As Gazprom Grows, So Does Russia’s Sway

Times Staff Writer

A year ago, Ukraine appeared to be pulling relentlessly away from Russia’s grasp and into the arms of Europe, and Russian President Vladimir V. Putin seemed helpless to stop it.

After the democratic Orange Revolution, Ukraine was rushing to join the World Trade Organization ahead of Russia and talking of reversing the privatization of companies bought by Russian investors. Together, those moves represented an economic nightmare for Russia in a nation it once considered a virtual client state.

The picture looked a lot different Sept. 30, when new Ukrainian Prime Minister Yuri Yekhanurov arrived at the Kremlin. “We have given a clear signal,” Yekhanurov declared. “Reprivatization problems will no longer worry our partners.”

What brought Ukraine around?

It turned out that Putin had a secret weapon known as Gazprom. The Russian energy giant supplies Ukraine with a third of its gas at a fraction of the price the company charges European customers. When Ukraine’s new pro-Western leaders talked of breaking out of Russia’s sphere of influence last spring, Gazprom executives announced that if Ukraine wanted to move toward Europe, it should begin paying European prices for its gas.

Most analysts predict such a move could cost as much as $3 billion and result in the virtual collapse of the Ukrainian economy.


Now, after Yekhanurov’s visit, the two sides plan to hold new and presumably more conciliatory talks on the gas pricing issue.

This is what can happen when the government owns the gas company.

With shipments of 545 billion cubic meters a year, the Gazprom behemoth dominates Europe and is already the largest-producing energy company in the world. Now, with the recently announced plans to buy Russian-based OAO Sibneft for $13.1 billion, open up half its stock to foreign investors and expand into energy projects across the globe, Gazprom says it could out-earn even international giants such as Exxon Mobil Corp. within the next five years.

“Just a few years ago, Gazprom’s activity was basically limited to the production of gas in western Siberia, distributing it virtually at cost, or sometimes below cost, throughout Russia and making a profit by selling it” to Europe, said Sergei Kupriyanov, deputy head of Gazprom’s information policy department. “Over the past few years, we’ve demonstrated colossal growth.”

Now, Gazprom supplies about a third of all Western Europe’s natural gas, including 39% of Germany’s gas and nearly all of Slovakia’s and Bulgaria’s.

With plans to acquire a 25% share in massive oil and gas deposits on Sakhalin Island off Russia’s east coast, plus its own huge new Arctic tracts in the Barents Sea, Gazprom also is poised to become a major gas supplier to the U.S., Japan and China.

The acquisition of Sibneft, previously owned by billionaire tycoon Roman Abramovich, marks the company’s foray into crude oil. The deal, scheduled to be signed in the next few weeks, will give Gazprom 650,000 barrels of crude oil production a day and make it Russia’s fifth-biggest oil company. Analysts say other oil acquisitions could be in the works soon.

Slowly but surely, Putin is building a state-controlled, internationally powerful energy giant. In less than two years, the Russian president has effectively renationalized much of an oil and gas sector that had been dominated by private oligarchs, even as he has opened unprecedented opportunities for private foreign investment.

It started in October 2003, with the arrest of Mikhail Khodorkovsky, chief executive of oil giant OAO Yukos, on charges of fraud and tax evasion. Yukos also was handed a bill for $28 billion in back taxes. The move came as Khodorkovsky was trying to put together a merger with Sibneft and the subsequent sale of a large stake in the resulting energy giant to a Western oil major.

Instead, Sibneft wound up in Gazprom’s hands. Yukos’ main production facility, Yuganskneftegaz, was sold to state-controlled oil company Rosneft, whose board chairman is senior Putin aide Igor Sechin, for about half of what international auditors said it was worth. (Gazprom’s chairman is Putin’s chief of staff, Dmitry Medvedev.)

Russian news agency RIA Novosti estimates that 57.4% of the energy sector is now under state control.

This, it turns out, may be what Putin had in mind all along. Martha Brill Olcott of the Carnegie Endowment for International Peace, a Washington-based nonprofit organization, last year examined a doctoral dissertation published by Putin in the late 1990s.In it, Putin outlined his vision of an economy built on natural resources, in which “financial-industrial corporations” large enough to be “able to compete on an equal basis with the West’s transnational corporations” would exploit Russia’s mineral wealth. They also would provide social guarantees and protect the international position of the Russian state.

Olcott argued that one of Putin’s main concerns appeared to be that oligarchs were siphoning profits instead of reinvesting in bigger and more efficient production, squandering the engine of Russia’s economic future. Mixed public and private ownership, under the ultimate control of the state, would be the optimal solution, he concluded.

“All of this is partly tied up with the Russians’ view of Russia as a great power,” said Andrew Kuchins, director of the Carnegie Moscow Center. “They clearly see that their energy assets are their key to being a great power. I think they also understand that they need to be careful and develop these as effectively as possible.”

Speaking to reporters at an EU-Russia summit in London this month, Putin portrayed Europe’s growing energy dependence on Russia as a win-win situation.

“I’ll remind you that some European countries, members of the European Union, cover 90% of their gas needs with Russian hydrocarbons. Ninety percent! And no one’s complained so far. Everyone is happy. Russia is a reliable partner,” Putin said.

Russia has decided for the first time to allow European partners to engage in gas production on Russian territory, he said, and to jointly build the infrastructure needed to bring Russian gas to market.

“Europeans will control everything from production to the final consumer, and we will participate as well,” the president said. “So the rumor of Europe’s possible loss of independence in terms of energy is hugely exaggerated.”

Gazprom on Sept. 16 announced a shortlist of potential partners in the development of its giant, 3.2-trillion-cubic-meter Shtokman gas deposit in the Barents Sea. They include Chevron Corp. and ConocoPhillips from the U.S., Norway’s Norsk Hydro and Statoil, and France’s Total.

In exchange for its 25% stake in the Royal Dutch Shell-led Sakhalin-2 project, Gazprom is offering Shell a 50% share in the Zapolyarnoye-Neocomian project, also in the Arctic.

The two projects not only provide foreign companies with a toehold in Russian gas, but they also open the door to Gazprom becoming a major supplier of liquefied natural gas, much of it bound for the U.S.

Gazprom has made it clear that its decision on partners at the Shtokman gas deposit will depend on opportunities for Gazprom involvement in other venues.

“Naturally, we’d like to receive something in exchange, not money, but other assets or opportunities,” Gazprom’s Kupriyanov said. “Most successful companies implement precisely this sort of strategy: to be present on several continents, at once in several markets, and not to occupy one narrow sector, but to diversify in a way that our various areas of activity complement one another.”

The government has acted to take firm ownership of 51% of Gazprom. Meanwhile, it is pushing through legislation allowing foreign investors full access to the remaining 49%. Moreover, an initial placement offer of a minority of Rosneft shares is contemplated for mid-2006, according to the Russian Economy Ministry.

“From an economic standpoint, they’re liberalizing in a quite dramatic way, compared to any other country in the world,” said William F. Browder, CEO of Hermitage Capital Management.

“A lot of people have characterized the Sibneft deal as being some kind of renationalization, or the government stepping into the oil sector. But if you look at it economically, instead of Roman Abramovich owning Sibneft, foreigners and minority shareholders are going to end up being able to indirectly own 49% of Sibneft via that share liberalization of Gazprom,” he said. “It seems to me that foreigners are getting more access, rather than less, through this combination of deals.”

Yet state control means the Kremlin calls the shots, and Gazprom continues to be available as an instrument of Russian foreign policy.

That was the case with Ukraine.

Threatening to raise gas prices to Ukraine wasn’t Gazprom’s only leverage. When Ukraine countered with threats to raise the prices it charges Russia to transport Europe-bound gas, Gazprom announced plans to build a 720-mile pipeline to Europe straight through the Baltic Sea, bypassing Ukraine and Poland. For good measure, Gazprom bought up most of Ukraine’s potential alternative gas supplies in Turkmenistan and, in late September, locked up a lease on gas transport routes Ukraine might look to via Uzbekistan.

Owning the gas company gives the Kremlin leverage over the domestic scene as well: Gazprom-Media, a division of Gazprombank, owns television stations NTV and TNT, plus the news radio station Echo of Moscow.

In June, the company bought a 50.19% stake in the respected daily newspaper Izvestia, and the company announced this month that it would launch a youth-oriented radio station that would feature news and talk shows.

“It’s not like there’s a person sitting at Gazprom and calling [NTV] to tweak the news lineup, not in a literal sense. But there is a common understanding of the situation,” said Arina Borodina, a media analyst for the Komersant newspaper. “Gazprom is concentrating some strong media assets in its hand because after all, the next elections aren’t that far down the road.”

Many speculate that Gazprom is becoming so powerful that its board chairmanship is emerging as a likely landing spot for Putin himself, should he keep his pledge not to run again in 2008.

“I think it’s the most likely scenario for him at this time,” said Carnegie’s Kuchins. “One, it puts him in a position of tremendous power and influence ... and he has shown a keen interest, clearly, in the strategic importance of the company’s energy assets and its future development.”

Natasha Yefimova of The Times’ Moscow Bureau contributed to this report.



Vital supplies

European countries rely heavily on Russia’s natural gas production.

Top European importers of Russian natural gas in 2003, with the amount (in billions of cubic feet) imported and the percentage of total domestic consumption

Germany: 1,045.9 (39%)

Italy: 756.2 (28%)

Turkey: 431.1 (60%)

France: 402.8 (22%)

Hungary: 364 (68%)

Czech Republic: 275.6 (79%)

Slovakia: 275.6 (103%*)

Poland: 258.0 (62%)

Austria: 190.8 (97%)

Bulgaria: 190.8 (65%)

*Slovakia reexports some of the natural gas it imports.

Sources: U.S. Energy Information Administration, BP, East European Energy

Databook 2004, Commonwealth of Independent States