Mixing oil, gas and politics

Jun 20th 2005
From The Economist Global Agenda

The Russian government is tightening its grip on the country’s lucrative oil and gas industry. After wresting a key Yukos subsidiary from its former owners, it has struck a deal to take control of Gazprom, Russia’s gas monopoly. Sibneft, another big independent oil producer, could be next in line for renationalisation. Should the wider, energy-hungry world worry?

IT WAS, in some respects, a step forward. On Thursday June 16th, Gazprom, Russia’s gas monopoly, agreed to sell a 10.7% stake in itself to the country’s government for $7.2 billion. The price is below that suggested by banks charged with valuing the deal, but at least it was an open and honest transaction. This is uncharacteristic in Russia’s notoriously murky energy sector. Given the ugly dismemberment of Yukos, no one would have been surprised to see Russia’s government employ questionable methods to wrest control of the country’s other oil and gas giants from the lucky investors who got them on the cheap in the privatisations of the early 1990s.

The government’s deal with Gazprom will take its stake in the company above 50%, which will allow it to open the shares to western investors. At present Gazprom’s shares are “ring-fenced”: they cannot be traded on the Russian stockmarket by westerners but only held as American Depository Receipts, which are more costly than ordinary shares. By reasserting control, the government hopes to give Russia’s stockmarket a boost. But it is also aiming to create a national energy giant in the style of Saudi Arabia’s gargantuan Aramco.

When the government gets round to paying for its increased holding in Gazprom and drops the ring-fence, foreign investors may find that the stock is not to their taste. The gas giant has been likened more to a state ministry than a profit-motivated corporation. Hermitage Capital, a Russian investment fund with a stake in Gazprom, publishes a yearly audit noting the firm’s shortcomings. Hermitage says that Gazprom has at least stopped the wholesale stripping of assets that it used to allow through the sale of gas reserves to joint-venture partners at knock-down prices. But it points to wasteful tax-payment schemes, seeming nonchalance about unpaid bills, disproportionately high wage costs and suspiciously costly pipeline projects. No wonder Gazprom’s market value in relation to its reserves is tiny compared with the likes of ExxonMobil or Shell.

Some foreign investors will steer clear as a result. Others will instead conclude that a company that holds 20% of the world’s gas reserves, produces 16% of world output and has 25% of the European market is in a strong position despite its many foibles. But Gazprom’s growth prospects are questionable. Its gas output in 2004 was no higher than in 1999.

The deal with Gazprom this week is not the government’s first attempt to take control of the company in a bid to create a state-owned energy colossus. The original plan was to merge Gazprom with Rosneft, a second-tier oil firm. But last December Rosneft, supported by some but not all factions in the Kremlin, got its hands on Yuganskneftegaz (known as Yugansk), the main oil-production arm of Yukos, after a curious, $9.4 billion auction. This sale had been forced on Yukos after it was brought to its knees by demands for back taxes.

Once Yugansk was under its wing, Rosneft insisted that the combined group was too big to be absorbed by Gazprom. Furthermore, Russia’s government started to fear the threat of legal challenges against Gazprom if it merged with the victor of a controversial auction. The Gazprom-Rosneft merger soon fell apart. Rosneft’s managers seem happy to plough their own furrow: with Yugansk’s assets, Rosneft has become a powerful competitor to Lukoil, the country’s leading oil producer since the demise of Yukos.

Rumours abound that Gazprom and Rosneft are vying to bring another independent producer under state control: Sibneft, Russia’ fifth-largest oil firm. Sibneft’s majority shareholder is Roman Abramovich, an oligarch who spends most of his time these days in London. But Yukos still owns a 34.5% stake in Sibneft as a result of an aborted merger in 2003. With Yukos’s assets still frozen as a result of the tax claims against it, this stake could be up for grabs. The winner would have a useful lever to prise Mr Abramovich’s controlling interest in Sibneft from his hands.

If another independent oil producer fell into state hands, this would leave little for foreign oil companies that are still keen to lay their hands on some of Russia’s vast energy reserves. Lukoil is partly owned by America’s ConocoPhillips and may welcome more investment; TNK-BP, a joint-venture equally divided between Russian investors and British oil giant BP, and jostling with Rosneft as the country’s number-two oil firm, provides another toe-hold for outside investors; Surgutneftegaz, Russia’s fourth-largest producer, is management-owned and has so far proved impervious to foreign advances. As for Rosneft and Gazprom themselves, they have had discussions regarding assistance with investment in their expansion plans, but only with state oil companies from India and China.

What price national champions?

Foreigners’ frustration at not being able to grab a bigger slice of the industry is understandable. Russian oil production has increased rapidly in recent years to keep up with the burgeoning demand of energy-hungry economies around the world. Between 1999 and 2004, Russian oil companies boosted output by around 50%. Oil exports are now nearly on a par with those of Saudi Arabia, OPEC’s main producer (Russia is not a member of the cartel). Not only has this provided a healthy stream of income for Russia’s government, which takes a big chunk of oil revenues in taxes, but it has made its oil a vital foreign-policy tool.

However, as the state has exercised more control over the energy sector, oil production has stalled. From a level of 9.28m barrels per day (bpd) in January this year, it has edged up to just 9.33m bpd in May. This 50,000-bpd increase compares poorly with 2004, when output rose by 150,000 bpd between January and May. The blame for this lies, partly at least, with the turmoil created at Yukos. Some analysts think that if production suffers any more, the government may have to rethink its drive to nationalise large chunks of the industry, especially since the oil-output slowdown is contributing to a broader economic one—last week the economy minister, German Gref, cut his 2005 growth forecast for the second time in a month, to 5.5%, well below the 7.1% growth seen in 2004. Those state-owned national champions appear to be coming at quite a price.

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