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RUSSIA

Rebranding Gazprom

The transfer of presidential power to Dmitry Medvedev will likely mark a turning point in how the world views Gazprom. For much of the last four years, Gazprom has been viewed with suspicion mixed with frustration as approval for projects to increase the country's energy exports were often delayed. The huge Shtockman gas field is perhaps the most vivid example, mired in delays of more than three years over thorny European Union-Russia trade issues such as Russia's stake in Airbus. The result is that until now, Gazprom, more than any other Russian publicly traded company, has been synonymous with the Kremlin. (This incidentally was taken to an absurd level when a heightened and emotional political standoff with Estonia about moving a monument to fallen Soviet World War II soldiers had a short-term negative impact on Gazprom's share price.)

For investors, the strong Kremlin-Gazprom link has meant prolonged periods when the company's share price has performed poorly. Today, if you combine Gazprom's oil and gas production on an oil-equivalent basis, Gazprom produces more energy every day than Saudi Arabia.

At the same time, the world's biggest energy producer is also one of the cheapest. This is the legacy of four years of project delays and the headlines generated by the Kremlin's often fractious relationship with Brussels.

But today the message is much more positive. Real progress has been made toward starting work on major new production projects, and the first battles in the "pipeline wars" have seen Gazprom score decisive victories. The Kremlin's relationship with Europe has considerably improved over gas since this time last year, and this trend will certainly continue as the French are about to assume the presidency of the European Union and as the Kremlin-friendly Italian Prime Minister-elect Silvio Berlusconi is soon to be back at the helm.

As much as anything else, Medvedev is expected to preside over the "rebranding" of Russia on the global stage and of its energy sector. This inevitably means a major rebranding of Gazprom as well. This will play a key role in reaching the Kremlin's goal of increasing the market capitalization of Gazprom to $1 trillion by 2014, which would make it the largest company in the world based on market value -- roughly twice the size of ExxonMobil. This can be best accomplished not by hoping for some valuation expansion with a secondary Asian listing, but by developing major real energy projects, by expanding into higher margin business in Europe, and by being at the forefront of the development of liquefied natural gas.

As we enter this new period in the development of the country, Gazprom will remain a clear standard bearer for Russia's rebranding. For this reason, the energy giant is more than capable of doubling in price during the next four years under Medvedev as president.

The past eight years can best be described as the preparation phase of the 20-year Putin Plan. The main priority for the government was to stabilize the country and the economy after the chaos of the 1990s. It also recreated a very strong role for itself and its agencies in the economy and especially in the so-called strategic industries. The oil and gas sectors rank at the top of that list and are dominated by the two state-controlled energy companies, Rosneft and, especially, Gazprom. In practical terms, this meant that while the Kremlin was busy renegotiating what it considered to be fundamentally flawed deals of the weak 1990s, it did not give its support for the development of any major new energy projects -- despite the fact that quite a few major deposits of both oil and gas have been known for more than a decade.

Against this backdrop and with rising hydrocarbon prices, the energy fear factor has been rising in the EU. Gazprom's efforts to reduce the amount of gas it sells at a substantial discount -- a legacy of Russia's foreign-aid program and inconsistent with its obligation to shareholders -- threatened the reliability of gas supplies to Europe and only heightened its fears. The share price of Gazprom suffered accordingly.

But today, Gazprom has signed off on new Nord Stream and South Stream pipeline routes that will reduce the EU's current vulnerability to the existing two gas export pipelines. They will eventually allow valuable gas exports to Europe -- now accounting for the bulk of Gazprom's profits -- to rise by 60 percent over the next seven years. Gazprom has secured contracts and pipeline routes in and out of Central Asia and is carving a leading role in the group of gas-producing countries that wants to better coordinate the development of the gas industry, especially in LNG.

It is hoped that the spending and investment phase of the 20-year plan will fundamentally change the country from being highly dependent on commodities to one with a much more diversified economy. For this to happen, Russia needs an improved trade relationship and a greater two-way investment flow with the EU. That is as much a guarantee of increased energy cooperation and progress in building new projects as any signed contract.

The major new gas project intended to replace the expected decline from existing and depleting gas fields is located in the Yamal Peninsula in northwest Siberia. Its reserve base is 10.4 trillion cubic meters and is projected to produce 150 billion cubic meters of gas -- equal to the country's total current export volume to the EU -- by 2012 and rising to around 250 billion cubic meters annually after 2020. The projected cost of developing this project is $40 billion to $50 billion and has plenty of engineering challenges to overcome. It is expected that Gazprom will control this project with the minority participation of European companies. The involvement of Europe's largest energy companies, primarily in an operational role, should raise the comfort level that we are now firmly into the new development phase.

Medvedev's shift from Gazprom chairman to Russia's president will be a key factor in rebranding Gazprom and Russia as a whole. This will undoubtedly improve EU-Russian economic and political relations, and it promises to be a big boon to Gazprom shareholders as well.

(The Moscow Times 6.v.08)

 
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