[OIL MAJORS] As Gazprom's chairman moves up, so does Russia's most powerful firm

On a frigid evening in February, the hottest place to be here was the Kremlin Palace theater. The draw inside the towering hall wasn't Tina Turner or Deep Purple — rock icons well past their prime — but Gazprom, Russia's most powerful corporate leviathan, which was celebrating its 15th anniversary.

Gazprom certainly had reason to party: its chairman, Dmitri Medvedev, was riding high on the Russian campaign trail as the hand-picked successor of President Vladimir Putin. Although Gazprom forked over a handsome sum to book Turner and Deep Purple, Medvedev's favorite band, the opportunity for the company, the world's biggest producer of natural gas, to have its own man installed as Russia's next leader was priceless.

"The gig at the Kremlin was fun, but it wasn't wild," Ian Gillan, Deep Purple's frontman, wrote in an article for The Times of London after the show. "The young guys and more junior staff were all up on their feet, although they were looking nervously over at their bosses to see whether they could loosen their ties. It was as if they were asking, 'How much fun are we allowed to have?' "

Medvedev was sworn in as president on Wednesday, after winning the election in early March, and his ascent confirms that in today's Russia, the line separating big business and the state is becoming so fine that it's almost nonexistent.

Gazprom and the government have long had a close relationship, but the revolving door between them is spinning especially fast this year: Medvedev, 42, replaces Putin as president; Putin becomes prime minister, replacing Viktor Zubkov; and Zubkov is expected to take Medvedev's place as Gazprom's chairman at a general shareholders meeting in June. Medvedev and Putin "are as close to a dream team as Gazprom could ever hope for," said Jonathan Stern, a British energy analyst and author of "The Future of Russian Gas and Gazprom."

It's hard to overemphasize Gazprom's role in the Russian economy. It's a sprawling company that raked in $91 billion last year; it employs 432,000 people, pays taxes equal to 20 percent of the Russian budget and has subsidiaries in industries as disparate as farming and aviation.

The company is a major supplier of natural gas to Europe, and it is becoming an important source of gas to fast-growing Asian markets like China and South Korea. In 2005, at the urging of the Kremlin, it bought Russia's fifth-largest oil company from the tycoon Roman Abramovich. If crude oil and natural gas are considered together, Gazprom's combined daily production of energy is greater than that of Saudi Arabia.

With energy prices continuing to hit record highs, Gazprom is more influential than ever, both at home and abroad. Gazprom says that before 2014 it will surpass ExxonMobil as the world's largest publicly traded company — a goal that Medvedev himself endorsed before he became president.

When Putin was still president, he used Gazprom's wealth and economic might to fight political enemies inside Russia, to reassert influence over former Soviet republics, to gain leverage over West European countries by increasing their dependence on Russian gas, and to wrest Russian energy assets back from foreign companies.

Now that Russia is seeking to reclaim the geopolitical clout it had in Soviet days, it is wielding its vast energy resources, rather than missiles, to reassert itself. More often than not, its most potent artillery is Gazprom itself.

In a news conference last year, Putin denied that Russia uses its economic might to achieve foreign policy goals. But others disagree. "Energy should not be used for a policy tool, but it is," said Vladimir Milov, president of the Institute of Energy Policy, an independent research organization in Moscow, and a former deputy minister of energy. Gazprom, he said, has at times been a "tool of punishment for neighboring countries."

At a Gazprom worksite in the Yuzhno-Russkoye field in Siberia one day last winter, it was so cold that two dozen diesel engines were left roaring day and night, lest they would freeze until spring. Every winter, some Russian roughnecks get frostbite.

"Your skin just peels a little," said Sergei Koshel, a drilling supervisor, dismissing the dangers. Another burly man, taking a break from the rig, pantomimed the issue more graphically, reaching up to his ear, pinching off a phantom piece and flicking it away like a cigarette butt.

The Yuzhno-Russkoye field alone has proven reserves of 800 billion cubic meters of natural gas, or enough to meet the gas demand in the United States for more than a year, and it is only the first of half a dozen huge developments that are planned in the north. Over the next two years, Gazprom plans to triple its capital outlays in its core business of exploring, extracting and transporting gas — just to maintain its current production levels. Investments will rise to 969 billion rubles, or $45 billion, in 2010 from 330 billion rubles, or $14 billion, last year.

To help finance a heady expansion into the Arctic, Gazprom is working on ways to push up natural gas prices in Russia and in the export market.

Last year, it floated the idea of creating a cartel for natural gas, similar to OPEC's oil cartel. Iran supports the idea, but Algeria, Qatar and others are uncommitted. A gas cartel would allow Russia to increase its influence in global energy markets, but at this point it's unclear how hard it will push the concept.

Gazprom's ties to the government are already paying dividends in the domestic market. Under a policy championed by Medvedev when he served as deputy prime minister, Russian consumers are going to have to pay starkly higher prices for natural gas. Prices are set to rise about 25 percent a year, starting this year, with the goal of reaching parity with world energy prices by 2011.

Policies like this mean that average Russians won't continue enjoying their traditional access to cheap energy, and they offer a stark example of the government's willingness to give Gazprom a leg up — regardless of the social fallout. Just as Gazprom's riches make it a proxy for Russia's newfound power and prestige around the world, the company also epitomizes the risks of state capitalism: waste and inefficiency.



Back in the 1990s, Gazprom was the archetype of the unreformed Soviet enterprise. While oil companies were being privatized and sold to Russian, and even foreign, investors, Gazprom stayed intact and under government control. It bankrolled many of the Kremlin's pet projects and the high-rolling lifestyle of a generation of company executives.

Gazprom says that many of the investments that critics once labeled political, such as the purchase of television stations and newspapers, have in fact turned out highly profitable.

Now Russian leaders consider Gazprom the template for a new industrial policy. In a globalized world, their thinking goes, strategic Russian companies should be controlled by the government, yet open to the capital and skill of Western investors — just as Gazprom is. It's a throwback to the Soviet economic model, with an emphasis on gigantism and economies of scale and faith in the pricing power of monopolies.

Under Putin, oil companies were brought back under the Kremlin's control, and dozens of state-controlled but publicly listed corporations sprung up in industries like energy, metals, aviation and auto manufacturing. It won't end there. A former first deputy prime minister, Sergei Ivanov, who is also chairman of the state-owned Unified Aircraft Corporation, has proposed forming state corporations for radio electronics, optics and space ventures.

Rich as it is, Gazprom faces big challenges in the Medvedev era.

Rising prices for steel, equipment and labor have caught the company at the outset of its largest capital program in two decades. Like other Russian companies, it invested little money maintaining or upgrading equipment in the 1990s. But the days of coasting on Soviet-era infrastructure are over, as output declines from fields first tapped in the 1970s.

To meet export commitments in Europe, as well as growing demand at home, Gazprom will have to spend at least $75 billion to bring its two largest fields in the Arctic into production within the next decade, according to Cambridge Energy Research Associates.

Yet exploring and extracting gas in a region where temperatures dip to 50 degrees below zero is technologically challenging, as well as expensive. Gazprom must build pipelines, gas processing plants, liquefied natural gas factories and a full panoply of supporting infrastructure like roads, railroads and ports. And to accomplish those feats, it moves thousands of tons of steel and heavy equipment to the middle of a vast, frozen swamp.

"The complexity and the size of it is what creates a huge challenge for Russia and for Gazprom," said Vitaly Yermakov, director of research for the Russian and Caspian region at Cambridge Energy Research Associates.

Critics say that Gazprom muscled its way into the ranks of the world's energy giants with blatant and often ham-handed tactics, particularly during the Putin years. The Yuzhno-Russkoye field, which Gazprom points to as an example of its resurgence, is a case in point. Richard Moncrief, a Fort Worth oilman, says he is the rightful owner of 40 percent of the field, which he says he bought in a series of agreements with Gazprom about a decade ago. But he says that Gazprom didn't recognize his contract, instead granting BASF, a Germany company, a 35 percent stake in the field. Moncrief is suing Gazprom in Berlin, contending that his stake is now worth $12 billion.

Gazprom maintains that the agreements were not binding: "The company denies any obligations toward Moncrief Oil in relation to the Yuzhno-Russkoye field," the company said in a statement.

Moncrief disagrees, but is pessimistic about his legal position. "Nobody has ever gotten a Russian company into a court that could enforce a contract," he said in a telephone interview. "In the end, the Russians are going to do exactly what they want to, and they're going to ride the back of Western commerce to fund their country."

Western executives say that the Kremlin is always on call whenever Gazprom needs a boost.

Last year, TNK-BP, a Russian joint venture involving BP and the Alfa Group, Access Industries and the Renova Group, agreed to sell Gazprom a vast Siberian gas field after Russian authorities threatened to cancel the venture's license to operate there. Gazprom offered $700 million to $900 million for TNK-BP's stake in the field and a local gas distribution company. It is a complex deal that has yet to close. Whatever its terms, analysts say, they would hardly compensate BP for the field, Kovykta, which is thought to hold immense gas supplies — and for the millions of dollars that the venture had already invested there.

Gazprom's spokesman, Sergei Kupriyanov, says that Gazprom is not responsible for TNK-BP's regulatory troubles and that the terms reflect market conditions.

Other deals involving Gazprom have followed similar patterns. In transactions involving both Shell and BP, Putin met directly with corporate executives. For a time, Kremlinologists thought that he might segue into the chairman's job at Gazprom; executives say Putin, a former spy, shows a keen interest in the oil and gas business.

"The president clearly knows as much about BP's business in Russia as I do," Anthony Hayward, BP's chief executive, said after a meeting last spring, during negotiations to sell the Kovykta gas field to Gazprom. "I stopped being surprised by his attention to detail some time ago."

A Kremlin spokesman, Dmitri Peskov, said at the time that the government's role in these talks was limited to regulatory issues.

In the first year of his presidency, Putin turned to Gazprom to buy out an opposition television station, NTV. Since then, the company's politically tinged media business has ballooned, but its finances are often opaque because of complex partnership agreements.

When Gazprom raised prices on newly democratic countries ringing Russia, like Ukraine, the Kremlin's foreign policy and Gazprom's commercial interests were symbiotic; punishing the Kremlin's opponents also brought the company revenue.

With Gazprom contractually bound to export to European customers far into the future, the pain of any production lapses will be borne by average Russians in the form of gas shortages, analysts say.

Kupriyanov denied that Gazprom faces a production shortfall. The company, he said, is developing fields specifically to meet the needs of customers in Europe holding long-term contracts.

He added that the company is shedding many of the sideline businesses that had been a target of criticism for financial analysts, to focus on its capital investment program. Just in 2007, for example, the company sold noncore assets worth 38 billion rubles, or $1.6 billion.

Such assurances, though, have not quieted critics of Aleksei Miller, a Putin appointee expected to stay on under Medvedev as chief executive of Gazprom.

Mikhail Delyagin, a former economic adviser to President Boris Yeltsin, is skeptical of Gazprom's ability to deliver the new gas on time or on budget. Gazprom's resources have been tapped for so many political and sideline business ventures that it has become a financial company more than an energy company — threatening its capacity to continue pumping gas, Delyagin said.

"Miller turned Gazprom into the Kremlin's wallet," he said. "You cannot drill a hole with a wallet."

And yet, with oil at more than $125 a barrel, Gazprom's wallet is becoming fatter every year. After Medvedev's inauguration last week, Gazprom's value surpassed those of General Electric and China Mobile, making Gazprom the world's third-largest company by market value.

"If they can bite the bullet and raise domestic prices, this company has a real shot at becoming the world's largest," said James Fenkner, the managing partner at Red Star Management, a hedge fund that holds Gazprom stock. "It is not that far off."

Source: International Herald Tribune| by By Andrew E. Kramer