Gazprom and the Russian State (Russian Foreign Energy Policy)

GAZPROM AND THE RUSSIAN STATE ‘The question is not whether energy and politics are connected but how.’ Javier Solana, European Union High Representative for Foreign Policy1

Dr Kevin Rosner Series editor: Dr Kevin Rosner

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Publisher’s note Every possible effort has been made to ensure that the information contained in this publication is accurate at the time of going to press and neither the publishers nor any of the authors, editors, contributors or sponsors can accept responsibility for any errors or omissions, however caused. No responsibility for loss or damage occasioned to any person acting, or refraining from action, as a result of the material in this publication can be accepted by the editors, authors, the publisher or any of the contributors or sponsors. Users and readers of this publication may copy or download portions of the material herein for personal use, and may include portions of this material in internal reports and/or reports to customers, and on an occasional and infrequent basis individual articles from the material, provided that such articles (or portions of articles) are attributed to this publication by name, the individual contributor of the portion used and GMB Publishing Ltd. Users and readers of this publication shall not reproduce, distribute, display, sell, publish, broadcast, repurpose, or circulate the material to any third party, or create new collective works for resale or for redistribution to servers or lists, or reuse any copyrighted component of this work in other works, without the prior written permission of GMB Publishing Ltd. GMB Publishing Ltd. 120 Pentonville Road London N1 9JN United Kingdom www.globalmarketbriefings.com This edition first published 2006 by GMB Publishing Ltd. © Dr. Kevin Rosner Hardcopy ISBN 1-905050-30-5

E-report ISBN 1-905050-85-2

British Library Cataloguing in Publication Data A CIP record for this book is available from the British Library.

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Contents About the author

v

Foreword

vi

Introduction

1

1. Russian energy diplomacy

5

2. What is Gazprom?

9

„ „ „ „ „

Flat domestic production Russian markets Unfolding history Troubles from the beginning Downstream de-coupling

3. Gazprom and global energy

19

4. Recent restructuring

25

5. Confluence of Russian foreign energy policy

27

„ Gazprom share purchase „ Governmental public diplomacy: sending the right corporate message

6. Gazprom management

31

„ Gazprom factions

7. Mergers and acquisitions

39

„ Non-core acquisitions „ Core acquisitions „ Companies with a Gazprom shareholding

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8. Struggle for a Gazprom strategy „ „ „ „

iv

47

Building share value Building performance Challenges to building Gazprom share value Ongoing and new export and development projects

9. Conclusion

55

Notes and references

57

About the series

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About the author Kevin Rosner, PhD is a specialist in Russian oil and gas, security of critical energy infrastructure, and international energy security policy. He is an external expert to the North Atlantic Treaty Organization and presently serves as the Director, NATO Forum on Energy Security. He is a Senior Fellow, both at the UK Defence Academy and at the Institute for the Analysis of Global Security (IAGS) in Washington DC. Posts held include Senior Security Advisor to the Baku-Tbilisi-Ceyhan pipeline company, Project Director with the Programme on Cooperation with the Russian Federation at the OECD, and Project Manager with the UNESCO Science Division in Paris. Dr Rosner is the founder of Therosnergroup®, serving leading members of the global oil and gas community with energy and security analytical products.

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Foreword Vladimir Milov, former Deputy Minister of Industry and Energy, Russian Federation The emerging phenomenon of Gazprom is attracting enormous interest throughout the world. This brand now seems more than just the name of a business group, but rather a philosophic concept, symbolic of the superpower idea – from energy superpower, as it started back in the 1990s, to the key tool in global political powerplay that Gazprom is seemingly becoming now. However, the world obviously lacks certain real information on what Gazprom really is. After the Russian authorities had established total control over the national media (a large part of which is controlled by Gazprom itself), they have been quite successful in promoting a one-sided picture of what Gazprom is and what problems and challenges it faces. And the international community sometimes buys it. During recent months, Russian and international analysts had been saying and writing tons of words on the Kremlin-promoted idea of transfer to ‘transparent market prices’ for gas in relations with the post-Soviet states. The fact is that, in reality, no one clearly knows the actual price of gas supplied from Russia to Western and Eastern European countries – this information is kept away from public eyes and can not be found in the open sources. For five years public attention was drawn to the fact that Vladimir Putin’s aim was to eliminate the ring-fence around Gazprom’s share trading – it was believed that elimination of the ring-fence would help Gazprom attract new direct investments, through free sales of shares to foreign investors. In reality, however, elimination of the ring-fence came together with adoption of the legislation that prohibited the reduction of the state’s ‘50 per cent plus’ stake in Gazprom, which made the issue of new shares virtually impossible. Russia’s NTV television channel carries daily advertisements proclaiming that ‘Gazprom pays one billion roubles to the state budget daily’, however, not stressing the fact that Gazprom actually pays only a little above $20 of tax per ton of oil equivalent of hydrocarbons produced, compared to $80–110 paid by private Russian oil companies. Sadly, one rarely finds real analysis of the real problems of Gazprom – sharply falling production from matured gas fields, underinvestment in production development as a result of a bad investment track record, the inefficient nature of new projects and commercial transactions, and huge financial problems. These problems are well-hidden behind high revenues from gas exports and generous political support from the authorities. What is Gazprom in reality? On one hand, it’s a story about control over resources – total control, the materialization of a superpower idea, which attracts global interest and, often, fascination. Gazprom’s story started in the early 1990s as an idea to establish an instrument in the hands of the government that would accumulate control over gas export revenue inflows and, when necessary, be allowed to easily

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redirect this money for ‘special purposes’ – social, budgetary, private. The idea of transforming Gazprom into a more market-based entity during the 1990s met critical resistance from top decision-makers in Russia. Since 2001, when President Vladimir Putin decided to introduce his closest loyalists to Gazprom’s management board, the idea of control over resources has been brought to the ultimate level, from a defensive to pro-active, and, in fact, quite aggressive approach. Gazprom became an important centre of consolidation of various assets that the Kremlin wished to establish control over, be it media, power, nuclear, or oil. On the other hand, the Gazprom story is about how control over resources may not transform into development and value-building, but, instead, be used through a short-sighted approach for spending of resources for various, often destructive, purposes. Despite its fascinating scale, management practices in Gazprom have little evolved since the 1980s. Value is leaking from the company through non-transparent subsidiaries and affiliates, serving someone’s private interests. Expenses grow much faster than profits. New projects prove to be quite controversial in efficiency terms. Despite high revenues from gas exports and huge accumulated debt, sufficient money has not been invested in the last 15 years in development of new large gas deposits on Yamal Peninsula – the model of their development based on scale effect had clearly proved itself bankrupt. The recent engagement of Gazprom in political pressure on the post-Soviet nations, not politically loyal to Kremlin, puts the company at serious commercial risk – the conditions of its longterm gas supply contracts with European companies may be reconsidered, new Gazprom’s foreign acquisitions may be blocked. Recently, for instance, UK authorities have started to seriously discuss the possibility of the legal protection of Centrica and other British gas retailers from possible acquisitions by Gazprom. This picture leaves a lot of uncertainty about the Russian energy giant’s future. Kevin Rosner’s report on Gazprom, its status, future and political role is a good attempt to analyze the realities of Gazprom in more detail, blending important economic and management style analysis with political considerations. Of course, there’s a lot more to say – and, in particular, with regard to various assumptions of what the core strategic considerations Russian authorities might have with regard to the future of Gazprom. As Kevin Rosner correctly puts it, legitimate questions exist concerning the confluence of state policy and Gazprom corporate strategy. But is there a strategy? Or, if there is, does the existing Gazprom model allow for its successful implementation or is it a constraint on any successful strategic efforts? As O Henry once put it, the only way to break up a trust is from the inside. Kevin Rosner’s monograph certainly helps readers to better comprehend some important issues around Gazprom, and is a definitive ‘one step forward’ in understanding what’s hiding behind the ‘superpower’ facade.

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Open Joint Stock Company GAZPROM Fact Sheet Contact Information Full name:

Gazprom Open Joint Stock Company

Short name:

Gazprom

Location:

16 Nametkina Str., Moscow, Russian Federation

Post address:

16 Nametkina str., V-420, GSP-7, Moscow 117997

Phone:

+7 (095) 719-30-01 (for inquiries)

Fax:

+7 (095) 719-83-33, 719-83-35

Official website:

www.gazprom.ru

Email:

[email protected]

Notes: On 13 January 2006, trading in common shares of joint stock company ‘Gazprom’ (RTS ticker symbol – GAZP) started on the RTS Classic Market. Since 2001, RTS Group facilitates trading in ‘Gazprom’ stock on its T+O Market (RTS ticker symbol – GSPBEX). T+O trading is organized by NP ‘St Petersburg Stock Exchange’. Transactions are cleared and settled by NP ‘RTS Stock Exchange’ in Russian roubles.

Shareholder information at September 2005 Number of Employees

330,000

49.11%

owned by Russian Government

26.07%

owned by Russian legal entities (Gazprom subsidiaries)

11.50%

owned by non-Russian resident entities (individual & legal)

13.32%

owned by Russian individuals

*Calculations are those of the author alone based on available data

Evolution of Gazprom: shareholder structure (%) 2000

2001

2002

2003

2004

2005

Government

38.37

38.37

38.37

38.37

38.37

49.11

Citizens

17.68

16.07

15.06

14.03

13.32

13.32

Russian companies (Gazprom subsidiaries)

33.64

34.06

35.07

36.10

36.81

26.07

Foreign entities

10.31

11.50

11.50

11.50

11.50

11.50

100

100

100

100

100

100

Total

*Calculations are those of the author’s alone based on available data

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Introduction The [gas] pipelines are our legacy from the Soviet Union. We intend to retain state control over the gas transportation system and over Gazprom. We are not going to divide Gazprom. The European Commission had better forget about its illusions. As far as the gas is concerned, they will have to deal with the Russian state. Russian President Vladimir Putin 2

A

s this monograph goes to print, Russia has assumed the leadership of the G8 process. Some argue that Russia does not belong in the same league as other G8 members, whose economies are counted among the largest in the world. However, the Russians themselves believe they can and should be counted among this select group of industrial states, and energy is used as their trump card in a global play for power, dominance and influence. The Russian President intends to use the upcoming St Petersburg Summit to highlight the issue of global energy security and, in particular, Russia’s role in contributing to enhancing the world’s growing thirst for oil and gas. This decision does not come without considerable risk for Russia itself, accompanied by the scrutiny that will be focused on Russia’s oil and gas sectors. Although the Russian oil industry went through considerable evolution through privatization and restructuring in the 1990s, the case for Russian gas could not have been more different. Gazprom, for all its hope at being perceived as a legitimate commercial enterprise, remains largely a tool and now the crown jewel of Russia’s quest for empire. This was definitively settled as a result of the government’s

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reconsolidation of its majority ownership position over the world’s gas giant in 2005. Gazprom lost no time in exercising its new-found power in clamping down on Russian exports of gas to Ukraine in January 2006. Concurrent with this ownership recapture, has been Gazprom’s own push to gain control over an increasingly important share of Russia’s overall energy complex. In October 2005, Gazprom completed its acquisition of Russia’s Sibneft for some ഐ11 billion, giving it control over 30 per cent of the Russian oil industry.3 Sibneft will become Gazpromneft, if all goes well, at an extraordinary meeting of the Gazprom board in May 2006, which should complete the state’s recentralization cycle of control over this important component of Russia’s oil sector.4 If all goes to plan, it will also move its tax domicile to St Petersburg, the hometown of Chairman of the Gazprom Management Committee, Alexey Miller; Gazprom Chairman of the Board and First Deputy Prime Minister of the Russian Federation, Dimitri Medvedev; and of Russian President Putin. The process of creating national energy companies, particularly in the oil sector, is nothing new. This tendency holds, as well, for the natural gas sector. For example, over 76 per cent of the world’s oil is produced by national oil companies (NOCs), with the largest concentration in the Middle East.

What makes Russia different? What the world finds troubling and what makes Russia different are three things.

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First, 15 short years ago, the Cold War was brought to an end with the collapse of the Soviet Union. Through an extended period of high oil prices and economic recovery since 1997, the Putin government has scrambled to rebuild the state’s power apparatus through the resurrection of control over the energy sector. As elsewhere throughout the world, energy is power and that power now lies in the hands of a government, contiguous with Europe, whose stated ambition is to re-establish influence and/or control over the national energy sectors of the now independent former Soviet states. Second, Russia is the largest exporter of oil and gas among the G8. European Union (EU) G8 Member dependency on Russian imports for these fuels is growing. During the heady days of the 1990s, EU Members’ import dependency was allowed to grow, if not encouraged, as dependency was at least partially viewed as preferential to continued and expanded dependence on the decidedly non-democratic regimes of the Middle East, a classic example of expanding energy security through diversification of source country for primary energy resources. Third, East–West cooperation since 1991 has been predicated on the assumption of a Russian transition away from autocracy to democracy, fueled by liberal open markets. However, step by step the early vestiges of democracy have been slowly chipped away. ‘Among Russia’s best and brightest in the liberal community, there are few voices raised in Putin’s defence. He has systematically destroyed the fledgling democratic institutions that appeared in the 1990s. The Duma is subservient to the Kremlin, elections may be free but not fair, the Federation’s governors are now hand picked by Putin, and while newspapers may criticize the govern-

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ment, television carries few reports of that nature. With the jailing of Mikhail Khodorkovsky, “the richest man in Russia”, the business elite – and not only the wealthiest oligarchs – have expressed concern about further efforts on the part of the Kremlin to interfere in their affairs, and complain that government initiated corruption is on the upswing’.5 The transition on which East–West relations were predicated no longer holds. Russia under Putin has pulled back from both democratization as well as from liberalization in the country’s most important economic sector, that of mineral extraction and transport. In short, EU Members are becoming increasingly dependent on a country whose basic trajectories of political and economic development run counter to the precepts of their own foundation, ie democratization and competitive open markets. The shifts in Russia’s energy sector in 2005, in the internal ownership and control over Gazprom, and in the broadening and deepening of its involvement in the Russian oil industry, raise certain fundamental questions about the projected future profitability of a company that accounts for approximately 20 per cent of global gas production. Key points to be addressed are: what does structural consolidation over Gazprom by the Russian state mean for Gazprom’s future and for the future of the Russian energy sector? What will the impact be on Russian energy policy as a result of this consolidation? Specifically, what do these changes portend for the future of natural gas exploitation, production, distribution and the ultimate export of Russian gas to downstream consumers? And finally, what are the implications for downstream states’ energy sectors, whose infrastructures and energy resources themselves are increasingly sought after by Gazprom?

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These shifts have sets off alarm bells regarding Russia’s energy diplomacy, championed by none other than the Russian President himself. Legitimate questions exist concerning the confluence of state policy and Gazprom corporate strategy. Do these two move concurrently with one another on separate but equal tracks? At what point do the policies of the state and the strategy of Gazprom as a corporation intermingle? What are the manifestations of this confluence, which has both enormous domestic implications for Russia’s own energy sector as well as for the security environment of states in Russia’s near abroad, where energy has been recently used by Russia as a tool for influencing the decisions and behaviour of former Soviet states, as exemplified in Belarus, Ukraine, and Moldova? One objective of this monograph is to delineate the nature of the relationship between Gazprom and the Russian government. Such an understanding will be based on an elaboration of Russian energy diplomacy on the one hand and Gazprom’s corporate strategy on the other. An exclusive appreciation in the role of the state in its involvement with Gazprom on the one hand, and the role of this corporation in forwarding the public policy goals of the Russian state on the other, leads to a common understanding and appreciation of the numerous links that exist between Gazprom and the state. Understanding state goals and corporate objectives is instructional insofar as it helps

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clarify how the activities of both power centres, ie Gazprom and the state, may be coordinated. Hence, this study is less about current history and more about developing a flexible, mobile methodology that the reader can use to decipher the Gazprom–state relationship. A second step in deciphering the Russian state–Gazprom corporate relationship is to look at how this has played out through the select merger and acquisition activities of Gazprom at home and abroad. Actions speak louder than words; they serve as an appropriate measure for gauging Gazprom’s behaviour, and that of the Russian government, in fashioning Russia’s overall energy strategy. Key points

„ What does structural consolidation over Gazprom by the Russian state mean for Gazprom’s future? „ What will be the impact of this consolidation for Russian energy policy? „ Specifically, what do these changes portend for the future of natural gas exploitation, production, distribution and the ultimate export of Russian gas to downstream consumers? „ What are the implications for downstream states’ energy sectors, whose infrastructure is increasingly sought after by Gazprom?

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1. Russian energy diplomacy ‘Putin effectively controls the company and makes all key decisions about its strategy and displays a surprising acquaintance – for a politician of his rank – with the minute details of its operations’ Vladimir Milov, Institute for Energy Policy, Moscow

O

ne of the foreign economic policy instruments of former Soviet diplomacy in its relations with Warsaw Pact members was the conscious decision to create for these states energy dependence on the Soviet Union. The Soviet energy grid is a tangible manifestation of Soviet energy diplomacy, which found its roots in the Brezhnev doctrine of restricted sovereignty. In response to the efforts, early in 1968, of the Czechoslovakian Communist Party, under the leadership of Alexander Dubcek, to introduce a number of reforms, including the abolition of censorship, the Soviet Union adopted a policy of combating ‘anti-socialist forces’. This policy became known as the ‘Brezhnev Doctrine’.6 Under the masthead of ‘socialist internationalism’, the Soviet Union rallied its then Communist allies around a common set of economic and political policies. States would engage with one another, each to their particular strength. For the Soviet Union this manifested itself in subsidizing downstream pro-Soviet states with subsidized energy in return for political acquiescence. By the late 1970s, however, the doctrine’s assumption that the inter-

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ests of all socialist nations were fully compatible began to encounter some undeniable exceptions. In the interest of reviving a mired Soviet economy, Moscow sharply raised the price charged to its allies for badly needed energy exports.7 Hence a Russia-first policy, despite declarations to the contrary, has been a long-standing and well-understood feature of SovietRussian regional foreign policy. The use of energy as a political and economic lever of influence is therefore historic in nature, rationalized by the interests of the Russian state in maintaining its power and influence through the exercise of its comparative, ie energy, advantage. However, not everything changed immediately with the political and economic transition of Central and Eastern European (CEE) states after the collapse of the Soviet empire. Russian energy exports throughout the 1990s had to compete with low international prices for hydrocarbons in neighbouring emerging market economies and, as a result, subsidized energy exports remained largely intact. Another feature were the historic links between the old Communist nomenklatura across CEE, who were, during transition, now rapidly climbing into positions of authority in downstream energy industries, and the Russian nomenklatura who came to power in Moscow. The Soviet energy grid remained physically integrated, while its operational control passed to these new ‘Red Directors’ of various national persuasions. Over the process of Russian transition, the Russian

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oil industry became fragmented, divided up between a small, new class of oligarchs, with state control accordingly degraded, while the Russian gas industry remained monolithic with state control remaining intact and strengthened as a result of recentralized ownership in the hands of the government. Over the transition, the technical and physical state of former Soviet energy assets remained abysmally unchanged, as these new emerging economies now focused on balancing national budgets, retaining a semblance of health and social services, while constructing new governments and sustainable economic infrastructures. Energy systems, including pipelines pump stations, refineries, processing plants etc, ultimately ended up on the privatization chopping block, based on recommendations from International Financial Institutions (IFIs). The Russians were quick and interested in picking up ownership positions in these assets, which historically, technically and pragmatically corresponded to the Russian energy network. As Gazprom has grown in strength over the past 24 months – due in large part to the acceleration in international oil and gas prices – so too has their financial ability to purchase these assets accelerated. Yet, even without gaining ownership control over formerly state-owned downstream energy assets in transit Russian states, Russia is accelerating its access to Western markets through development of transport projects such as Blue Stream and the Northern European Pipeline. What has dramatically changed over the past 24–36 months is the political complexion of some selectively important former Soviet states. The democratic revolutions in Georgia followed by Ukraine (in spite of recent retrenchment in the Ukraine parliamentary elections in March 2006) have driven a wedge between Russia

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and these states, which hold economic and foreign policy importance for the pursuit of Russian interests across its own ‘wider neighbourhood’. As a result, increases in energy prices to these states have been accelerated as a sign of Moscow’s growing political displeasure with their internal political developments, accompanied by Russia’s own increasing dependence on energy exports to support the Russian national economy. Against this backdrop, Russian energy policy has emerged and evolved over the two successive Putin administrations. Even while Russian Prime Minister under President Yeltsin, Putin went to great lengths to address the strategy of commercial economic relations with the CEE countries. At the time, Prime Minister Putin stressed not only the strong economic relations between Russia and CEE but with the CIS as well. Today, Russia’s energy diplomacy stresses the strong position and historic ties Russia has with both regions and the importance that energy plays in bilateral relations. Energy diplomacy has three important elements: (1) Russian state protection of Russian companies in the fuels-and-energy complex; (2) the energy dimensions of Russia’s strategic interests, particularly on a regional basis; and (3) how Russian comparative advantage in fuels and energy can be used for both political and economic advantage. Russia’s energy strategy to 2020 also puts energy diplomacy into perspective and helps define Russia–CIS relations in the energy sphere as well. The strategy is based on a multi-vector approach, which allows the Russian state to seek alliances wherever possible while maintaining strong Russia– CIS ties across a broad range of subjects. During a 22 December meeting of the Russian Security Council, President Putin was exceedingly clear

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on the issue of energy and the power of the Russian state when he stated, ‘energy is the most important force of world economic progress. It always was and will be for a long time.’ He noted that Russia has ‘competitive, natural, and technological advantages’ that could place it in a leading position in the global energy sector. ‘In fact,’ he conceded, ‘Russia has no other area in which to claim leadership.’8 The political drivers behind Russian energy diplomacy are the accession of the vast majority of the former Warsaw and Council on Mutual Economic Assistance (CMEA) states to full NATO and EU Members. Beyond this, Ukraine, Georgia, and Azerbaijan among others have signed Partnership Agreements with NATO, which is a first preparatory step towards membership. However, Prime Minister, Putin stated that, ‘There exist certain problems connected with the EU and NATO integration of this region.’9 In short, as NATO moves closer to Russia’s western and southern borders and as the EU engages Russia’s largest block of downstream trading partners, it feels itself increasingly isolated. As a result, Russian energy diplomacy is designed to maximize its overwhelming presence and range of influence across CEE and the CIS by wielding its energy resources and power availability to its greatest advantage. Further to the West looms the EU, with its strict interpretation of competition policy and with a desire to see sweeping energy reform inside the Russian Federation. There are any number of reasons for Russia’s economic interests in a United Europe, not the least of which are access to the EU’s 25 members and its 450 million consumers. Resulting from the EU’s

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eastward expansion, Russia and the EU now have a common border of 1,500km. The old EU of 15 had already accounted for upwards of 40 per cent of Russian oil and gas exports, 45 per cent of petroleum product exports and 50 per cent of its electric power exports. These figures have expanded exponentially as a result of EU enlargement, with disproportionate ‘new Europe’ dependence on Russian hydrocarbon exports. However, in order to maintain, if not expand, this market, Russia is being asked to do a number of things that (1) it does not wish to comply with and (2) will require an extraordinary exercise of Russian energy diplomacy. Briefly, in return for Russian access to the EU’s internal market, EU President Barroso has asked Russia to provide (1) third party access to Russia’s pipeline network for non-Russian energy producers; (2) move towards de-monopolizing Gazprom and Gazexport; and (3) rectification in the differential between the internal price charged for Russian gas and its global market price. To date, Russia has largely objected to all three proposals and Russian–EU relations are at a standstill in the energy domain as a result. This does not hold true for Gazprom relations with EU and nonEU energy providers alike. Unlike in Russia where Gazprom may speak with the authority of the Russian state, international oil companies (IOCs) speak for the interests of their shareholders, who are principally interested in maximizing profit and return on investment (ROI). As a result, Gazprom–foreign business relations in up-and-mid stream project development continue unabated and unencumbered by what some view as niggling energy security concerns.

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2. What is Gazprom?

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ith the decline of the Soviet empire, the Russian state became the new albeit principal power in the region. At the time of transition, the Russian state’s economic vitality rested on its natural resource base, and the most potent resource among this basket of resources was gas. This still holds true today. In 1991, oil and gas alone accounted for some 80 per cent of all Russian exports10 and the figures today are not remarkably different. As a result, with the Russian Federation as the largest and most successful successor state of the Soviet Union, Gazprom became the world’s largest natural gas company by virtue of the fact that the country itself owns and controls approximately 30 per cent of world natural gas reserves.11 The country is so large, spanning eleven time zones, and energy resources so geographically diverse that it can simultaneously serve Pacific markets and successfully send product to downstream Atlantic states. Gazprom’s profile indicates that it owns 60 per cent of overall Russian reserves and is responsible for approximately 94 per cent of the country’s overall gas production. It supplies gas to all of Russia’s regions, exports its gas to 28 countries and it accounts for approximately 25 per cent of Europe’s natural gas imports. Import dependence on Russian gas is a subjective national function, ranging from 40 per cent of all gas consumed in Germany to nearly 100 per cent of all gas available in the Slovak Republic. These exports generated $18.3 billion in revenue for the

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Russian gas giant in 2004 alone, yet most revenue was absorbed by even faster rising costs. In 2005, net revenue was reported at some $7.33 billion, up a reported 26 per cent from 2004.12 This is largely attributable to a more than two-fold increase in the global price of gas exports and a ratcheting up of prices to former Russian republics. While exports only account for one third of Gazprom’s production, they are responsible for over two thirds of Gazprom’s revenue, highlighting Gazprom’s own dependence on foreign export markets for sustaining the company’s revenue base. In fact, in terms of Gazprom domestic sales, ‘Gazprom expects to lose RUR9 billion, or $324 million, selling gas in Russia this year and RUR11 billion in 2007’.13 This is largely attributable to the desire of the Russian government to continue subsidizing its industrial base with artificially low energy prices and, concurrently, to cap cost-push inflation from the energy sector.

Flat domestic production Russian gas production has been largely flat since 1999. In 2004, production came in at 22.4 trillion cubic feet (tcf), allowing exports to increase slightly to 7.1 tcf, still making the country the largest producer and exporter of natural gas in the world. Output was expected to marginally increase in 2005, expanding exports to 7.2 tcf, according to Ministry of Industry and Trade officials at the end of 2005 (official figures are

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not yet available).14 Gazprom’s own production figures anticipate growth of only 1.3 per cent by 2008, and it is anticipated that most new growth in Russia’s gas sector will be accounted for by new independent companies between 2008 and 2030, according to international sources.15

ences in import dependence. Given the absence of an EU energy policy, and due to differences in the development of legal structures, rule of law, corporate governance, and varying national security policies, particularly across the transitional economies of CEE, Gazprom historically had greater access to some of these downstream markets than it has had in the EU of 15 countries. This is now changing. As North Sea oil and gas are rapidly being depleted, Europe’s regional dependence on Russian gas is deepening, while Gazprom is increasingly interested in investing and controlling the entire European gas supply chain, from well-head to consumer. While outward Russian investment into CEE and Western European markets implies energy interdependence, largely considered a stabilizing factor for global trade in energy and power, such interdependence has security implications as well. In countries with a weak rule of law, accompanied by a weak ability to enforce what rules do exist, vulnerabilities emerge in the management and operation of these downstream energy systems to corruption and organized crime. This holds true regardless of the nationality of ownership. Negative security implications

Russian markets While the Russian Federation still continues to export significant amounts of natural gas to customers in the CIS, its real focus is on hard currency exports to Members of the EU, Japan and to Asia over the longer term.16 This is a trend that began in 1992 and has steadily increased since then. While in Western Europe this is expressed as import dependence on Russian gas, Gazprom, in turn, is structurally dependent on exports to Western Europe (due to the western orientation of its pipeline network for Russian gas transport). Import dependence on Russian hydrocarbons is more pronounced in the newer 10 Members of the EU and NATO than in Donald Rumsfeld’s ‘Old Europe’ of the EU-15. Tables 1 and 2 illustrate the significant differ-

56.7 7.5

6.6

71.6 13.8

12.3

7.3 4

World total: 180 tcm as of 1 January 2004

Figure 1: Global gas supply by region Courtesy: International Energy Agency

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Table 1: Major European recipients of Russian natural gas exports, 2004 Rank

Country

1

Germany

2

Imports (bcf/year)

Percentage of domestic natural gas consumption

1,110

44

Italy

777

29

3

Turkey

473

65

4

France

470

26

5

Hungary

378

72

6

Finland

269

100

7

Slovakia

261

100

8

Poland

258

60

9

Czech Republic

240

82

10

Austria

201

63

11

Bulgaria

184

94

12

Romania

177

24

13

Former Yugoslavia

74

-

14

Greece

74

92

15

Switzerland

18

17

Notes: Does not include exports through Ukraine and Belarus Source: EIA, BP (2005), CIS and E. European Databook, 2005

for cross-ownership of energy networks are even more pronounced in failed states, where energy operators often compete with national governments for domestic power and influence. This has been particularly true throughout CEE and in some of the Caucasus and CIS states, where weak

governance and the lack of transparency have contributed to a de facto transfer of power to mid- and downstream Russian intermediaries partially or wholly owned and operated by Gazprom. In EU Member countries, the situation regarding energy security is

Table 2: Foreign dependency on Russian hydrocarbonsof NATO’s ‘newest’ allies to the east Country/region

%

Poland

99

The Baltics

100

The Czech Republic

82

Hungary

81

Bulgaria

94

Slovakia

100

Romania

55

Slovenia

62

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Russia

25 Trillion Cubic Feet per year

23

Production Consumption

21 19

Net Exports (2004): 7.1 tcf/y

17 15 13 11 9 7 23.4 2005e

22.8 2005e

21.7 2005e

22.7 2005e

15.3 21.0 2003

15.3 22.4 2004

14.4 20.5 2001

14.6 21.0 2002

14.0 20.8 1999

14.1 20.6 2000

14.5 21.2 1996

13.4 20.2 1997 14.0 20.9 1998

15.2 21.5 1994

Consumption

14.5 21.0 1995

Production

16.5 22.6 1992 16.2 21.8 1993

5

Figure 2: Russian natural gas balance, 1992–2008 Source: 1992–2004: EIA, 2005: Interfax, 2006–2008: Gazprom

somewhat different. EU Members have well-established legal structures and judicial procedures that can be employed for monitoring and, if necessary, preventing asset transfer, if deemed appropriate by national government. This, however, does nothing for direct diversification of energy and power supplies. European energy security is undermined not necessarily by the growing weight of Russia in supplying Europe with vast quantities of gas, but in EU reluctance at bringing new power on line whose source is independent from Russia as an external source. Nuclear power is one such case in point. Large scale reintroduction of nuclear power would afford some power generating diversification away from natural gas fired power plants, which again depend on Russia imports.

Unfolding history Gazprom is the successor institution to the former Soviet Ministry of Gas, which was created in 1965 as the

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Soviet state decided to place considerable emphasis on natural gas production and transport. The Ministry was charged with exploring, extracting, processing, and transporting the country’s natural gas resources. In 1989, the Ministry changed its name to Gazprom and was officially reorganized in accordance with the Decree of the President of the Russian Federation of 5 November 1992 and confirmed by the Resolution of the Council of Ministers of the Russian Federation of 17 February 1993. According to company’s official position ‘the history of the company begins [began] with these two basic state decisions’.17 Gazprom’s lessons learned during the initial days of Russian privatization were to maintain control over gas development and transport by avoiding the splintering operations of privatization, which disembowelled state control over Russia’s oil industry.

However, as indicated Gazprom hardly began with a clean slate. On the

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positive side, as the Soviet state gas monopoly’s legal successor – first as a Russian joint stock company and then restructured as an open joint stock company – Gazprom inherited the Ministry of Gas land, mineral rights, and natural resources, physical and financial assets. However, it also inherited a bloated employee payroll, various social responsibilities attributable to its predecessor’s standing as a state institution within the centralized Soviet system, as well as its predecessor’s opaque decisionmaking structure.

Troubles from the beginning From its very beginning, Gazprom’s revenue profile was hampered by maintaining non-core businesses, which diluted its revenue stream by redirecting funds to non-essential ends. According to Alexey Miller, Chairman of Gazprom’s Management Committee, these non-core businesses will be spun off as the company undertakes large-scale restructuring.18 However, little evidence exists to indicate that Gazprom has moved to focus on its core business (gas production and transport), while concurrently the company is unable to keep pace with the massive investment challenge it faces simply to maintain its pipeline network, let alone expand it. The dilution of Gazprom capital into Gazprom Media (which includes more than 50 individual holdings) and its 2003 purchase of a 15.8 per cent stake in Mosenergo are but two cases in point. Gazprom’s business practices have also been slow to change. Industry practitioners with long experience of working with the company speak of the continuation of a ‘Gazprom or Russian norm’, which has little to do with building a business model based on efficiency and flexibility. This norm

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reflects a desire to maintain the status quo, while strengthening where possible the Russia-centric core of Gazprom’s Russian business relationships. According to these practitioners, these relationships sometimes conspire to favour inefficient Russian companies and their products over those of more technologically and cost-efficient foreign competitors. The Russian norm rests on the bedrock of the Gazprom–supplier relationship, which insists on Russian supplier ownership through a long chain of intermediaries,19 close bureaucratic connections with company personnel who may or may not financially benefit directly from this relationship, and an overall insular view for a company with activities that are by their very nature international. These practices perpetuate Gazprom inefficiencies, and in a distorted monopoly market, provide no incentive effect for improving corporate performance. Viktor Chernomyrdin, who presently serves as the Russian Federation Ambassador to Ukraine, was Gazprom’s main proponent both inside as well as outside of the Yeltsin administration during Gazprom’s early transition period. From June to December 1992, Chernomyrdin was Deputy Prime Minister for Energy, and during this period attempted to establish a stabilization fund for investment in Russia’s hydrocarbons sector. However, Chernomyrdin was famous for being appreciative of ‘investment without the investor’. For example, as Deputy Minister for Energy Chernomyrdin convinced a Russian investor to sink some $15 million in the Shotmonovsky oilfield in 1992. Chernomyrdian quickly persuaded the Russian President to transfer the company to Gazprom shortly thereafter.20 Chernomyrdin diligently fought to prohibit Gazprom’s unbundling through privatization in such a way

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that it would lead to a dilution of ownership and control. After Russian President Yeltsin appointed Chernomyrdin to be his Prime Minister in November 1992, Gazprom’s power and influence within ‘the family’ and government increased accordingly. While voucher privatization of Gazprom shares did occur, strict limits were placed on the percentage of foreign ownership allowed (a limitation incorporated into Gazprom’s bylaws). 21 In short, Gazprom’s experience with privatization was nominal at best. This was in no small part due to Chernomyrdin’s success in preserving the company’s monopoly position over upstream gas development but also in maintaining Gazexport’s control over Russia’s midstream gas transportation network inside the Russian Federation. Whereas Russian oil concerns must vie for access to the country’s pipeline network, owned and operated by a separate transport monopoly, Transneft, Gazprom has never been faced with a similar dilemma. Further, whereas Gazexport ostensibly guarantees pipeline access22 to alternative Russian gas producers, Gazprom product continues to dominate and feed the monopoly’s pipeline network. As a result, many Russian gas companies are now flaring their gas because Gazprom refuses to give them pipeline access.23 While monopoly control may be viewed by some as a fundamental advantage, this same model has starved Gazprom’s transport infrastructure from receiving the necessary investment income for the expansion, maintenance and repair of its pipeline system; it has institutionalized largescale inefficiencies that plague the company’s performance, and because of the monopoly structure of the market itself, there is no external incentive (ie competition) to drive change forward.

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This is further complicated by the fact that global energy markets are imperfect, and while oil is a fungible commodity, gas is not.24 This insulates the Russian gas industry from direct competition on Russian territory. Historically, gas has been a regional commodity. Unlike oil, gas has no spot market and is physically grounded in pipeline transit – with perhaps the exception of LNG, which in the future may develop a spot market for this commodity – and the industry remains largely land-transit based. This requires enormously long pipeline networks that traverse multiple states, leading to a multitude of vulnerabilities. Monopolization, however, does play into the hands of the Russian government. It gives them control over what, arguably, is the country’s greatest weapon: its energy card. Monopolization however does play into the hands of the government. It gives them control over what, arguably, is the country’s greatest weapon: its energy card.

Hence, Gazprom’s early lessons learned during the initial days of Russian privatization were (1) to maintain control over gas development and transport operations by (2) avoiding important and large-scale privatization. Further, Chernomyrdin the contrarian sought to build a vertical Gazprom empire, modelled after Western oil and gas giants at a time when the former Soviet Union’s industrial infrastructure was undergoing privatization and, in some cases dissolution, through asset stripping, rent seeking and bankruptcy.

Downstream de-coupling Where Chernomyrdin failed was in maintaining control over the gas transportation infrastructure in the

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neighbouring states of Belarus and Ukraine. The pre-independence pipeline system in Belarus remains under Beltransgas control.25 In Ukraine, the Soyuz pipeline and the two-thread Urengoy–Uzhgorod pipeline remain under Kyiv’s control, yet Gazprom will continue to push for a shift in ownership for years to come.26 Attempts at regaining control over these infrastructures are in direct response to the independence of these former Soviet states. In some cases, relations remain relatively stable as is largely the situation with Russian– Belarus bilateral relations, but others have worsened as has been the case between Ukraine and Russia, particularly in the post-2004 Orange Revolution period, with Ukraine’s push to distance itself from Moscow in both political and economic terms. As a result of the dissolution of the Soviet Union, Gazprom lost a large part of its assets outside of Russia – one third of its pipelines and one fourth of its compression capacity. In a very real sense, part of Gazprom’s corporate strategy today is indicative of an ongoing process of reclamation over downstream energy assets lost in the independence process that flourished across former Soviet states. This has provided the re-nationalization impetus for surrounding effective controlling repatriation over the old Soviet gas network on an extra-territorial basis and in the recentralization of domestic state control over hydrocarbons assets inside the Russian Federation. Anatoly Chubais, the Chief Executive Officer of Russia’s electricity monopoly, RAO UES, has characterized this process of state building as the quest for liberal empire. RAO UES and Gazprom are state monopolies, which view competition in zero-sum terms. Competition is only tolerated to the degree it is useful to, and serves

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as a function of, corporate or state building. Above all, Gazprom operates as a monopoly under post-Soviet monopolistic logic. It seeks to control the entire supply chain, from upstream exploration to downstream processing and distribution. Its expression of control domestically is through direct ownership. Internationally, control is expressed through a partial or whollyowned reconsolidated ownership position in downstream gas infrastructure, with the effect of obviating competition in accordance with its own monopolistic logic. The company’s description of its own ‘core activties’ reflects this thinking. According to Gazprom its core businesses are as follows: „ geological survey operations on the continent and continental shelf; „ well drilling; „ natural gas, condensate and oil production; „ gas condensate processing and oil refining; „ natural gas transmission; „ natural gas underground storing; „ gas marketing; „ research and scientific works and design developments; „ energy saving and environment protection.27 Russia’s own long-standing attempt at creating an international gas cartel28 is also reflective of Gazprom’s prominent position as the world’s largest producer of natural gas and, more particularly, in Gazprom’s aspiration of being to the gas market what Saudi Aramco is to oil. In short, Gazprom seeks to be a price-maker in the market. In order to do this it must effectively organize an international gas cartel capable of

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Gazprom employs

330,000

100,000 in West Siberia Figure 3: Gazprom: a major employer Graphic courtesy of Gazprom in Questions & Answers, 2005, available at www.gazprom.ru

setting and maintaining prices. This can be achieved either through (a) multi-lateral cooperative efforts of gas producers or through (b) compelling actions. With respect to CIS producers, ‘compelling actions’ can be principally defined as forcing CIS gas northwards through the Russian export system, which in turn benefits Gazprom vis-à-vis Gazexport through (a) increased transit tariff generated revenue or (b) through subsidizing the Russian gas market with cheaper imported gas, thereby allowing Gazprom to expand its export capacity abroad. A truly global gas cartel, along the lines of OPEC, would require, by definition, market-based cooperation between Russia and Iran, which together account for more than 50 per cent of global gas reserves. Russian support for the Iranian nuclear sector, Russian arms sales to Iran, and nonRussian intervention in Iraq are all indicative of (1) closer Russian– Iranian relations but also (2) of Russia’s long-standing ambition to create a strategic triangle between Moscow, Tehran and Beijing to offset US influence globally.

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Russian Foreign Minister Laverov’s objection to discussing a military response to short-circuiting Iran’s nuclear programme, calling it ‘hypothetical’ and ‘inappropriate’, is further evidence that if pushed too far by Western interests – exemplified by US and European rejection of Iran’s nuclear ambitions – Russia is ready to intervene in the UN Security Council by preventing a censure of Iran in the form of a trade embargo or the imposition of other non-military instruments to punish Iran for its behaviour. Russian–Iranian cooperation in the gas sector is but one aspect of an increasingly complex relationship, which also includes Russian–Iranian nuclear cooperation and Russian transfers of military equipment, among other items. Regardless of questions surrounding the credibility of creating a CIS or more global gas cartel, Gazprom’s vision stands as a testament to how the company’s perceives itself and, moreover, how the Russian government envisages Gazprom as a global industry leader, capable of reshaping the market for its own purposes.

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Finally, Gazprom is Russia’s single largest company with over 460,000 shareholders. It provides 25 per cent of all Russian tax revenue (averaging over $4 billion annually between 1993 and 2003) and accounts for at least eight per cent of the nation’s GDP. Russian state dependence on Gazprom revenue (1) prevents state de-coupling from interfering in Gazprom pursuing its own corporate strategy, and (2) because of Russian tax policy as applied to corporate activities, limits Gazprom’s ability to redirect before profit income into corporate investment. Russian state tax policy is essentially Soviet redistributive tax policy that allows the state to use corporate income for state-based purposes. While Gazprom’s employment profile is large and growing – its number

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of employees increased by over 80 per cent between 1997 and 2003 – its reportedly 330,000 employees are but less than half of one per cent of the total Russian labour force.29 This is not atypical for the hydrocarbon industry, which accounts for a high revenue stream but low employment. The Gazprom anomaly, however, is that it added employees while labour productivity dropped by over 40 per cent over the period 1997–2003. Unit labour costs in the gas industry jumped 107 per cent over the same period, while they rose only 25 per cent in the mostly privatized oil industry. Hence, state intervention implies under-performance, which is dangerous for a country largely dependent on a small basked of commodity exports for economic growth and national economic sustainability.

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3. Gazprom and global energy

A

ny appreciation of Gazprom as a company, considering both its strengths and weaknesses, should be placed in the context of global energy demand, the shift in demand patterns, and, most importantly, in the increasing importance of natural gas and its derivatives. Overall global primary energy demand growth is increasing, driven by China, India and the developing world. Comparatively speaking, energy demand will increase in mature economies by 1.1 per cent per year between now and 2025. This will be easily eclipsed by growth across Asia by some 3.5 per cent per annum during the same period. In the transitional economies of Eastern Europe and the former Soviet Union (FSU), growth in energy demand is projected to average 1.6 per cent per year. For Gazprom, its corporate challenge will be to meet this demand and to main-

tain and increase its market share as the world’s largest natural gas company, particularly in what it considers its own ‘near-abroad’. Demand growth in the Russian Federation itself may be curbed if, according to the terms of its accession to the World Trade Organization (WTO), the Russian government is forced, and Gazprom is allowed, to charge market prices for its gas to Russian industrial and individual consumers. Clearly, there will be much discussion within the context of the G8 Summit in St Petersburg in 2006 on Russia’s terms of accession to the WTO, and hard lobbying to avoid bringing Russian domestic energy prices in line with global market prices can be expected from President Putin. He can also be expected to argue that Russia is liberalizing its gas market and to point to the success of this policy by citing increased production figures from independent producers.

Table 3: World marketed energy consumption by region, 1990–2025 (Quadrillion Btu*) Average annual percentage change Region

1990

2002

2015

2025

1990–2002

2002–2025

Mature market economies

183.6

213.5

247.3

271.8

1.3

1.1

Transitional economies

76.2

53.6

68.4

77.7

෹2.9

1.6

Emerging economies

88.4

144.3

237.8

295.1

4.2

3.2

Asia

51.5

88.4

155.8

196.7

4.6

3.5

Middle East

13.1

22.0

32.4

38.9

4.4

2.5

9.3

12.7

19.3

23.4

2.7

2.7

14.5

21.2

30.4

36.1

3.2

2.3

348.2

411.5

553.5

644.6

1.4

2.0

Africa Central and South America Total world * British Thermal Units

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It is important to note, however, that these companies are not allowed to export their product but only to sell it on the domestic market for prices as low as one-fifth of the international market price for gas. Such ‘liberalizaton’ also helps Gazprom balance its books by having these independent producers satisfy domestic demand, thereby freeing up additional gas for Gazprom exports. Even then, regional European demand for natural gas has already stirred Gazprom to attempt to dominate the entire regional CIS market, including all available gas found in Kazakhstan, Turkmenistan, and Uzbekistan. Due to Gazprom’s slow-growth production, it needs these supplies to satisfy contractual commitments it has already made downstream. In 1997, for example, ‘Gazprom began importing natural gas from Turkmenistan to help fulfil its supply contract with the Netherlands. Since then, Turkmenistan and Russia have had repeated disputes over the pricing of the natural gas, resulting in a complete halt to natural gas supplies in 2004. Turkmenistan’s January 2005 agreement with Russia guarantees initial natural gas exports of 212 billion cubic feet (bcf) in 2005, drastically increasing to 2.4 trillion cubic feet (tcf) in 2007, and remaining at 2.8 tcf from 2009 to 2028. Turkmenistan maintains that the $1.55/mcf price it agreed to is too low in comparison to the resale value of natural gas in European markets, and it wants to raise the price to $1.76/mcf in 2006 and $2.12/mcf in the following years.’30 Gazprom and the state have no vested interest in allowing alternative natural gas export routes from the CIS to develop that obviate the Gazexport system and the Russian Federation in general.

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Gazprom and the state, together, have no vested interest in allowing alternative natural gas export routes from the CIS to develop that obviate the Gazexport system and, by implication, the Russian Federation. Part of this can be explained as a corporate effort to meet its downstream commitments for natural exports, particularly to its Western European clients, by forcing gas northwards through Russia; the other aspect of this equation is more unsavoury. The Russian government effectively undermines the attempts of FSU states in strengthening their own independence by dissuading, at every turn, the development of alternative transport networks that obviate Russian space. Revenue independence, in short, makes political independence possible. The fact is that Russia has never ratified the European Energy Charter with its Transit Protocol detailing third party access to transportation networks. The EU has unsuccessfully argued this point with Russia. It has offered access to its deregulating internal market for energy in return for Russian acceptance of third party access. Thus far, the only thing the EU has received is more Gazprom gas and hence increased dependence on Russian imports. Real issues it would like to see resolved are the de-monopolization of both Gazprom and Gazexport; neither of these are probable. According to the IEA, fossil fuels will account for over 90 per cent of the growth in energy demand, with natural gas playing an increasingly important role in the fossil fuel mix. World primary energy demand is projected to expand by almost 60 per cent between 2002 to 2030, with an average annual increase of 1.7 per cent per year. Demand for gas will grow at 2.3 per cent per year between 2002 and 2030 – the fastest rate of any fossil fuel. By 2030, gas use will be

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(as in China, where generation is heavily reliant on coal-fired capacity), natural gas is expected to gain share in the electric power mix over the forecast period. The natural gas share of total energy used to generate electricity worldwide increases in the forecast, from 18 per cent in 2002 to 24 per cent in 2025, with other energy sources showing small losses in market share.31 Given Gazprom’s interest and propensity to attempt to control the entire supply chain, it is somewhat surprising that they have not yet moved more aggressively into the distributed power and heat distribution networks of CEE and the FSU. The fact is that in Russia Gazprom’s three main fields (the ‘Big Three’) in Western Siberia – Urengoy, Yamburg and Medvezh’ye – comprise more than 70 per cent of Gazprom’s total natural gas production, but these fields are now in decline (gas extraction falls by 20–25 billion cubic metres (bcm) each year). As a result, Gazprom is actively studying new deposits suitable for large-scale exploration. The company plans to substitute falling extraction volumes from old deposits with deposits in Nadym-Pur Taz region, and then by development of new fields on Yamal Peninsula and

90 per cent higher than now, and gas will have overtaken coal as world’s second largest energy source. Total world natural gas consumption is projected to rise from 92 tcf in 2002 to 128 tcf in 2015 and 156 tcf in 2025. Natural gas is expected to remain an important supply source for new electric power generation in the forecast. It is seen as a desirable option for electric power in many parts of the world, given its efficiency relative to other energy sources and its low carbon content relative to other fossil fuels, making it a more attractive choice for countries interested in reducing greenhouse gas emissions. The industrial sector also remains an important end-use consumer for natural gas worldwide. The electric power sector will account for nearly 50 per cent of the increase in global natural gas demand over the 2002 to 2025 period, and the industrial sector will account for another 36 per cent. Natural gas is expected to be a favoured choice for new electricity generation capacity built over the next two decades. Its relative environmental benefits and efficiency make natural gas an attractive alternative to coal-fired generation. Moreover, where fuel diversification is desired

800

Quadrillion Btu Projections

History

645

600

598 553 504 412

400 285 200

207

310

348

366

243

25 20

20 20

15 20

10 20

02 20

95 19

90 19

85 19

0 19 8

75 19

19

70

0

Figure 4. World marketed energy consumption, 1970–2025.

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on the Arctic shelf, most notably, on the shelf of the Barents Sea near Murmansk (specifically the Prirazlomnoye and Shtokmanovskoye gas condensate deposits). A gas liquefaction plant is planned near Shtokmanovskoye field, and possibly in Leningrad Region near Ust Luga port.32 With respect to the often discussed Murmansk facility, it should be noted that while two individual pipelines have been discussed no decision has yet been made on either. Confusion on pipeline routes is rife within Russia’s bureaucratic structure, as Stephen Blank has pointed out.33 According to Blank, this is largely attributable to what he calls the ‘primary of rent seeking,’ whereby members of the bureaucracy seek to manipulate decision-making for personal financial and power aggrandizement. One of Blank’s examples is the case of Transneft in Murmask, whose President is pushing for a pipeline route to run close to property he owns in order to enhance its resale value. Gazprom is also striving to develop new export markets, most importantly North America, South-East Asia and the UK. Since it is not possible to extend pipelines to some of these markets, Gazprom plans to start production of new products such as

LNG (liquefied natural gas) and various synthetic fuels (such as liquefied petroleum gas, petrol, etc). These liquid products can be delivered to customers using ocean tankers. Gazprom has already started to look for foreign partners with marketing capabilities and regasification facilities in North America, who would also be willing to invest in Gazprom’s new projects in Russia. ChevronTexaco, Statoil and PetroCanada have signed Memorandums of Understanding with Gazprom. Whereas LNG will be mainly delivered to North America, Gazprom also plans to expand its capacity in Europe by building a new North-European Gas Pipeline, which would enable it to saturate increasing demand in its traditional European markets, and to develop new ones. The pipeline will stretch underwater from Vyborg near St Petersburg to Germany, with possible continuation to the UK. Both of the anticipated Gazprom export projects (NorthEuropean Gas Pipeline and development of Shtokmanovskoye field with the construction of an LNG plant) are located in Northwest Russia. LNG is an important derivative that will help the global market for natural gas and a particularly important one for Gazprom. However, like all hydrocarbon products it has its Percentage of total 100

80 Natural Gas 60

Nuclear Renewables

40

Coal Oil

20 0 2002

2010

2015

2020

2025

Figure 5: Fuel shares of world electricity generation, 2002–2025.

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own set of challenges. Among these are the marketability of LNG for distances under 3,500 miles,34 the cost factors in constructing deep-water port facilities capable of handling ocean-going vessels, and the associated cost of liquification and regasification facilities (although these are declining and the cost efficiencies and ROI on new facilities are increasing given the present high price of gas, which make projects like this feasible). In spite of this, the future for Russian LNG in the North American market appears bright. Among the factors underscoring this optimism are: „ natural gas is the fastest growing energy source in the US; „ natural gas supplies approximately 25 per cent of US energy; „ the US consumes about 25 per cent of the world’s annual natural gas production; „ natural gas demand in the US is expected to increase almost 40 per cent by 2025.35 As a result, the future for Gazprom natural gas and associated LNG appears ostensibly bright. However, it should be pointed out that one major incident involving LNG facilities and terminals around the world could shut down this growing industry, not unlike the effect that Three Mile Island and Chernobyl had on the nuclear industry. This threat is largely asymmetric, ie from global terrorism and piracy, and while this high risk threat may be perceived as having a

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low probability, the threat remains. Therefore, any investment decision in long-term Gazprom performance, predicated on increased access to overseas markets, should take this factor into account if that investment is predicated on the revenue growth of Gazprom from US markets. Key points

„ Gazprom benefits from the global increasing demand for natural gas. dependency on „ Import Russian gas imports is most pronounced in CEE, given the architecture of the former Soviet natural gas network; this is changing, however, as the availability of North Sea oil is steadily decreasing and EU/ NATO Members increase their natural gas imports from the Russian Federation. „ Gazprom’s revenue base for hard currency imports is correspondingly focused on Western European markets. „ While LNG is an alternative for Russian gas exports and for the creation of new markets, in the mid-term Gazprom’s exports will be land-transit based. „ Gazprom requires additional sources of natural gas from the CIS in order to meet its export commitments to Western Europe.

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4. Recent restructuring

G

azprom’s 2005 restructuring is the centrepiece of Russian state energy policy. It concurrently provides a working success story that proponents of state-based control over strategic elements of the Russian economy can point to, and also provides the government with an active agent for state recapture over other elements of Russia’s energy complex. President Putin, himself a graduate of the prestigious St Petersburg Mining Institute in 1997, published in 1999 an article on the role of ‘Mineral Resources in the Development Strategy of the Russian Economy’. ‘In it, Putin posited that hydrocarbons were key to Russia’s development and the restoration of its former power. He argued that the most effective way to exploit this resource was through state regulation of the fuel sector, and by creating large and vertically integrated companies that would work in partnership with the state.’ 36 Gazprom is important, therefore, not only for what it represents but more importantly for what it is. Surprisingly as large and influential as Gazprom has been historically, recent developments have imbued it with even more power as a manifest tool for government intervention. The application environment for potential intervention includes not only Russia’s domestic political landscape and its national economy, but also the global strategic environment subject to impact through the exercise of Russian foreign policy. In the opinion of one Russia’s most respected Western investment banks,

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Renaissance Capital, and its leading analyst, Roland Nash: ‘Increasingly, energy is becoming Russia’s single major foreign policy tool, not just in the near abroad (Belarus, Turkmenistan, Georgia, Ukraine), but also in its relations with the world’s global powers. While this can be frustrating for Russia’s partners, and explains much about Putin’s obsession with the ‘strategic sectors’ of the economy, pipelines and ports are clearly a much healthier way to project international influence than missiles or the financial suicide threats of the Yeltsin era.’ 37

Setting Nash’s rationalization of the relative gravity of Putin’s choice of pipeline politics over missiles aside, it is worth noting the increased weight assigned to energy as a tool governing relations among and between states. In an era pronounced by globalization in which economics and the management of a country’s national economic assets have given rise to the concept of ‘economic security’, energy and its availability is key to maintaining an economically secure environment. Energy’s role in the national security of nation states transcends the buying and selling of commodities that drive economic growth forward. In the developed world, energy (or more appropriately the absence of access to national energy resources) is visibly eclipsing traditional security threats from the use of conventional (or nonconventional) weapons (aside from the threat of asymmetric warfare) as an issue of concern; energy ‘statecraft’ is becoming a new measure of a

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country’s ability to navigate forward in an increasingly treacherous global security environment. If used properly, energy statecraft can enhance the producer–consumer dialogue and therefore contributes to global stability. If misused and if energy is chosen as a tool for political leverage, it can inflict a large and dangerous uncertainty quotient into the global security framework. This is a fine line that those responsible for the pursuit of a Gazprom corporate strategy have to balance against the heavy weight that has been placed on Gazprom by the state as a result of this restructuring process. In conclusion, President Putin’s choice of energy security as the focal point for the G8 Summit in St Petersburg is a positive step forward for raising the visibility and impor-

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tance of global energy security. Russia’s concurrent threatening posturing towards the Ukraine, Georgia and Moldova among others, discredits this otherwise positive policy and injects uncertainty where stability should reign. Russia, and potentially Gazprom, will suffer over the long term from these developments, causing Western European, importdependent nations to look for solutions elsewhere while concurrently encouraging other market players, technologies and instruments to be deployed to diversify away from Gazprom market dominance. Having said this, market and resource diversification should be a coordinated action for the purpose of enhancing stability and should therefore avoid increasing risk and threats to the present profile of resource availability.

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5. Confluence of Russian foreign and energy policy Gazprom share purchase

T

he event that formally linked Russian foreign and energy policy was the government’s 2005 repurchase of a controlling interest in Gazprom shares. In 2005, the government purchased 2,542,500,000 shares (10.7399 per cent of the corporate charter capital) for RUR203,501,700,000. The transactions were endorsed by Rosneftegaz38 shareholders and by Gazprom’s Board of Directors on 16 June 2005. The share transfer transaction was settled through a series of three separate payments. The first in the amount of RUR16.2 billion was received by Gazprom in July 2005. The second and third payments were completed in October and December 2005 respectively. At current exchange rates, the transaction was valued at approximately $7.11 billion, well below the $8.39–$9.92 billion the transaction was valued at by Morgan Stanley or the $10.2–$11.5 billion as estimated by Dresdner Kleinwort Wassertstein.39 Although the acquisition price paid for by the government for the Gazprom stock was well below market estimates, it was calculated close enough to avoid the psychological pitfall of spooking the foreign investment community and thereby undermining foreign investor confidence in the company’s future. In a convoluted ideological twist, government

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spokesmen rationalize the renationalization of Gazprom as a method of paving the way forward for increased foreign investment in Gazprom shares. In fact, Gazprom media reported on the share price valuation and subsequent transaction that, ‘increasing the state’s share in Gazprom’s authorized capital to a controlling stake marks the initiation of the Company’s share market liberalization’.40 Gazprom defines this liberalization as ‘no restrictions on Gazprom shares on the Russian market, and the lifting of restrictions on Gazprom share purchases by non-Russian entities. It would also mean that Gazprom shares circulating in Russia could be freely converted into ADRs.’41 As widely circulated, the transaction was intended to provide the state with a controlling percentage of Gazprom shares in excess of 50 per cent. However, according to calculations based on the government’s historic share capital of 38.37 per cent, the present shareholdings of the Russian government in Gazprom authorized capital only reaches a total of 49.11 per cent, 1,039 of total shares issued thus falling short of the oft stated 50 per cent share total but well in advance of any other individual or institutional shareholder. This is supported by a report filed by the influential Russian business daily, Kommerstat, a media holding of Gazprom subsidiary Gazprom-Media. Kommerstat reported that the government had miscalculated the state’s holding of Rosgazifikatsiya (a majority state-owned

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company that controls state-owned stakes in regional natural gas distribution networks in Russia). The Russian state must significantly increase its share in the regional distributor from 74.5 per cent to more than 99 per cent, or to otherwise ensure that the regional distributor sells its securities to Rosneftegaz. Therefore, the calculation of the Russian state government’s holdings of Gazprom stock at approximately 49.11 per cent without the additional Rosgazifikatsiya shares appears correct. Increasing the government’s stake in Rosgazifikatsiya to virtually 100 per cent, resulting in the contribution of minority stakes in more than 50 state-owned regional natural gas distribution organizations, will push the government’s majority position in Gazprom’s authorized capital above the 50 per cent threshold as originally intended.42 The most telling aspect of this government miscalculation in failing to exceed the 50 per cent threshold in Gazprom shares in its first attempt, is that it suggests those driving policy discount the importance of the commercial and financial ‘detail’ and place a premium on the political implications of what otherwise should be considered commercial transactions. Simply put, government policymakers placed premium on the recentralization of state control over Gazprom rather than the financial costs of achieving this control.

Governmental public diplomacy: sending the right Gazprom message Exercising the government’s purchase of a controlling interest in the company vis-à-vis the financial markets was a palatable way of achieving this objective. It placated foreign

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investors’ desire for at least quasimarket measures used in the re-exertion of the government’s controlling interest over Gazprom, coupled with the fact that an approximation of a market price for this controlling interest was actually paid. Second, the government’s promise to raise the ceiling percentage on foreign ownership provides the illusion that foreign investment in the firm is welcome, at the same time prohibiting FDI sharelevel investment from rising to a majority shareholder position. There has never been any doubt, however, about the ultimate success of its policy ie government recapture. The financial cost of this policy was a negotiated one between Gazprom management, as representative of its individual and corporate shareholders who do in fact have a commercial interest in what it is paid, and the government, which ensured ownership transfer at the lowest relative cost. In short, the outcome of the government’s decision to recapture Gazprom was never in question regardless of the economic or financial costs of the purchase. The larger and much more relevant question that this process raises is whether Gazprom as a commercial organization can be run profitably by a management board interested less in corporate finance than in the power derived from its control. A second important point bearing on the desire to see Gazprom viewed as a commercially efficient enterprise is that state-owned and operated energy industries, regardless of location, are hardly the paragons of economic efficiency. Already, Gazprom has suffered from its legacy as the successor institution to the Soviet Ministry of Gas. The outstanding issue is whether Gazprom can break this trajectory in spite of its restructuring. Considerations concerning the long-term investment potential for Gazprom should take account of

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the recent past of the Soviet gas industry under the Soviet regime, when the Soviet gas complex suffered from a long-term decline in capital investment, new field development and in Gazprom’s case, flat output since 1999. Russia beyond Putin is unknown. Despite its huge reserves, short-tomedium term investment in Gazprom should factor in as a risk premium the overall impact on performance and the logic of the company’s down-

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stream investments in low- or nonreturning asset acquisitions. This risk premium is counter-balanced by Gazprom’s principal dominance over Russian natural gas, its long history as a reliable supplier of gas to its downstream customers (with the exception of recent experience) and the demand premium placed on an evolution away from coal-based and nuclear power generation by its geographically contiguous neighbours to the west.

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6. Gazprom management

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azprom’s Board of Directors is comprised of 11 individuals supported by a Management Committee of 17. Both the Board and Management Committee strongly reflect the friendships, ties, and relationships developed by the Russian president over his own career in the KGB and those relationships forged during his tenure spent in St Petersburg, both as a student and political appointee. The president spent 15 years in the former Soviet KGB (now FSB) as a Federal Security Agent and then went on to study at the prestigious St Petersburg Mining Institute.43 He also served as the Director of the St Petersburg Foreign Economic Relations Department attached to the Mayor’s office in St Petersburg. From a conceptual standpoint, part of Putin’s vision was groomed by Vladimir Litvinenko, rector of the school at the time when Putin was a PhD student. Litvinenko’s vision, in turn, may have been shaped by the Brezhnev doctrine, which strove to retain influence and a good deal of control over the then Soviet Union’s neighbours by keeping them largely dependent on subsidized Soviet energy imports as detailed earlier in this monograph.44 Litvinenko now serves on the newly created Russian Energy Commission as a key member of that commission and is believed to have been one of the principal architects of Russia’s Energy Strategy to 2020. From an operational standpoint many of the present Gazprom appointees originate in the political ties the Russian

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President forged while part of the St Petersburg Administration.

Gazprom factions Market liberals Like Russia itself, there are many competing factions in the government and Gazprom vying for the president’s ear. How to manage energy as an efficient tool of state power is one issue. Another is if and when Gazprom should be used as a foreign policy lever when those in Russia’s near abroad embark on policies that run contrary to those held by the Kremlin. There are at least three factions within the horizontal government– Gazprom–Rosneft triad which compete against one another for power and influence. ‘The failure to proceed with the merger between Gazprom and Rosneft, which would have created a Russian state energy company to rival Saudi Arabia’s Aramco, highlighted infighting between competing Kremlin factions allied to the two companies’, offers one analyst.45 However, the President’s position of ‘once a KGB man always a KGB’ man holds: he is loyal to those who have been loyal to him both in and out of the Russian security services.46 A further nuanced approach points to the struggle among competing groups within the Kremlin’s circle, broken down along ideological lines. The first group can be identified with market liberalization and includes the Russian Minister of Economic Development and Trade,

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German Gref; (former) Russian Presidential Advisor, Andrei Illainov; and Viktor Khristenko, Minister of Industry and Energy. Gref has stated on more than one occasion that the Russian government has no business in taking an ownership position in companies in economic sectors otherwise governed by competition. For his own part, Illainov had been quoted, prior to his departure from government, in characterizing the government’s prosecution of the country’s most profitable oil company, Yukos, as ‘the swindle of the year’.47 Taken together, while this camp may sympathize with the economic security importance of Gazprom, the tendency would be to argue that the best way of maximizing national economic security, and thereby Gazprom’s contribution to the national budget, would be to allow the company to function as a sensible and profitable economic unit, unencumbered by Kremlin politics. The Russian Federation Minister for Economic Development and Trade German O Gref was born on February 8, 1964, in Panfilovo, Pavlodar Oblast, Kazakh Soviet Socialist Republic. Mr German O Gref was Legal Advisor, Regional Agriculture Department, Irtish Region, Pavlodar Oblast in 1981–1982. He served in the Soviet Army from 1982 to 1984.

German Gref studied at preparatory courses, Law Department, Omsk State University, and was a student at the University from 1985 to 1990. He graduated from Omsk State University and obtained his law degree in 1990. German Gref taught at the Law Department, Leningrad University, in 1990, and completed the post graduate programme at the Law Department, Leningrad University, in 1993. Mr Gref held various jobs at St Petersburg City Administration, including: Legal Adviser, Economic Development and Property Committee, Petrodvorets District Administration in 1991–1992, Chief, Petrodvorets District, City Property Management Committee in 1992, Chairman, City Property Management Committee, Deputy Head, Petrodvorets District Administration in 1992–1994, Vice Governor, Deputy Chairman, Director, Real Estate Department, First Deputy Chairman, City Property Management Committee in 1994–1997, Vice Governor, Chairman, City Property Management Committee in 1997–1998. Mr Gref served as Member of Board, Ministry for State Property of the Russian Federation in 1998, and First Deputy Minister, Ministry for State Property of the Russian Federation in 1998–2000. He has been Member of Board, Federal Commission for the Securities Market of the Russian Federation since 1999. German Gref was appointed Minister of Economic Development and Trade of the Russian Federation in 2000. Source: www.gazprom.ru

German O Gref

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The Russian Minister of Industry and Energy Viktor Khristenko has also been outspoken on the issue of using the market and non-political market instruments to address Russian energy security. In a speech to the Asian Economic Forum in 2005, Khristenko stated that, ‘Only by balancing this issue [energy security] at the global, regional and national levels can we correctly identify, diversify and meet the risks of economic development. An effective management of non-political risks directly in the hydrocarbon sector of the economy is possible only through a comprehensive attainment of the following goals: „ greater access to and the transparency of data on reserves, demand and stocks; „ market predictability through broader use of long-term contracts and dialogue between energy producers and consumers; „ efficient development of the energy infrastructure in the interests of the market.’48 Based on Gazprom’s continued monopoly position in the Russian market, both in terms of gas supply and effective control over the transit network, and in view of the absence of meaningful Russian energy market reform, the fact that Russian reserve data is considered a state secret is prompting the removal of Western managers in the upstream Russian

oil sector who have access to this information. Continued state proprietorship over all Russian natural resources, and the lack of market liberalization measures along the lines of the Greff–Illarnov–Khristenko plan have been stymied. The Russian Federation Minister for industry and energy Viktor B Khristenko was born on August 28, 1957, in Chelyabinsk. He graduated from Chelyabinsk Polytechnic Institute, where he obtained his degree in construction management and economics. In 1995, he graduated from the Academy of National Economy, the Government of the Russian Federation, holds a PhD (Economics) degree, and is the author of a number of research publications. Viktor Khristenko was elected Deputy, Chelyabinsk City People’s Deputies Council in 1990. From 1991 to 1996 he served as Deputy Governor, Chelyabinsk Oblast. Mr Khristenko was appointed Representative Plenipotentiary of the President of the Russian Federation in Chelyabinsk Oblast in 1997. Viktor Khristenko served as Deputy Finance Minister of the Government of the Russian Federation from 1997 to 1998. Mr Khristenko was appointed Deputy Prime Minister of the Government of the Russian Federation in 1998, and from 1998 to 1999 he served as First Deputy, Minister of Finance of the Government of the Russian Federation. In May 1999, Dr V B Khristenko was appointed First Deputy Prime Minister of

Viktor B Khristenko

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the Government of the Russian Federation, and on 10 January 2000 was appointed Deputy Prime Minister of the Government of the Russian Federation. Viktor Khristenko is Member, Board of Directors, Gazprom. On 9 March 2004 Viktor B Khristenko was appointed the Russian Federation Minister for industry and energy. Viktor Khristenko is married with three children. Source: www.gazprom.ru

Silivoki A second identifiable group comprise those relationships based on the President’s KGB past. These originate from the ‘silivoki’ or security service personnel who worked with the President while he served his tenure with the KGB and then its successor organization the FSB. The silivoki seek to re-establish a strong Russian state that will project Moscow’s security interests in areas formerly dominated by the Soviet Union. Exploitation of Russia’s massive energy wealth is viewed as a means to this end. They are Russian nationalists and, in some cases, neo-imperialists, who selectively choose ‘market mechanisms’ to advance their position when opportune, while just as selectively discount the economic component of the energy trade in purely commercial terms over larger policy considerations; they prefer to see an extension of Russian energy policy as an extension of foreign policy and are the most contentious and often the most influential group affecting Russian foreign energy policy.49 Those belonging to this group include Aleksander Ryazanov, the deputy chairman of Gazprom, and reportedly the head of the ‘siloviki’ faction within the gas giant. Ryazanov became chief executive of the Sibneft oil company after it was purchased by

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Gazprom in 2005. He has also been appointed head of UkrGazEnergo, the newly created Ukrainian–Russian joint venture, to act as an intermediary between Ukraine’s state-run Naftohaz Ukrayiny and the Swissbased RosUkrEnergo.50 In February 2006, Gazprombank’s subsidiary Arosgas Holding sold its shares in RosUkrEnergo to Gazprom itself, thereby consolidating the company’s position both through managerial control through UkrGazEnergo and ownership control (50 per cent) of RosUkrEnergo.51 When the Russia– Ukraine agreement was signed in early January, and then a second deal signed in February, the ownership structure of RosUrkEnergo was, and remains, largely opaque. It is of little doubt that had all Ukrainian authorities, particularly those in the Parliament, understood Gazprombank’s involvement in RosUrkEnergo, the agreement ending the Russia– Ukraine gas crisis would have been subject to a much greater degree of scrutiny prior to its signature by the Ukrainian President. Gazprom’s habitual exercise of obscuring its involvement in downstream subsidiaries and its back-door method of ultimately making its presence known to downstream states unnecessarily complicates its own corporate image as a commercially driven organization. It in fact creates the impression of unscrupulous behaviour, regardless of the legality of that behaviour, with specific intent to defraud its partners and customers. It belies a basic appreciation and respect for the value of its corporate reputation and undermines its long-term objective of becoming a respectable member of the international business community.52 Numerous other examples of Gazprom obscuring its involvement in investment deals range from Poland to the Baltics, where at the ministerial and prime

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minister levels respectively, individuals have come under investigation accused of representing Gazprom interests to the detriment of their own national interests in the privatization of critical energy infrastructures sought after by Gazprom itself. Deputy Chairman of Gazprom’s Management Committee, President of Sibneft Aleksander N Ryazanov was born in 1953. He graduated from I. M. Gubkin Moscow Petroleum and Gas Industry Institute in 1979, and from USSR Finance and Economics Institute by correspondence. Additional education: USSR Finance and Economics Institute (by correspondence). Mr Ryazanov was Director, Surgut Gas Treatment Plant, from 1988 to 1994. He also was the top manager at Sibneftepererabotka after an upgrade training course in the USA. Aleksander Ryazanov was elected Deputy, State Duma, the Russian Federation Council, in December 1999 representing Nizhnevatorsk single mandate (candidate) Electoral District. He has been a member of the Yedinstvo faction since 2001. He is (was) Chairman, Property Committee, Deputy Chairman, State Duma, in charge of investors’ rights protection. Aleksander N Ryazanov was appointed Deputy Chairman, Management Committee, Gazprom, on 5 November 2001. Gazprom Board of Directors appointed Aleksander N Ryazanov Member, Management Committee, Gazprom.

On 21 October 2005, Sibneft Board of Directors appointed Aleksander Ryazanov acting President of the company. On 23 December 2005, Aleksander Ryazanov was approved as President of Sibneft at an extraordinary general meeting of shareholders. Source: www.gazprom.ru

The St Petersburg clan The most prominent St Petersburg key legacy contributor to the Gazprom Management Committee is its Chairman, Alexey Miller, who concurrently serves as the Deputy Chairman of the Gazprom Board of Directors. Miller was hand picked by Russian President Putin, as yet another member of the St Petersburg clan, to rid Gazprom of corruption, set the company on the road to profitability, and to serve as a loyal leader to the behest of the Russian President in his capacity as the Gazprom CEO. Complementing Miller’s St Petersburg connection with the Russian President is Gazprom Chairman of the Board and First Deputy Prime Minister of the Russian Federation, Dimitri Medvedev. Prior to these appointments Medvedev served as Putin’s chief of staff and was one of the principal architects of the President’s successful re-election campaign. That campaign reflected a decision-making style intent on marginalizing the opposition by discrediting their credibility through innuendo, opportunism and a clear

Aleksander N Ryazanov

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sense of legal minimalism. However, he is also viewed as a pragmatic deal-maker, with a keen sense of how short-term compromise can lead to the fulfilment of long-term, clearly articulated objectives. Turning towards Russian energy policy and Gazprom in particular, he embodies the President’s will to see Gazprom become a formidable mechanism for the advancement of state policy. There is a great deal of speculation that Medvedev may ultimately prove to be Putin’s hand-picked successor to the Russian presidency, although Russian Defence Minister Sergi Lavarov is also well positioned to inherit this position. Another Putin successor candidate, and also a Gazprom insider, is Deputy Chairman of Gazprom’s Management Committee and Director General of Gazexport, Alexander Medvedev. Should either Medvedev ascend to the Russian presidency, Gazprom’s political future would be stabilized, providing additional investor confidence that the monopoly would largely remain untouched. While political connections are a prerequisite for Russian longevity, such a close connection to the Kremlin also has its downside in preventing necessary reform and the restructuring of Gazprom to move forward.

Deputy Chairman of the Board of Directors, Chairman of Gazprom’s Management Committee Alexey B Miller was born on 31 January 1962, in Leningrad. He graduated from high school in 1979 and became a student of N. A. Voznesenskii Leningrad Finance and Economics Institute. Upon graduation A B Miller was engineer-economist, the General planning division, LenNIIProekt – Leningrad Civil Construction Research and Design Institute. Alexey Miller was a post-graduate student at N. A. Voznesenskii Leningrad Finance and Economics Institute from 1986 to 1989, and obtained PhD (Economics) degree in 1989. In 1990, Mr. Miller was appointed Researcher, Leningrad Finance and Economics Institute, and then Head of Section, Committee on Economic Reform, Leningrad City Council. From 1991 to 1996 Alexey Miller served with the Committee for External Relations, St Petersburg Mayor’s Office. He was Head, Markets Monitoring Section, Foreign Economic Relations Department. Later, he was appointed head of the Department, and Deputy Chairman of the Committee. From 1996 to 1999, Mr Miller was Director, Development and Investments, at Morskoy Port of St Petersburg Open Joint Stock Company. From 1999 to 2000, he served as General Director, Balttiiskaya Trubo-

Alexey B Miller

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provodnaya Sistema (Baltic Pipeline System). In 2000, Mr. Miller was appointed Deputy Minister of Energy of the Russian Federation. He has served as Chairman of the Management Committee, Gazprom, since 2001. Source: www.gazprom.ru Chairman of the Board of Directors, First Deputy Prime Minister of the Russian Federation Dmitry A Medvedev was born on 14 September 1965, in Leningrad. He graduated from the Law Department, Leningrad State University, in 1987. Upon completion of the post-graduate programme at the University in 1990, he obtained a PhD (Law), and assistant professorship. Mr Medvedev taught at St Petersburg State University from 1990 to 1999. From 1990 to 1995 he served as Advisor to the Chairman, Leningrad City Council, and Expert Consultant, Committee for External Relations of the St Petersburg Mayor’s Office. Mr Medvedev was appointed Deputy Chief of Staff of the Government of the Russian Federation in 1999. In 1999– 2000 he was Deputy Head, First Deputy Head of the Presidential Administration. Mr Medvedev was Chairman of the Board of Directors, Gazprom, from 2000 to 2001, and Deputy Chairman of the Board in 2001–2002. He has been Chairman of the Board of Directors, Gazprom, since June 2002.

Mr Medvedev was Chief of Staff of the Presidential Executive Office from October 2003 to November 2005. Mr Medvedev was appointed First Deputy Prime Minister of the Russian Federation in November 2005. Dmitry A Medvedev is married with one son. Source: www.gazprom.ru Chairman of Gazprom’s Management Committee, Director General of Gazexport Ltd. Alexander Medvedev was born in 1955 on 14 August, in Shakhtersk, Sakhalin region. He has a Higher Science degree: PhD (Economics) and graduated from the Moscow Physics and Technology Institute in 1978. His profession is in automated control systems and since 2001 has Acting Member of the International Academy of Investments and Construction Economics. Between 1978–1989 he was an employee of the Foreign Economic Relations Department of the Moscow Institute for Global Economy and Foreign Relations Research (IMEMO) of the USSR Academy of Sciences, and later on a Senior Researcher, Acting Leader of the Group, Secretary for the Complex Programme of Scientific and Technological Progress (USSR Academy of Sciences and USSR GKNT), Moscow. Between 1989–1991 he was Director of Donau-Bank AG, Managing Director of a branch of Inter Trade Consult, GmbH, Austria; between 1991–1996, Director of IMAG Investment Management &

Dmitry A Medvedev

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Alexander Medvedev

Advisory Group GmbH, Austria; between 1997–1998, Vice-President of Vostochnaya Neftyanaya Kompania, Moscow; and between 1998–2002, Director of IMAG Investment Management & Advisory Group GmbH, Austria.

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Since 2002, he has been Director General of Gazexport Ltd, and Member of the Gazprom’s Management Committee, Moscow; and since April 2005, Deputy Chairman of Gazprom’s Management Committee. Source: www.gazprom.ru

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7. Mergers and acquisitions

T

he global oil and gas industry has itself been experiencing an intense decade of merger and acquisition activity. Compelling reasons for industry consolidation include higher costs for exploration and production in increasingly harsh and remote climates, thereby requiring a larger scale to pursue, compete and to develop expensive upstream resources. Government sponsored privatization and market liberalization policies have also provided investment opportunities in what were once state-owned monopolies.53 According to the United Nations Conference on Trade and Development (UNCTAD), of the 1,035 regulatory changes made globally between 1991 and 1999, 974 were specifically aimed at increasing foreign direct investment and M&A activity.54 Historically across CEE, state-owned energy monopolies were the standard, with privatization allowing the purchaser to access a historically non-competitive market on an advantageous basis. As previously stated, Gazprom has been extremely aggressive in downstream acquisitions largely tied to their corporate competencies (gas production, transport, and distribution). However, the entire question of foreign portfolio investment should take into consideration a number of criteria. These criteria are as follows. First, Gazprom’s core competency is Russia itself and the obvious fact that it is Russia’s and the world’s largest producer of natural gas. Its convenient relationship with the government, its history and expertise,

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and the up- mid -and downstream assets it holds are all objective indicators of its strength and competitive advantage in the Russian market. One should keep in mind, however, that as Gazprom moves abroad this competitive advantage decreases exponentially. While Gazprom may be admired for its size and power, it is also feared. Downstream partners have difficulty in determining whether the company is acting out of pure commercial interests or in some combination of commercial–Russian state interest(s). This is a decided disadvantage in its desire to acquire downstream assets that make perfect commercial sense to Gazprom as a commercial entity. Second, investment risks in many downstream states are diminishing as these states turn to the rule of law and the judiciary to enforce commercial contracts and agreements. Having said this, Gazprom outward investment may be seen as a viable risk mitigation strategy, but these investments do not always increase the ROI to Gazprom as a holding company. There are many reasons for this, not the least of which is that Gazprom, Gazprombank or Gazexport have all been active in establishing opaque subsidiaries across the large space of CEE. As a result, repatriation of capital earned abroad cannot be taken as a given, and as a result Gazprom’s downstream investments may not necessarily show up on the company’s balance sheet. Another point is that in the early days of transition, particularly in CEE because of the weaknesses in the legal

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structures of these economies and because of historic ties to Moscow exemplified by the ‘red directors’ ie former officials now company directors with long-standing ties to the Communist party and Gazprom, relationships were already established between the representatives of these foreign entities and Gazprom. This made it easier for Gazprom to acquire them. However, during the Yeltsin era competition for foreign assets also meant competition between Russian firms abroad seeking to acquire these assets. Competition between Lukoil and Yukos over the Bulgarian Neftokim refinery is a case in point.55 The Putin administration has successfully brought this practice to an end by (1) having effectively destroyed Yukos (Russia’s most efficient oil company) and (2) having effectively engineered non-competition between Russian firms for foreign-owned assets by pre-determining which Russian firm would compete abroad for these assets. Such a step is reflective of Putin’s insistence on protecting the interests of Russian companies in the fuels and energy sector (FES) abroad and, in turn, protecting the interests of the Russian state by having the Kremlin ‘pre-qualify’ which Russian firms will be allowed to compete for downstream energy assets abroad. It is a capital vetting process that allows Kremlin-minded enterprises to flourish, while effectively punishing those companies who see no role for the Russian government in this process. Yet another advantage of Gazprom owning downstream assets is the capability of transfer pricing to its downstream subsidiary. The tax regime outside of Russia is much more lenient than it is domestically, therefore owning and producing abroad has, at least in the abstract,

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positive implications for Gazprom as well. Third, downstream investments, particularly in a developed or mature economy have a comparatively lower margin due to the higher level of competition in these foreign markets. This may, in fact, contribute to the frequent accusations that Gazprom often acts on the margins of foreign legal systems, given the behaviour it exhibits in obtaining these assets at the lowest possible cost. A much more sceptical view of this would be that Gazprom is allowed to act in Russia without impunity and, as a result, the expectation that they would behave differently in a foreign market is suspect at best.

Non-core acquisitions Finally, it is important to note that downstream acquisitions can, and should, have a positive net gain for the acquiring company, ie Gazprom, as long as these assets are performing. However, many in the Moscow investment community have objected to what they consider Gazprom’s portfolio investment through acquiring non-performing downstream assets, which is explained easier by the political capital these assets carry with them for Moscow to use later as it sees fit, rather than a commercial transaction rationalized by the need to exercise capital for pure commercial gain. This also applies to Gazprom’s maintenance of non-core businesses in Russia itself. ‘For instance, Gazprom says it is steadily unloading non-core assets – farms, holiday resorts and so on – that were either left over from Soviet times or received as barter payments from customers thereafter. Yet it continues to make questionable

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acquisitions, given its existing assets and debt ($18 billion at the end of 2004, before it bought Sibneft). From a commercial point of view, for example, Gazprom's media business seems less than sensible. Why did its media arm recently buy a majority stake in Izvestia, a loss-making newspaper? In 2001, Gazprom also controversially took over NTV, a television station whose founder, Vladimir Gusinsky, was the first of the “oligarchs” to fall out with Mr Putin but why does Gazprom need a media arm at all?’56

Core acquisitions Objectively speaking, Gazprom and other Russian companies were often the only upstream buyers interested in downstream energy assets where, in addition to the acquisition price, considerable additonal upfront investment was necessary to repair and replace outdtated equipment and machinery simply to bring the asset up to industry standard. Russian companies in the oil industry, in particular, have been riding

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the wave of economic growth in the country leaving them, ostensibly, with resources that could be marshalled for acquisition purposes. Also, as many of these assets were tied to the old Soviet pipeline network, acquisition could be justified as an extension of the Russian supply chain in oil refining, for example. Russian oil and gas companies, and Gazprom in particular, have successfully been riding the wave of privatization that has moved across Central Europe. Late transition countries, spurred on by the hope of EU integration or at least in part by the establishment of a favourable trade regime with the EU, too will move along the privatization scale. As a result, Gazprom will follow, at least if they are allowed to do so by the EU. Aside from these investment-related concerns regarding Russian outward investment, is the fact that the Russian state is navigating to position a Gazprom monopoly in a capacity with decision-making influence over super-critical infrastructures in downstream states.

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Table 4: Sample Gazprom downstream acquisition activity57 Acquisition

Country

Asset type

ArmRosgazprom58 Armenia

Electricity supply

AS Eesti Gaas

Estonia

Natural gas National gas company Gazprom share holding (30.64), Estonian government share calculated at 27%

Panruysgaz

Hungary Gazprom shareholding 50%

Gas trading and transport

Gazsnabtranzit,

Moldova Gazprom shareholding 50% of authorized capital

Gas transit, transport and delivery

Volta

Italy

Gazprom

Gas trading and transport

Latvias Gaze

Latvia

Gazprom shareholding 25%

Gas trading and transport

Stella Vitae

Lithuania Gazprom shareholding 30%

SPP

Slovakia

Slovak national gas com- Gas transit pany. 49% owned by a consortium of Gazprom, Rhurgas & GDF

Slovrusgaz

Slovakia

Gazprom shareholding %50

Gas trading and transport

EvRoPol Gaz

Poland

Gazprom shareholding 46%

Gas transit for Russian gas through Poland

RosUrkEnergo

Ukraine

February 2006 Gazprom Gas transit and distribution in Ukraine acquisition of 50% of shares in RosUrkEnergo from Gazprom bank subsidary

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Product Russia to Armenia Gas exports

Gas importer

Product/ancillary activity Re-export of Electricity from Armenia to Georgia (generating facilities owned by RAO UES) Gas for power generation. Eesti Gaas owns the company’s gas transportation system, effectively under Gazprom control

Exports electricity, fertilizers and other chemical materials; imports natural and liquefied gas, fertilizers and other chemical materials Provides all gas coming out of Ukraine into Western Europe via Slovakia

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Table 5: Some major stakes of Gazprom in European gas joint ventures Country Germany

Joint Venture

Stake %

Activities

Wingas

35 Gas transportation and storage

Wintershall Erdgas Handelshaus (WIEH)

50 Gas trading company. Single trader of all the gas exported by Gazexsport until 2012.

Zarubeûgas Erdgashandel

100 Gas trading

Verbundnetz Gas (VNG)

5.3 Gas transportation and marketing

Ditgaz

49 Gas trading

UK/Belgium

Interconnector

10 Pipeline which connected Bacton (UK) with Zeebrugge (Belgium)

Poland

Gas Trading

35 Gas trading

Europol Gaz

48 Gas trading

Volta

49 Gas trading and transport

Promgaz

50 Gas trading and marketing

France

FRAgaz

50 Gas trading

Austria

GHW

50 Gas trading company

Serbia

Progress Gas Trading

50 Gas trading

Slovenia

Tagdem

7.6 Gas trading

Greece

Prometheus Gaz

50 Marketing and construction

Finland

Gasum Oy

25 Gas transportation and marketing

North Transgas Oy

50 Construction of a pipeline beneath the Baltic Sea

Italy

Estonia

Eesti Gaas

Latvia

Latvijas Gaze

Bulgaria

Topenergo

Romania

WIROM

25 Gas trading. The stake of Gazprom is hold by WIEH

Hungary

Panrusgas

50 Gas trading and transport

Turkey

Turusgaz

50

Yugoslavia

JugoRosGaz

50 Gas trading and transport

Slovak Republic Slovrusgaz

30.6 Gas trading and transport 25 Gas trading and transport 100 Gas trading and transport

50 Gas trading and transport

Sources: Heinrich (2001); Compiler Trade Portal http://www.compiler.fi/idankaupan/tutkimukset/specialreports/LTKK-report5-engtable. html#Table%201.

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Companies with a Gazprom shareholding 100 per cent ownership

42. Podzemgazprom 43. PRT 1 44. Samaratransgaz 45. Servicegazprom 46. Severgazprom 47. Severneftegazprom 48. Surgutgazprom 49. Surgutstroygaz 50. Surgutstroygaz Building Company Ltd 51. Szhizhenny gaz (Liquefied gas) 52. Tattransgaz 53. Temryukmortrans 54. Topenergy 55. Tomsktransgaz 56. TyumenNIIgiprogaz 57. Tyumentransgaz 58. Uraltransgaz 59. Urengoigazprom 60. Volgogradtransgaz 61. Volgotransgaz 62. VNIIgaz 63. Yamalgazinvest 64. Yamburggazdobycha 65. Yugtransgaz 66. ZGG GmbH

1. Astrakhangazprom 2. Bashtransgaz 3. Burgaz 4. Ecological and Analytical Centre 5. Ecomed-91 6. Gazexport 7. Gazflot 8. Gazkomplektimpex 9. Gaznadzor 10. Gazobezopasnost 11. Gazpromavia Aviation Company 12. Gazpromenergo 13. Gazprom Finance B.V. 14. Gazprom Marketing and Trading Limited (GM&T) 15. Gazprominvestarena 16. Gazprominvestholding 17. Gazprommedstrakh 18. Gazpromokhrana 19. Gazpromrazvitie Ownership over 50 per cent 20. Gazpromstroyengineering 21. Gazpromtrans Brest-Gazoapparat 22. Gazsviaz Dialoggazservice 23. Informgaz Ditangaz 24. Informgazinvest Druzhba 25. Irkutskgazprom Druzhkovski ZGA 26. IRTs Gazprom Electrogaz 27. Kaspiygazprom Fatherland Fund 28. Kavkaztransgaz Fora Gazprom 29. Kubangazprom Gazenergoservice 30. Lentransgaz Gazcom 31. Mostransgaz Gazmash 32. Mezhregiongaz Gazprombank 33. Nadymgazprom Gazprom-Media 34. Nadymstroygazdobycha Gazpromgeofizika 35. NIIgazeconomika Gazprom Kran 36. North Transgas Oy Gaztelekom 37. Novourengoysky GCC Gaztorgpromstroy 38. Noyabrskgazdobycha Gazstroydetal 39. NPTs Podzemgidromineral Giprogaztsentr 40. Orenburggazprom Giprospetsgaz 41. Permtransgaz Kostromatrubinvest

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Krasnodargazstroi Lazurnaya Lengazspetsstroy Metaprom Orgenergogaz Peter-Gaz B.V. Promgas Rivmar SevKavNIPIgaz AK Sibur Spetsgazavtotrans Spetsgazremstroy Tsentrenergogaz Tsentrgaz TsKB Nefteapparatury Urengoystroygaz VNIPIgazdobycha Volgogaz Volgogradneftemash Vostokgazprom Zapsibgazprom Zarubezhneftegaz

Ownership up to 50 per cent Arctic Energy Armrosgazprom Belgazprombank Blue Stream Pipeline Company B.V. Chestem Commercial Bank Olimpiiskii SR-DRAGA Eesti Gaas EuRoPol Gaz Exchange Russian Gas Gas-oil Gaz-Agro-Friport Gazavtomatika Gazpromenergo

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Gaztransit Gaz-Truby Gazum Horizon Horoshevskaya energy company Hotel Tyumen Inkombank Insurance Company Sogaz Interconnector (UK) Limited Interfin Iveko Uralaz KazRosGaz Khimsorbent Latvias Gaze Media-Most Moldovagaz Moskovskii Vekselnyi Bank Mospromagrotorgdom Motors technology Noyabrsky Gorodskoy Bank Orenburgskaya Finance Company Prometey-Sochi Promstroybank of Russia Rosshelf Sibneftegas Slovrusgaz Stella Vitae AKB Tobolsk Tomskgaz Trade House Rus-gaz Turusgaz Union of energy exporters IK Vega VIP-Premier Vologdapromresurs Volta Yugorosgaz YuzhNIIgiprogaz Institute Source:Gazprom

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8. Struggle for a Gazprom strategy

A

ccording to Gazprom, its primary short-term corporate strategy is to enhance the company’s capitalization. ‘The strategy is supposed to be realized through improvement in the legislation of the Russian Federation, liberalization of the share market of Gazprom, convergence of share prices in Russia and abroad, expansion of foreign participation in the registered capital of the Company up to 20%, simplification of the procedure of stock purchase and sale. The corporate management sophistication will assist the solution of the problem through development of directive documents of the Company regulating procedures of decisionmaking and relations with different social groups.’59

Obviously the government’s purchase of a controlling stake in the company has raised considerable capital that could be used for investment purposes. However, raising capital is one thing and spending it is another. Over the past three years, Gazprom’s expenses have been accelerating at three times its rate of profitability. In order to re-capitalize the company, Gazprom will first have to stop the haemorrhage of presently available capital through cost containment. It has thus far failed to prove its ability to do so. The link between re-nationalization and capitalization was a carrot that Russia provided to foreign investors. From a strict investment standpoint, the government has promised that restructuring will lead to the lifting of

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restrictions on the ability of foreign investors to purchase outstanding shares in the Russian company beyond the level of state ownership (49 per cent). Long-term investors should be keen to watch for the issue of ADRs in London and New York for Gazprom shares late in 2006. Further, foreign ADRs should not suffer from the heretofore preferential treatment Russian ADRs have received (at a discount) in the past in an attempt at levelling the playing field for the foreign investor. Therefore, lifting the restrictions on the foreign ownership of Gazprom stock will lead to further increasing the company’s capitalization. There is little doubt that both steps that the Russian government (1) has taken and (2) has promised to undertake should capitalize Gazprom at a sufficient level to undertake some of the important domestic and exportdriven investment it requires. From an investor standpoint, long-term Gazprom sustainability will depend on its abilities to (1) build share value based on (2) demonstrated performance.

Building share value There are numerous obstacles in building Gazprom share value. First, is the pejorative regulatory regime under which the company must operate. Second, are the massive expenditures that must be made simply to maintain the Gazexport system. Third, are constrictions on Russian gas exports, the vast majority of which must run through Ukraine. This

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requires confronting challenges related to the building of new pipelines and in meeting the capital requirements that will necessarily follow. Finally, Gazprom must persistently maintain output and, in doing so, find more gas in increasingly harsher and more remote climates simply to maintain current production levels. This implies even more investment, which at present Gazprom has thus far been either incapable or unwilling to meet.

Building performance The link between Gazprom renationalization and company performance has yet to be demonstrated. The issue of gauging corporate performance is itself nuanced by whether performance is measured in conventional investment terms or from a non-fiduciary Russian state perspective. Further, building a performing company in economic terms will require Gazprom to demonstrate its ability to navigate the numerous political barriers it will encounter in the process of building a successful company, while concurrently retaining the ability to adhere to its corporate strategy driven by the desire to maximize profit. The underlying working assumption here is that there is a reciprocal relationship between increased Russian government control over Gazprom and increased investor confidence. In short, government involvement in Gazprom is the lowest common denominator ensuring business continuity as measured against the devastating prosecution and ultimate dismemberment of oil companies such as Yukos and its imprisoned founder, Mikahil Khodorkovsky. Without the confidence of continuity Gazprom would not even be afforded an opportunity to move forward with an expectation of creating value.

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Challenges to building Gazprom share value Regulatory regime There are potential downside implications and risks to the Russian government’s majority position in Gazprom that investors need to be aware of. Consideration of these risks provides the backdrop against which future Gazprom productivity, profitability and efficiency may be calculated. The Russian government’s further tightening of control over the private oil sector by Gazprom’s purchase of Sibur is another indication of the government’s willingness to consolidate the entire oil and gas sector, as much as possible, in Gazprom and Rosnefts’ hands. What we do know is that government ownership, exercised through a monopoly structure, crushes competition and therefore quashes any incentive to remain profitable and inventive. What we do know is that where the Russian state has intervened, productivity has either flattened or fallen as costs have risen. Further, what we do not know is whether, in the absence of competitive forces, the government will continue to liberalize the market domestically, forcing both industrial and residential consumers to begin paying something closer to the market price for gas. This would obviously have a positive effect on Gazprom’s bottom line. In 2004, the domestic price for Russian gas was about $29 per thousand cubic metres (tcm) versus approximately $140 per tcm on the open market. Again, while present gas at subsidized prices has a deleterious effect on Gazprom’s bottom line, they have enormous implications for the Russian economy, which is large, cold and inefficient.

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The other issue Gazprom will have to strongly lobby for is for changes to its tax regime. Without tax relief, almost anything the company does to enhance performance and create value will be mitigated by an ever increasing and encroaching tax imposed on net profit. The dilemma is that those who politically benefit from tax revenue in terms of Gazprom’s contribution to Russian national economic security, a balanced budget and the redistribution of Gazprom tax proceeds to other sectors of the economy, are the same that govern the company itself.

Maintaining the Gazexport system In order to maintain Gazprom’s 150,000 kilometres of pipeline, Gazprom will require considerable mid-stream investment. According to the Energy Strategy of the Russian Federation to 2020, investment in the transport sector alone should top $80 billion between 2001 and 2020. Unfortunately, the Strategy does not provide separate assessments for internal and export investment requirements.60 Clearly not all of these dollars will be spent on maintenance but a good deal of necessary investment will be made for this purpose. The reason is simple. More than 70 per cent of the high pressure, large diameter transmission lines were commissioned before 1985 and more than 19,000 kilometres are beyond their design life-span and need replacement. In general, the high-pressure transmission system – for which Gazprom has responsibility – is in better condition than the low-pressure transmission systems maintained by regional and local companies with meagre investment resources.61 This does not even begin to address the condition of pipeline systems on which Gazprom exports depend that are now under

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ownership and operation by companies outside Russian territory. According to published reports, recent Gazprom announcements indicate they are taking the investment issue in critical infrastructure seriously. According to a RBC-Moscow 2005 report ‘Gazprom’s investment programme for 2005–2007 is estimated at $27 billion, head of the investments and construction department of Gazprom, Valery Golubev, told journalists at a press briefing. In 2006, Gazprom is to invest RUR284.8 billion (around $10.17 billion) in gas production, its transportation and storage, drilling, refining and exploration work. Its investments in 2007 are estimated at RUR283.1 billion (around $10.11 billion). Exploration work will enable Gazprom to enhance an increase in gas reserves worth 586.7 billion cubic metres in 2006 and 500.8 billion cubic metres in 2007.’62 Based on generalized data it is impossible to disaggregate what will be spent on maintenance, but clearly the issue has to take priority if Gazprom seeks to maximize exports to its Western downstream customers. In addition to straightforward pipeline repair and maintenance, clear indications are that human intervention in the form of terrorist attacks against pipe and associated infrastructure are accelerating on Russian territory. The area of the North Caucasus with the comprehensive attack on Russian gas pipelines running to Georgia and on electricity transmission lines in January 2006 is but one case in point. Having said this, attacks in 2005 against Russian infrastructure have occurred in Samara, Novorissik and elsewhere, prompting a pipeline security review of the domestic Russian transport system and calling on the introduction of pipeline security and surveillance technologies to combat against these attacks.

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Overall, new export projects aimed at maintaining and expanding market share will depend crucially on the maintenance of (oil and gas) prices at the levels of 2003–05. European exports will also depend on the pace of EU market liberalization and Gazprom’s ability to agree mutually acceptable terms for transit, principally with Ukraine and Belarus. In particular, the role of Ukraine in the export of Russian gas cannot be underestimated. The Ukraine provides the transit corridor for 70 per cent of total Russian gas exports and for more than 90 per cent of Russian gas exports to the EU.63 This is complimented by the state’s ambitious strategy of reconstructing the old Soviet gas network that it once dominated, through overt and covert attempts at gaining control over the transport networks in these transit states. More specifically, realization of Gazprom’s export strategy involves an enhanced ability to realize unimpeded transit across Ukraine or to obviate Ukraine territory altogether. All Russian gas exports to Europe with the exception of exports to Finland and those to Turkey via Blue Stream must pass by pipeline through either Belarus, Ukraine or Moldova. The Ukraine is far and away the most frequented corridor for Russian gas transit, accounting for the transit of 80 per cent of all Russian gas exported to Europe in 2004. There is very little Gazprom can do about bypassing the Ukraine until at

Ongoing and new export and development projects Ongoing Gazprom development and export related projects with international E&P providers include a joint venture with Shell to develop the deeper oil and gas deposits of the Zapolyarnoye field; with ENI, to develop deep horizons of the Asktrakhan field, which contains high sulphur gas; and to develop the remote offshore Shtokmanovskyoye Barrent’s field deposit(s) with a Western consortium involving, among others, ConocoPhilips and France’s Total. All of these are of course upstream development projects. On the mid-stream front, the burning issue at present is the development of the Northern-European or what is sometimes referred to as the Trans Baltic Pipeline. In many development cases, Gazprom is offering, in part, upstream swaps of undefined future energy resources in return for immediate investment in infrastructure. There is no lack of interest from international oil companies (IOCs) and international gas companies (IGCs) for entering into what otherwise resembles modern barter trade. Gazprom sees itself, and correctly so, in a position to maximize its overwhelming presence in European regional gas development through a multi-vectored strategy developed over time with a multitude of partners.

Table 6: Projected investments in the Russian gas sector 2001–2020 ($billion) Investments Production Transportation Storage Total

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2001–2005

2006–2010

2011–2015

2016–2020

Total

12–13

17

19

23–24

73

18

17–19

20–21

22–23

80

3–4

4

5

6

19

35

39

45

53

172

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least 2010 for Russian gas exports. Second, as long as Moscow depends on Western Europe for its exports, and thereby on the generation of hard currency from these markets, it will need Ukraine even if alternative routes do become available after 2010. Third, alternative export pipelines and modalities (deep-water vessels for LNG for example) are expensive to develop and Gazprom needs to ensure it will have sufficient excess supply to fill these pipes. This is entirely unclear at present given the slow rate of production and Gazprom’s inability to take in new gas sources, which in principle could replace falling production in the NadymPur-Taz production fields. New production could come from the Barents Sea and by additional production from the Yamal fields. Yet, getting this gas out is an issue and with the present halt in the Yamal II pipeline a new land-transit based pipeline ie in the form of the extension of Yamal I is highly unlikely at present.64 All of this brings us back to the Ukraine and its importance to Gazprom.

Blue Stream The Russian–Turkish Blue Stream gas pipeline was launched as the result of the signing of an intergovernmental agreement between Russia and Turkey. It was executed through the creation of a joint venture between Gazprom and Italy’s energy giant, ENI. Construction began in the late 1990s and was completed in October 2002. The pipeline consists of three main parts. The route comprises a 222 mile section in Russia from Izobilnoye (where there is a Russian gas plant) to Dzhugba on the Black Sea Coast (the Russian onshore section); a 235 mile section on the bottom of the Black Sea connecting Dzhugba to Samsun on the Turkish coast (underwater section); and a

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further 300 mile link from Samsun to Ankara (Turkish onshore section). Blue Stream is therefore intended for deliveries of Russian natural gas to Turkey going under the Black Sea, with the express intention of avoiding third countries’ issues. Blue Stream’s design capacity of 16 bcm should be reached in 2007, providing a major alternative to the Ukraine aboveground gas transit to Western markets. Having said this, even if the pipe is filled to design capacity it will still constitute a minor bypass solution compared to the volume of 132 bcm transiting Ukraine at the present time.65 In addition, capacity throughput is only one Blue Stream issue. The larger issue looming is Turkey’s ability to absorb Blue Stream’s off-take. Turkey halted deliveries of Blue Stream gas in July 2005, as they also did in March 2003, due to pricerelated issues arising from the oversupply of gas on the domestic Turkish market from partnering countries, Azerbaijan and Iran. Interestingly enough at the inauguration of Blue Stream, Russian President Putin made several statements to the effect that he welcomed additional Russian–Turkish pipeline projects, positing Turkey as a possible Russian favourite southern-bypass of Ukraine. Whether this is a Turkish-specific strategy designed to assist Gazprom in capturing the Turkish gas market or an obvious strategy to avoid Ukraine or a mixture of both, the message is clear that part of Gazprom’s export strategy is a consolidated effort at avoiding Ukraine space.

Northern-European Gas Pipeline (NEGP) The development of the NorthernEuropean Gas Pipeline (NEGP) is expressly designed to avoid CEE transit states in order to access the

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Western European market directly. The first joint meeting of the NEGP was held in February 2003. The project accelerated decidedly after the election of President Yushchenko in Ukraine, coupled with the nomination of Yulia Tymoschenko as Prime Minister. Tymoschenko has been an outspoken critic of Russian interests in the Ukraine market and was a most vocal opponent of the agreement between Russia and Ukraine, which brought the January 2006 Ukraine gas crisis to a temporary halt. The pipeline is planned for commissioning in 2010, consisting initially of a single pipeline of a 1,200 kilometre underwater link from Portovaya bay near Vyborg on Russia’s Baltic coast to Germany’s coast in the Greifswald region. Its designed annual transmission capacity is 27.5 billion cubic metres (bcm). The project envisages laying a second pipeline and the doubling of the project’s transmission capacity to 55 bcm. The pipeline will also have a spur to deliver gas to consumers in Sweden. The gas pipeline construction will help expand gas supplies to Scandinavian countries as well as provide reliable gas supplies to consumers in Western Europe, the North-Western region of Russia and the Kaliningrad Region, as gas consumption continues to grow in these areas. Again, even if this project is completed on time by 2010, NEGP throughput at 27.5 bcm/annum registers again at only one-fifth of Ukraine’s present transit capacity of 132 bcm/annum. Initially, capital costs were estimated at approximately $6 billion. Interestingly enough, Gazprom announced on 5 April 2006 that the above-ground cost of construction is estimated at $6 billion with an additional $5.4 billion allocated for the undersea portion of the pipeline. This can be compared to the estimated $900 million cost of the Yamal II stretch of pipeline, which is

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one-twelfth the cost of the NEGP. Again, with the lack of approval on Yamal II, the NEGP can be clearly seen as an attempt to bypass all land transit countries. The German partners in this venture did not consult with their Polish neighbours on the NEGP. Gazprom’s strategy can therefore be seen as an attempt on the one hand to reach Western European markets directly, with the effect of driving a wedge between Germany and Poland, both NATO and EU Members. NEGP also posits Ukraine interests against German interests, again causing a schism between these two states in the continuation of Gazprom’s successful divide and conquer strategy that has prevented strong IEA member condemnation of the lack of Russian energy reform by dividing IEA members along bilateral Russia–downstream state lines. Expansion eastwards demands Gazprom intervention in East Siberia for upstream development, continued growth of a Gazprom presence in Shakalin, and pipeline construction to China in developing this largely new and important market. Beyond China both South Korea and Japan beckon as major downstream markets interested in expanding their off-take of Russian hydrocarbons. Gazprom is clearly interested in developing Eastern Siberian licensed blocs initially allocated to TNK-BP. However, with changes in Russian law stipulating that only companies with a 51 per cent Russian ownership may hold Russian licences, this weakens the 50/50 TNK-BP split, allowing for Gazprom to play an increasingly significant role in the development of these upstream gas deposits. In summary, Gazprom is pursuing as a large part of its strategy an antiUkraine vector, seeking both through northern and southern bypasses to obviate the transit of Russian gas through this transit country. The vec-

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splitting NATO and EU Alliance Members. The fact remains, however, that in the medium term (2006–2015) even if NEGP and Blue Stream become come fully operational, this will still fall short of replacing less than 50 per cent of Russian gas now transiting Ukraine. Clearly, however, the anti-Ukraine dynamic should be appreciated and will play into midstream Russian–Gazprom pipeline development for years to come.

tor includes driving alliances with its downstream EoN Rhurgas (German) shareholder, making Germany increasingly dependent on Russian imports of natural gas, developing Turkey as a major southern transit hub for Russian gas, and in engaging other players throughout the region (Greece, Romania, Bulgaria and the Balkans) in a large number of pipeline proposals that feed Gazprom’s downstream interests while simultaneously

Oil pipeline

Barents Sea

Proposed oil pipeline

Varandey

Gas pipeline Proposed gas pipeline Refinery

Murmansk

Tanker terminal

Proposed Murmansk pipeline routes

500 Numbers

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-E

Baltic Sea

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Nor

Switz

Austria

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Proposed reversed Adria Pipeline Odesa

BOS & Her. Serbia

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and Mont. Bulgaria Alb.

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PRAGUE Czech. Rep.

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Novorossiysk CPC terminal Black Sea

Central Asia

Atyrau Caspian Pipeline Consortium Project Tikhoretsk (CPC) Tuapse Blue Stream

Bosporus

Kazakhstan

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Sweden Denmark

U.K.

ur

Finland Norway

North Sea

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500 Nos

Li

o o

Nadym TimanPechora West Basin Siberian Pechora Basin Krasnoleninskaya

Caspian Sea Turkm

Georgia Azerbeijan

BAKU

Greece ANKARA

Turkey

Iran

Iran

Figure 6: The Russian pipeline network Source: CIA

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9. Conclusion

G

azprom as a company is a formidable presence to be dealt with, from almost every aspect. Commercially, it has unique access to unparalleled reserves of natural gas, which is only equalled by the unparalleled political support it enjoys in the Kremlin among advocates of reconstituting a strong Russian state based on exploiting the country’s rich natural resource base. Advocacy of Gazprom can range from economic arguments that favour economies of scale in large up- and midstream gas development, which reflects Gazprom’s present trajectory, to political arguments that directly link the aspirations Russian neo-imperialists to the ability of the state to extend its influence over its near abroad in the form of granting or withholding energy resources based on policy considerations that sometimes, but not always, have nothing to do with energy but everything to do with power in its accumulated and expressed form. The Russian President is without question the company’s greatest advocate in charting a state policy that enhances the state’s international standing through the building of a Russian oil and gas empire with Gazprom at its core. For years the question of whether Gazprom was a commercial or a state-controlled enterprise ignited hand-wringing among analysts. This question is moot; it was definitively settled with the repurchase of the Russian state of a controlling ownership position in the company. Any lingering uncertainty has been verbally clarified by the Russian President himself as a result

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of the appointments he has made to Gazprom’s Board of Directors and Management Committee. Perhaps these Gazprom appointments can be likened to the appointment of US Supreme Court nominees by an American President. Appointments are made to ensure the continuation of a political legacy or vision long beyond the official tenure in office of the appointing official. In Gazprom we know who we are dealing with and it is with the Russian President who sits in the Kremlin. Yet the confluence of Russian foreign and energy policy runs much deeper. This is a Russian systemic issue. It is institutionalized across local, regional and national Russian political lines. Its commercial effects flow downwards and outwards from the citadel of Gazprom’s gleaming blue international headquarters into the soft and weak underbelly of the Russian economy and those SMEs found there that depend on continuing Gazprom largesse for their survival, and outwards across the Russian industrial landscape in the form of cheap gas effectively supporting a sputtering industrial economy in a post-industrial era. While Russia may no longer present a peer security threat as its predecessor state did during the Cold War, the Russia–Gazprom tandem presents significant commercial challenges that easily bleed into the national security concerns of its neighbours, whether they be friend or foe. It is as incumbent on downstream recipients of the effects of Russian foreign energy policy to underscore its genus as much

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as it is incumbent on Russian decisionmakers across the power ministries and Gazprom to understand how and why they are perceived as they are abroad. Clearly Russian state energy diplomacy and Gazprom’s corporate strategy are as internally consistent and complementary as much as they are manipulative and structurally distorted in external free market terms. The Russian state is intent on maintaining and enhancing its sphere of influence through the manipulation of the internal and external dimensions of neighbouring states’ political policies. Gazprom is intent on protecting the markets it controls and expanding into those it does not. Where energy diplomacy and corporate strategy

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come together is in the exercise of availing energy resources to downstream customers and in gate-keeping access to its pipeline network for transit gas. The only transit gas that transits Russia is its own. The remainder is burned in Russian electricity generating plants or redirected at subsidized prices to inefficient Russian industry in a concerted effort to keep European energy markets dependent on Russian gas at high prices. As a result, as Russian state policy has an economic dimension so, too, does Gazprom’s corporate strategy have a decided extra-territorial or foreign policy dimension. Taken together, the confluence of Russian foreign and energy policy should be seen for what it is and not mistaken or dismissed for what it is not.

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Notes and references 1

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Solana, Javier, ‘Europeans must act collectively on energy strategy’, Financial Times, 9 March 2006:8. Putin quoted in Kupchinsky, Roman, ‘The Shaky Gazprom Empire’, RFE/RL 9 December 2004, Volume 4, Number 47. ‘Russian gas giant completes purchase’, Associated Press, 23 October 2005. ‘ Sibneft to Change Name, Move Home’, Moscow Times, 3 April 2006. For an excellent discussion of Khodorkovsky and his troubles, see Baker and Glasser, pp. 333–353. Peter Baker and Susan Glasser, Kremlin Rising: Vladimir Putin’s Russia and the End of Revolution, New York: Scribner, 2005, pp. 197–206. For a comprehensive view of the Russian military, see, William Odom, The Collapse of the Soviet Military, New Haven: Yale University, 1998. Modern History Sourcebook: the Brezhnev Doctrine: 1968. http://www.fordham.edu/halsall/mod/ 1968brezhnev.html. For a complete analysis of the Brezhnev doctrine see, Ouimet, Mathew J. The Rise and Fall of the Brezhnev Doctrine in Soviet Foreign Policy, University of North Carolina Press, 2002. ‘Georgia: Is Georgian Gas Crisis Evidence of Moscow’s New Energy Strategy?’, see RFE/RL 23 January 2006: http://www.rferl.org/ featuresarticle/2006/01/207cd3c0-56a4-4b43bc0b-9f929ca75c79.html. V. Putin’s address at the National Conference on the Development of Russia’s Fuel-Energy Complex held on 3 March 2000 in Surgut (see www.president.kremlin.ru). Bond, Andrew,‘Reflections on Post-Soviet Geography’ in Post Soviet Geography, 1992:5–6. Quoted in Rosner, Kevin ‘The Russian Petroleum Industry 1985–1993’ Endogenous Determinants of Russian Petroleum Policy, Doctoral Dissertation, Catholic University of Louvain La Neuve, Belgium, 1999. Printed by The Petroleum Economist, 1999. It is the 10th largest energy company globally with market capitalization of $100 billion. In contrast BP’s market capitalization is $250 billion. According to Alexey Miller, Gazprom seeks to increase its market capitalization beyond the $250 billion market over ‘the next three to five years’. Part of this may be through direct acquisition in Gazprom shares but another important strategy touted by the company is an exchange of future access to upstream reserves in return for immediate

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downstream investment, particularly in the transport sector that Gazprom would continue to control. See ibid. 5 for more information on the capitalization issue. According to William Browder, manager of the Moscowbased Heritage fund, Russia’s single largest privately-held mutual fund, Gazprom shares are decidedly underpriced. According to Browder, ‘Gazprom is the cheapest hydrocarbon company in the world. It trades at $1.50 per barrel while BP and Exxon trade at $15 per barrel’. Browder goes on to point out that ‘On an asset basis, Gazprom trades at a 90 per cent discount to Western oil companies and a 50 per cent discount to Russian oil companies. I think it so undervalued it will ultimately eclipse the valuation of Exxon and Royal Dutch Shell at some point in the future’. Browder quoted in Schwartz, Nelson: Gazprom stock worth waiting for: Fortune, 6 January 2006. ‘Gazprom Net Up 26%’, Moscow Times, 3 April 2006. ‘Gazprom Seeking to Increase Sales’, Bloomberg News, 30 March 2006. US Energy Information Administration, US Department of Energy, Russian Country Analysis, updated January 2006. Independent companies of interest include Novatek, Northgaz, and Itera. However, the term ‘independent’ is being used subjectively here. For example, Itera is largely considered a shell company set up by Gazprom principals in the 1990s to handle gas sales and processing outside of the Russian Federation. Itera was incorporated in the US State of Florida and has effectively represented Gazprom’s interests where it was largely absent from a market or where Gazprom chose to be absent. Gazprom has also taken back market share from Itera in select markets such as the Republic of Georgia, where Itera initially handled gas imports but was then squeezed out of the market by Gazprom itself. Northgaz is decidedly not an independent company as it is listed as a Gazprom subsidiary by the company itself. This is underscored by an article from 7 March 2007 which attests that, ‘Nortgaz will supply to its parent company Gazprom about 4.2 billion cubic metres of net stripped gas at the price of 450 roubles per 1,000 cubic metres. The shareholders of Nortgaz have approved the terms and conditions of Additional Agreement N1 to the Supply Agreement between Gazprom and Nortgaz in 2006’. See ‘Northgaz Approves Supply Agreement with Gazprom’, A&K,

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7 March 2006 http://www.akm.ru/eng/news/ 2006/march/07/ns1645965.htm for additional information. Independent companies produced approximately 14% of the gas consumed on the Russian market in 2004. See Russia Country Analysis, Energy Information Administration, US Department of Energy, updated January 2006: http:// www.eia.doe.gov/emeu/cabs/Russia/ NaturalGas.html for an entire macro report on the Russian oil and gas industry. See ‘History of the Company’ at http:// www.gazprom.com/eng/articles/ article8517.shtml. Doman, Frank & Mayr, Walter: Inverview with Alexey Miller, Der Spiegel, September, 2005. See for example ‘Gazprom: Russia’s Energetic Enigma’ in The Economist, 5 October 2005. In this article, Vadim Kleiner of Hermitage Capital, a fund that tries to drive up Gazprom’s share price by exposing graft, points out that Gazprom uses a ‘long chain of intermediaries and costs are rising fast’. Rosner, Kevin ‘The Russian Petroleum Industry 1987–1993: Endogenous Determinants of Russian Petroleum Policy’, Doctoral Dissertation, Catholic University Louvain La Neuve, Belgium, 1999. Printed by The Petroleum Economist, London, UK, 1999. As a result of the government’s renationalization of majority ownership over Gazprom, only now in late 2005 and early 2006 has the Russian government promised to rescind limitations on the percentage of Gazprom shares that can be owned by foreign entities, including a liberalization in the types of shares that can be owned and traded by non-Russian shareholders. The total amount of Gazprom shares that can be collectively owned by foreign entities is presently capped at 20 per cent. Gazexport is to provide pipeline access if ‘additional capacity’ is available under the terms of the Russian law. Difficulty arises with the opaque nature of Gazexport itself and the ability to independently verify whether such capacity exists. Mandelson, Peter ‘Come Together Right Now Over Gas’, Intenational Herald Tribune, 21 March 2006. With the expansion of global LNG the future may provide a spot market for this transportable commodity. In December 2005, Belarussian Economics Minister Nikolai Zaichenko announced that his country’s natural gas pipeline operator, Beltransgaz, and Russian energy giant, Gazprom, had resumed negotiations to set up a joint venture, after almost a year-long suspension over disagreements on the value of Beltransgaz’s assets. Zaichenko said the sides had agreed to invite an independent evaluator to assess Beltransgaz’s actual worth.

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He also said the Belarusian government was buying back the 0.103% stake sold to the company’s staff in a privatization campaign. Commenting in the resumption of discussions, Gazprom CEO Alexey Miller said that successful completion of the talks would give Gazprom ‘control over Belarus’ entire gas transportation system’. The establishment of a Gazprom–Beltransgaz JV is envisaged by an April 2002 intergovernmental agreement. ‘Beltransgaz and Gazprom Resume Talks on JV’, RAI Novosti, 12 December 2005. See Kupchinsky, Roman: Does Gazprom have a major pipeline plan? RFE/RL http://www.rferl.org/reports/rpw/ 2006/02/3-060206.asp. Gazprom Facts and Figures Annual Report 2002. For an extended discussion of the gas cartel issue, see Cohen, Ariel: Kazakhstan’s Energy Co-operation with Russia, GMB Publishing, January 2006: 26–28. The Russian labour force in 2005 was estimated at some 74.22 million persons. CIA Factbook. Ibid.4. See The World Energy Outlook 2005 from the Energy Information Agency, US Department of Energy, for a complete global energy analysis of energy demand by source and content. See Yegoroy, Igor: Gazprom Projects in Northwest Russia, 2005 Update, BISNIS Representative in Northwest Russia, January 2005. www.bisnis.doc.gov/bisnis/bisdoc/0501 NWRusGazpromProj. Stephen Blank is the author of the GMB Report on Russian-Chinese relations and was quoted on 2 March 2006 at a Heritage Foundation event entitled: Russian Energy Policy: Moscow’s Newfound Clout. See http:// www.heritage.org/Press/Events/archive.cfm for the video link of this conference. This was pointed out by Hisashi Yamamoto of the International Organization of Maritime Universities at the NATO Forum on Energy Security which took place in Prague, Czech Republic, 22–24 February 2006. Notes courtesy of Sweet, David ‘NATO Forum on Energy Security’ presentation Prague, Czech Republic, 22–24 February 2006. Referenced in Kupchinsky, Roman: ‘Team’ RFE/RL. 9 February 2006. Russia’s Summit Diplomacy with the West, China, Prime Tass, 5 July 2005. OAO Rosneftegaz was founded as a special purpose company to consolidate the state’s controlling interest in Gazprom. Initially, the state intended an asset-swap deal with Rosneft, the state oil company, to consolidate its oil and gas holdings into a single giant. However, Rosneft raised its value by buying OAO Yuganksneftegaz, Yukos’s largest oil unit. The state had seized and sold the unit to cover the tax claims against Yukos. Because of

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this the Gazprom–Rosneft deal was nullified for a number of reasons. First, having gone ahead with this would have subjected the Russian state to the embarrassing position of having to defend the sale of Yuganksneftegaz in a US court where its acquisition by Rosneft is being challenged by Yukos management. A second consideration is that Rosneftgaz, after its Gazprom share acquisition, is relatively cash poor. The Russian government reportedly will sell shares of Rosneftgaz to the public to raise capital to retire the loan capital borrowed from the private sector for the Gazprom share acquisition. Effectively burdening Gazprom with a debt not entirely its own, through a Rosneft-Gazprom merger, would have weakened Gazprom’s cash position (at least initially by diluting its share capital acquired through its sale of its shares), which in turn would have inhibited its ability to make strategic investments in other Russian oil and energy concerns such as in Surgutneftgaz, Sibneft or even in Rosneft itself as advised by Deutsche Bank. Over the longer term, a conclusive merger of the Russian state’s oil and gas interests is expected as these peripheral issues are resolved. ‘Gazprom likely to buy Rosneft stake’, 10 June 2005 Financial Express online: http:// www.financialexpress.com/fe_full_story.php? content_id=93483. ‘ Citigroup provides fairness opinion on Gazprom 10.74% Stake Sale to Rosneftegaz Transaction’, Gazproom Media, 2 August 2005. Gazprom in Questions and Answers 2005: 8. For more detail see, ‘State finds way to consolidate Gazprom controlling stake’, RIANovosti, 1 August 2005. The author is indebted to the painstaking work of Roman Kupchinsky at RFE/RL for his important insights bundled together in his article ‘Team’ RFE/RL, 9 February 2006. In fact, former Warsaw Pact allies of the Soviet Union did not consistently pay lower than market prices and on a number of occasions, the energy price issue became a contentious issue within that Alliance. Meyer, Henry, ‘Russian state to get Gazprom stake’ Associated Press, 16 June 2005. The two companies being Gazprom and Rosneft, each with their own power structures and interests. Evidence of this is the president’s appointment of Igor Sechin, a man with ties to the former KGB, who is currently the deputy head of Putin’s administration as well as the Chairman of the Board of Directors at the state-owned oil company Rosneft. Ibid.9. Another carefully placed appointee is Anatoli Chubais, one of the principle architects of the country’s early voucher privatization programme. Chubais was one of early privatization’s ‘young Turks’, an economist with St Petersburg roots who while he has often been at odds with the Russian President has

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managed to maintain good standing as the head of Russia’s electricity monopoly RAO UES. Chubais is also the self-proclaimed author of Russia’s theory of liberal empire, which seeks to regain Russian domination over the former Soviet Union’s electricity grid and thereby expand Russian influence across the CIS and CEE through downstream merger and acquisition activities. Next to Alexey Miller, he is a dominant personality, and through position, an individual to be reckoned with in any dealings with Russia’s energy complex across the board. Another man with reported considerable influence over Russian energy policy in general is Ivanov, another deputy head of the presidential administration. Ivanov has a colourful history. A graduate of the Leningrad BonchBruyevich Electrical Technical University, Ivanov worked as an engineer before reportedly joining the KGB in 1977 and fighting with Soviet forces in Afghanistan. Upon his return, he rose to the head of the anti-contraband department of the Leningrad Oblast KGB. He retired from service in 1994 with the rank of colonel and was appointed by Putin to head the administrative departments of St Petersburg city hall. Again see ibid.9. Illianov quoted in Baev, Pavel, ‘Gazprom’s Crisis of Overgrowth’, 31 January 2005. ‘ Khristenko: the world energy market must follow transparent and clear-cut rules’, Speech to the Asian Energy Summit, November 2005. Former KGB-FSB personnel are said now to control enterprises that collectively generate 70% of Russia’s GDP. While under the Yeltsin regime, security service personnel in high administration positions occupied only 11% of the administration total, this figure is reported to have tripled under Putin. Additionally, and not to be discounted, is the transfer of wealth from Russia’s ‘billionaires’ (oligarchs) to ‘millionaires’ (silivoki) who now seek to manage and control the main components of the nascent Russian private sector based on self-interest coupled with a belief in re-establishing the Russian state’s ‘great power’ status. Ibid 8. The other major shareholder in RosUrkenergo is Centragas Holding, an affiliate of Raiffeisen Bank. Raiffeisen Bank has refused to disclose the names of its specific shareholders in RosUrkEnergo, citing the wish of these shareholders not to have their names disclosed. It should be pointed out as well that Raiffeisen Bank is one of the fastest expanding banks in Russia, emerging from a decidedly non-competitive market as one of that market’s leaders. For more information on the ministrations of RosUrkenergo in Ukraine see Socor, Vladimir, ‘Kyiv Reopening the Door to RosUrkEnergo’ Jamestown Foundation,

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16 March 2006. Socor quotes Ukraine Foreign Minister Minister Borys Tarasyuk as having declared in Washington that the gas deal will be implemented for lack of other options, despite its being ‘far from transparent’ and other flaws (Action Ukraine Report, March 12). Socor outlines four points that illustrate how Russia, in this case through RosUrkEnergo, further penetrated the Ukraine market. These were a) RosUkrEnergo would operate within Ukraine as well, through the UkrGazEnergo joint company set up by RosUkrEnergo with Naftohaz Ukrainy, sharing Ukraine’s internal distribution market; b) a few key Ukrainian government officials worked with the Russian side to insert RosUkrEnergo into these deals; c) official Kyiv prefers to plead ignorance or agnosticism about RosUkrEnergo and other shadowy aspects of the gas deals, ever since the presidency last September quashed the National Security Service’s investigation into the matter; and d) Kyiv is not addressing the high probability (widely reported by the Ukrainian press) that influential Ukrainian individuals with official connections may be involved with RosUkrEnergo and Gazprom. These points underscore one of the working hypothesis as laid out in this study’s introduction, which is that Gazprom is largely successful in markets with (1) a weak rule of law where (2) relationships between ‘red directors’ and Russian companies are well established historically and (3) where the opaque nature of Russian downstream subsidiaries allows for these companies to act with impunity outside of Russia itself. In this particular case, it would further appear that the choice of RosUrkEnergo was one taken in Russia itself allowing for little recourse by Ukraine authorities for an alternative solution. 76% of the world’s oil remains in the hands of National Oil Companies, so privatization should be viewed in relative terms. United Nations Conference on Trade and Development, ‘World Investment Report 2000: Cross-border Mergers and Acquisitions and Development’: 146. See Vatansever, Adnan, ‘Russia’s Involvement in Eastern Europe’s Petroleum Indus-

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try’, GMB Marketing, 2006, for a complete discussion of the competition between Yukos and Lukoil over this Bulgarian asset. ibid 10. Please see additional tables detailing Gazprom downstream investments in to this monograph. Ibid.4: Kupchinsky further explains that Gazprom insisted on a small diameter pipe installation between the Iranian–Armenian interconnector in order to prevent re-export of gas from Iran to Georgia, which would by implication reduce Georgian gas import dependence on Gazprom. See Gazprom Business Strategy: http:// www.gazprom.ru/eng/articles/ article8523.shtml. Russian Energy Survey 2002, International Energy Agency, 2002:120. ibid. RosBusinessConsulting Moscow, 16 June 2005 Press Release (http://www.rbcnews.com/). This 90% equates to 132 bcm of the 153 bcm Russia exported to the EU in 2005. The remaining 9.93% is exported via the Yamal I pipeline via Belarus and Poland. See ‘Gas Dispute Disrupts Fradkov’s Trip to Kiev’, FSU Oil and Gas Monitor 23 November 2005:11. The writer is also indebted to Theodore Tsakiris, a research fellow at the Hellenic Centre for European Studies for this thoughtful insights. Industry analysts calculate that construction of Yamal II would be approximately $900 million versus the anticipated cost of the Northern-European Gas Pipeline at $9 billion. This is yet again a case where politics has taken precedence over commercial utility. Construction of the NEGP’s only rationale is that it obviates the Ukraine and Poland as transit states for the export of Russian gas. While pipeline diversification is prudent from a supplier standpoint, it is entirely unjustified on a cost basis. Ibid 64: Theodore Tsakiris comments.

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About the series: Russian foreign energy policy reports

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his series of reports establishes for the first time the confluence of Russian foreign policy with the acquisition of foreign energy assets by Russian entities. Nine specific country profiles focus on the oil, gas, electricity and nuclear power industries. Each report, written by an author of international standing, explains how Russian foreign energy downstream mergers and acquisitions are transpiring to consolidate the new Russian empire. These unique studies address many questions of substance for energy industry professionals, investors, policy experts, and decision makers who seek to make sense of the dynamic changes that have overcome the Russian energy complex and altered the balance of global energy geopolitics. Series Editor Kevin Rosner Ph.D., is a specialist in Russian oil and gas, security of critical energy infrastructure, and international energy-security policy. He is an external expert to the NATO and presently serves as the Director, NATO Forum on Energy Security. He is a Senior Fellow both at the UK Defence Academy and at the Institute for the Analysis of Global Security (IAGS) in Washington, DC. Posts held include Senior Security Advisor to the Baku-Tbilisi-Ceyhan pipeline company, Project Director with the Program on Cooperation with the Russian Federation at the OECD, and Project Manager with the UNESCO Science Division in Paris. Dr. Rosner is the founder of The Rosner Group serving leading members of the global oil and gas community with energy and security analytical products.

‘Russian Involvement in Eastern Europe’s oil, Petroleum Industry: The Case of Bulgaria’ Adnan Vatansever

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his report answers questions such as: as one of the largest foreign acquisitions by a Russian company occurred in Bulgaria, what lessons are applicable to charting future Russian downstream takeovers? Why have Eastern Europe and Western FSU countries been the primary focus of Russian acquisitions? What drives LUKoil (and other Russian oil companies) to pursue acquisition of assets in these regions? Finally, what is the stance of the Russian government in terms of promoting such acquisitions abroad? Adnan Vatansever is a freelance energy consultant and the author of a number of reports for Cambridge Energy Research Associates. He is currently in the process of completing his Ph.D. dissertation on Russia’s energy sector at the Paul Nitze School of Advanced International Studies, Johns Hopkins University. He holds a B.A. in International Relations from the Middle East Technical University in

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Ankara, M.A. in Russian and East European Studies from Georgetown University’s School of Foreign Service. Hardcopy ISBN 1-905050-40-2 E-report ISBN 1-90505080-1

‘Kazakhstan: Energy Cooperation with Russia – Oil, Gas and Beyond’ Dr Ariel Cohen

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his important study explains how Russia, with its private sector and policy makers working in tandem, has exerted a significant amount of control over Kazakhstan’s vast natural resources and its economic freedom. It looks at the way Russia and Kazakhstan agreed to divide the Caspian Sea shelf and how Kazakhstan has managed to maintain good relations with Moscow overall, despite its insistence on exporting energy resources to China and Europe directly and its hopes to export through Iran. Ariel Cohen, L.L.B., Ph.D., is an international expert in international security/ terrorism; Russian, Eurasian, European and Middle Eastern foreign, security, economic and business policy. He is Senior Research Fellow in Russian and Eurasian Studies and International Energy Security at the Davis International Studies Institute at the Heritage Foundation. Dr. Cohen has conducted conferences and briefings for the US Government departments and agencies. He appears on major US and foreign TV networks. Dr. Cohen also has extensive experience consulting for the private sector, international organizations, and technical assistance projects in the Central and Eastern Europe and CIS regions. Hardcopy ISBN 1-905050-41-0 E-report ISBN 1-905050-81-X

‘Georgia: Russian Foreign Energy Policy and Implications for Georgia’s Energy Security’ Liana Jervalidze

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his report shows that as Georgia has restructured its energy sector, the new Russian and Georgian political elites exerted their influence, particularly through the participation of Russian gas company Itera in privatizations of Georgian gas enterprises. And how, over the past few years, Russian-Georgian business groups with their offshore capital have been working to monopolise the Georgian economy and Russia’s gas industry has been consolidating its hold over the CIS pipeline infrastructure, particularly through the expansion of Gazprom. However, Gazprom failed to take control of Georgia’s pipeline infrastructure and Georgia is insistent on developing its pipeline potential in order to boost its role as a transit route to Europe, Turkey and Iran. Liana Jervalidze has worked with several government and research institutions working on Caspian region energy policy and development. She has advised private

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sector companies in on the development of east-west energy corridor and Georgia’s potential role in regional integration. Since 2003, Ms.Jervalidze has been working on the development of Georgia’s gas market. She has spoken on regional energy policy at international conferences in the CIS, Europe and the US. Her analyses have been published in both Georgian and English. Hardcopy ISBN 1-905050-35-6 E-report ISBN 1-905050-84-4

‘Russia’s Energy Interests in Azerbaijan’ Fariz Ismailzade

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n 2003-2004, an increased number of senior Russian officials and major energy companies, such as Itera, Gazprom and RAO UES visited Baku in the hopes of participating in energy projects in Azerbaijan. While maintaining diplomatic relations with Moscow, Azerbaijan is more hesitant when it comes to close cooperation with Russian energy companies. Baku fears that if Russia gains more assets in Azerbaijan, control of these assets will be used for political purposes. This unique study looks at the confluence of Russian private and public sector interest Azerbaijan’s energy sector. Fariz Ismailzade works with the International Republican Institute in Baku and is a part-time lecturer at the department of political science at the Western University in Baku. He holds an MA in Social and Economic Development from Washington University, St. Louis, and a BA in Political Science from Western University, Baku. Hardcopy ISBN 1-905050-42-9 E-report ISBN 1-905050-87-9

‘Ukraine: Post-revolution Energy Policy and Relations with Russia’ Olena Viter

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his report looks at how the new Ukrainian government plans to decrease Russian influence over Ukraine’s energy sector. President Viktor Yushchenko has declared goals which include the diversification of oil and gas supply sources, the reform of the domestic market, and the creation of a strategic oil stock. Ukraine’s search for more partners in the energy sphere has affected the relationship between Ukraine and Russia; from a “brotherly” relationship to one of pragmatic interest. Olena Viter is a Senior Adviser to the Operational Department of the Secretariat of the President of Ukraine. She is Coordinator of Energy Programs at the School of Policy Analysis, National University of Kyiv-Mohyla Academy, and a member of the non-governmental Expert Council on Energy Security. In 2002, she was an

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intern at the Hudson Institute, and in 2003 she participated in drafting Ukraine’s Energy Strategy. Hardcopy ISBN 1-905050-31-3 E-report ISBN 1-90505077-1

‘Turkmenistan-Russian Energy Relations’ Gregory Gleason

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urkmenistan has large gas reserves, but as its immediate neighbours have little import demand, Russia holds the key to its gas transport. In April 2003 Turkmenistan and Russia concluded a 25 year transport and marketing agreement for Turkmen natural gas. The new arrangements permit Turkmenistan’s gas production to reach 100,000 million cm per year in 2007. This unique study details the background and looks at the prospects for Turkmenistan’s gas production and export in the context of Russian strategy, and at Turkmenistan’s role in the new energy strategies throughout Eurasia and the Middle East. Gregory Gleason, Ph.D., is an internationally recognized expert in energy policy and international relations. A professor of political science and public administration at the University of New Mexico, Dr. Gleason has extensive field experience in Turkmenistan and the other countries of Eurasia and Central Asia. He has served as a consultant to Lawrence Livermore National Laboratory, Sandia National Laboratories, the Asian Development Bank, and the US Agency for International Development. His research has been sponsored by the National Science Foundation and the National Academy of Sciences as well as other public and private foundations. Hardcopy ISBN 1-905050-33-X E-report ISBN 1-905050-82-8

‘Belarus: Oil, Gas, Transit Pipelines and Russian Foreign Energy Policy’ Dr Margarita M Balmaceda

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elarus relies on Russia for about 85% of its total energy needs, while Russia needs Belarus’ oil and gas pipelines to export its supplies to Western Europe. How will energy exports from Russia and Belarus’ transit capabilities impact Western Europe if this interdependent relationship ends, either through political changes in Belarus or if Russia ends its energy subsidies to Belarus? This report looks at transit, infrastructure and investment issues and analyzes both the state of the current infrastructure, as well as the possibilities this transit opens to Western investors, particularly as the Yamal Pipeline nears completion. In addition, it looks at the current conflict between Belarus and Russian investors for control of the country’s gas transit system and oil refineries. Margarita M. Balmaceda is Associate Professor at the John C. Whitehead School of Diplomacy and International Relations, Seton Hall University, New Jersey, and an Associate of Harvard University’s Davis Center for Russian and Eurasian Studies

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and the Harvard Ukrainian Research Institute. She received a Ph.D. in Politics from Princeton University (1996), and Post-Doctoral training at Harvard University. She has published widely on Russian, post-Soviet and East European energy and foreign policies. Hardcopy ISBN 1-905050-34-8 E-report ISBN 1-905050-83-6

‘Gazprom and the Russian State’ Dr Kevin Rosner

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azprom is the world’s single largest producer of natural gas, long acknowledged as a state-within-a-state. In 2005 it reached a turning point in its history when the Russian government reasserted its majority stakeholder position, whilst also continuing its own push to gain control over an increasing share of Russia’s energy complex overall. This timely report provides answers to questions such as: what do these movements mean for the future of the Russian energy sector? What will be the impact of state control over Gazprom on domestic and foreign shareholders? And what do these changes portend for the future of natural gas exploitation, production, distribution and the ultimate export of Russian gas to downstream consumers? And what will these changes mean to world? Hardcopy ISBN 1-905050-30-5 E-report ISBN 1-905050-85-2

‘Baltic Independence and Russian Foreign Energy Policy’ Dr Harold Elletson

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stonia, Lithuania and Latvia are uniquely dependent on the Russian Federation for energy supplies. The security of energy supplies are national security issues in the three ex-Soviet republics, which are now part of the EU. Increasingly dependent on Russian gas imports and with negligible sources of domestic energy supply, the Baltic countries have been the target of aggressive Russian commercial activity and a sustained attempt to lock them into a long-term reliance on Russia. Now, as Baltic political leaders, energy specialists and intelligence analysts consider their options, the implications for the security and independence of the three Baltic States are a matter of concern well beyond the Baltic. This important report will be essential reading for anyone with an interest in the future energy supplies of both the Baltic States and eastern Europe. Dr Harold Elletson leads The New Security Programme, which conducts research into the implications of the new security environment. He was previously Director of the NATO Forum on Business and Security. A former Member of the UK Parliament, he served as Parliamentary Private Secretary to the Secretary of State for Northern Ireland and as a member of the Select Committee on Environment. An INTERNATIONAL public affairs consultant and a fluent Russian

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speaker, he has advised many leading companies on aspects of their business in the former Soviet Union, including BP in Azerbaijan and Alstom in Siberia. Hardcopy ISBN 1-905050-36-4 E-report ISBN 1-905050-89-5

Russo-Chinese Energy Relations: Politics in Command Dr. Stephen Blank

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his report makes the point that in both Russia and China it is politics – and not market or commercial considerations – that largely drive energy relationships with each other and the outside world. For both countries, energy and energy security are regarded as strategic assets and/or objectives that are at risk from outside forces. Moreover, both countries are taking a statist approach to energy issues. Therefore cooperation between Russia and China will be difficult even though Russia wants to sell and China wants to buy. Russia has blocked Chinese efforts to realize its version of energy security, yet it has not been able to come up either with the resources or means for a coherent policy of supplying China with reliable quantities of energy that would lead China away from Middle Eastern and other producers. Given the political dimension in both countries, the under-fulfilment of the potential for Russia to supply energy to China will continue and remain a source of strain in their relationship. Stephen Blank is Professor of Russian National Security Studies at the Strategic Studies Institute of the U.S. Army War College. Dr. Blank has been an Associate Professor of National Security Affairs at the Strategic Studies Institute since 1989. In 1998-2001 he was Douglas MacArthur Professor of Research at the War College. Prior to this appointment Dr. Blank was Associate Professor for Soviet Studies at the Center for Aerospace Doctrine, Research, and Education of Air University at Maxwell AFB. Dr. Blank's M.A. and Ph.D. are in Russian History from the University of Chicago.

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