these amounts anyway, by functioning pipelines if Nord Stream is not ready by 2011.

By the way, the Nord Stream project is a bargaining chip in the Russia-EU talks on the Energy Charter. EU guidelines on gas, adopted as a supplement to the agreement on the Energy Charter, question Nord Streamís pay-back capacity. Gazpromís deputy chairman Alexander Medvedev demanded to ďeliminate points concerning the access of third parties to the gas-transporting facilitiesĒ from the guidelines. He justified his request by reminding that there exist such restrictions for the BBL pipeline under construction, which is to link the Netherlands and Great Britain. Russia is trying to carry out the Nord Stream project, changing the EU gas legislation en passant. So far, there have occurred no system changes in that sphere.

Gazprom plans to surround Europe with pipelines in the north (Nord Stream), in the middle (Yamal-Europe), and in the south (Blue Stream-2). The monopoly will be able to really control the gas streams in the EU only if it creates a complete ring supplies system. The planís weak link is the Blue Stream-2 project, so far. The matter is, after laying the first thread of the pipeline along the Black Sea bottom from Russia to Turkey, Gazprom encountered the problem of customersí absence, because the gas-transporting network is not developed in Turkey. Then, Gazprom decided to turn the Blue Stream to Europe. It plans to lay the second thread along the Black Sea bed. Then, it will pipe gas through Turkeyís gas system, build an underwater bridge along the Bosporus seabed, till Greece or to Bulgaria. So far, Blue Stream has not been cost-effective. The project was developed by Rem Vyakhirevís team. So, its low effectiveness cannot be blamed on Millerís team only. On the contrary, Blue Stream-2 is to save the under-loaded Blue Stream.

It is hard to insist that such projects bring losses to Gazpromís shareholders, because they might either bring positive or negative results in different time periods. Yet, they obviously upset the balance at the gas market and create instability. It is likely that Nord Stream and the Altai project (gas supplies to China) might be postponed for undetermined time or cancelled. Anyway, Gazpromís plans to organize extraction from shelf sea, to develop the functioning transporting network, and to apply new technologies will remain stable.

In summer 2005, Alexei Miller said that Gazprom will grow to the level of a largest world energy holding. The corporation has been gradually fulfilling that task in the last two years. Gazprom bought up to 64 percent of Mosenergo shares, and is now discussing the scheme to exchange 10.49 percent of RAO UES of Russiaís shares for the assets of subsidiary energy companies. The salaries of Gazprom CEOs were raised in 2006 to the level of international energy giants. Each of the 16 members of Gazprom board earned $1.3 million on average, including the salary. Gazpromís market cap drastically jumped up over the last year. The shares grew from $8 to $11.5 per share, although they fell to $10 in June 2007.

Progress of Gazprom businessí main indexes, million rubles

2006 2005 2004 2003 2002 2001
Profits from selling natural gas on Russiaís territory 366 226 315 202 258 470 195 796 140 098 138 000
Purchase Price of the gas sold on Russiaís territory 137 383 116 932 94 626 63 189 69 459 59 000
Expenditures on transporting the gas sold on Russiaís territory 235 933 190 076 147 559 134 020 122 052 185 000
Total expenditures (prime cost): 373 316 307 008 242 185 197 209 191 510 244 000
Profits (losses) -7090 8194 16 285 -1412 -51 412 -106 000
Profitability Ė ratio of profits to prime cost -2% 3% 7% -1% -27% -43%
Non-CIS countries: :
Profits from selling gas to non-CIS countries 754 320 562 475 394 098 383 683 305 650 326 134
Purchase price of the gas sold to non-CIS countries 58 506 49 425 41 885 27 563 27 477 23 185
Expenditures on transporting the gas sold to non-CIS countries 239 089 200 074 168 903 154 401 131 017 138 913
Total expenditures (prime cost):: 297 594 249 499 210 787 181 963 158 494 162 098
Profits (losses) 456 725 312 976 183 310 201 720 147 156 164 036
Profitability Ė ratio of profits to prime cost
153% 125% 87% 111% 93% 101%
CIS countries: Profits from selling gas to CIS counties
Purchase price of the gas sold to CIS countries
191 780 90 903 54 043 44 049 47 808 39 580
Expenditures on transporting the gas sold to CIS countries
106 738 27 661 17 393 8 310 11 057 7031
Total expenditures (prime cost):
42 420 42 744 29 858 21 287 15 186 19 974
Profits (losses)
149 158 70 405 47 251 29 597 26 243 27 005
Profits (losses)
42 622 20 498 6792 14 452 21 564 12 575
Profitability Ė ratio of profits to prime cost
29% 29% 14% 49% 82% 47%
Total amount of gas sold
Profits from selling gas
1 312
968 580 706 611 623 528 493 556 503 714
Purchase price of sold gas
302 628 194 018 153 904 99 061 107 993 89 216
Expenditures on transporting the sold gas
517 441 432 893 346 319 309 708 268 255 343 887
Total expenditures (prime cost):
820 069 626 912 500 223 408 769 376 248 433 103
Profits (losses)
492 257 341 668 206 387 214 760 117 308 70 611
Profitability Ė ratio of profits to prime cost
60% 55% 41% 53% 31% 16%
Profits from organizing gas transportation
23 421 20 404 32 148 30 928 16 967 17 309
Expenditures on organizing gas transportation
32 305 30 109 38 275 36 262 18 804 25 435
Profits (losses)
-8884 -9704 -6128 -5334 -1837 -8126
Profitability Ė ratio of profits to prime cost -27% -32% -16% -15% -10% -32%
See p. 520 of the report on the first quarter of 2007. According to the Russian accounting standards.

Natalya Grib

All the Article in Russian as of June 26, 2007

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