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Russian Gas Giant Battles Negative Energy

By Steven Mufson
Washington Post Staff Writer
Friday, December 1, 2006

For a company that has a market capitalization about the size of Microsoft or Citigroup and natural gas reserves that would make most OPEC members blush, Gazprom still finds itself with a lot of explaining to do.

The Russian state-controlled natural gas monopoly has openly proclaimed its goal of becoming the world's dominant oil and gas company, and in the process it has raised hackles everywhere, from neighboring Ukraine to the boardrooms of major international oil companies and the capitals of Europe and the United States.

It has jacked up gas prices to once-subsidized neighboring countries, pressured U.S. and European companies for stakes in overseas projects and pipelines, blocked access to its pipeline network in order to leverage its way into existing exploration deals and shelved a prized gas project because it wasn't satisfied with foreign bids.

Now the company is seeking to polish its image in the United States, where it has a small office in Houston looking for investment opportunities. Moreover, among the biggest Gazprom shareholders are U.S.-based emerging-market mutual funds.

This week, the company's deputy chairman, Alexander Medvedev, will attend a hockey game between a Gazprom-sponsored team and former Boston Bruins players. Yesterday he spoke at a U.S.-Russia Business Council luncheon at the exclusive Metropolitan Club here. And on Monday he delivered a speech at Harvard Business School about whether energy can be a bridge between the United States and Russia.

But there hasn't been much construction work on that bridge, one energy company executive quipped. And recently Gazprom has come under fire for using its Russian state-backed muscle to expand beyond its core business into areas from real estate and hotels to media, petrochemical and oil deals while neglecting its own massive natural gas business.

In a report issued Monday, the Organization for Economic Cooperation and Development in Paris called the expansion of state ownership a "step back" for Russia's economy. "Of particular concern is the state-owned gas monopolist OAO Gazprom's seemingly insatiable appetite for asset acquisitions, often at the expense of a focus on its core business," the report said. "At the same time, the absence of any significant steps to restructure the gas industry as a whole constrains the growth of other producers even as concern about the sustainability of Russian gas supply is growing."

Gazprom has responded to growing criticism by unveiling a $40 billion investment program devoted solely to bringing on new gas production in the Yamal Peninsula in northwest Siberia. But yesterday, Russia's government put off a plan to boost subsidized domestic natural gas prices to world market levels over the next five to 10 years, a move that would increase revenues for Gazprom and tame Russia's surging domestic demand.

"We are not an instrument of policy because it cannot comply with our commercial structure," Medvedev said in an interview yesterday.

But ever since a contract dispute with Ukraine led to a cutoff of Russian gas exports on New Year's Day, Europeans who rely heavily on Russian gas have worried about security of supply. Russia, meanwhile, has argued that Gazprom needs to expand into the European and U.S. distribution business to assure Russia of "security of demand."

Many experts say that Gazprom is unwieldy and poorly run and will have trouble meeting gas delivery obligations regardless of the politics of supply. Vladimir Milov, president of the Institute of Energy Policy in Moscow and former deputy energy minister, said yesterday that Gazprom had spent $18 billion in the past three years on acquisitions outside the gas sector, more than it has spent in the past decade to increase gas production.

Gazprom's relatively flat gas output was no surprise, Milov said. "To grow, you have to invest," he said. As long as Gazprom was a monopoly, he added, it would have little incentive to bolster production in Russia. "Monopolies are motivated to conquer new markets, not to develop markets already conquered."

When Gazprom does invest, it often does so inefficiently. Much of the company's recent spending has gone to building new pipelines and repairing aging ones. Yet one study Milov quoted said that every mile of new pipeline built by Gazprom costs two to three times as much as those built in the rest of the world.

Gazprom's Medvedev defended the company's non-gas ventures, calling the newspaper it bought, Pravda, a "pure commercial decision" and not a tactic for controlling public opinion. He said many of the non-energy ventures were being managed by Gazprombank.

Moreover, he said the company would meet its gas commitments thanks to the new capital spending and anticipated dampening of Russian demand as higher prices kick in. "We will invest as much as necessary to develop our upstream business, transport business, and to diversify our activity," he said.

A recent Deutsche Bank Securities analyst report warned that "Gazprom will have to begin its Yamal expansion relatively soon. On the supply side, Gazprom likely won't be able to maintain production without new investments."

Medvedev defended Gazprom's controversial decision to raise gas prices to former Soviet states. He said that since 1991, Russia had provided subsidies worth a total of $45 billion to Ukraine alone. As for Georgia, which faces a doubling of the gas price, "they have a possibility if they want a local price, not an import price, they have a possibility, not an obligation, to offer us assets, which we would consider as a partial payment."

Industry publications reported that Gazprom was close to such a deal with Belarus, swapping lower gas prices for partial control over that country's pipeline network.

Russia experts and energy consultants say that individual Gazprom positions may not be unreasonable, but the fact that they coincide with political tensions has worried other countries that rely on Russian exports.

Similarly, many energy consultants and executives question whether environmental problems with Royal Dutch Shell's project on Sakhalin Island were discovered to give Gazprom leverage to increase its ownership stake. Medvedev, who said he was born on Sakhalin, said the government's environmental concerns were genuine.

Just recently, the development of the deep water Shtokman gas field in the Barents Sea was seen as an opportunity for U.S.-Russia cooperation. It would include plans for liquefied natural gas exports to the United States. But Gazprom turned down bids by five companies, including U.S.-based Chevron Corp. and ConocoPhillips Co.

Medvedev said that the bids did not put a high enough value on the Shtokman reserves, pricing them lower than reserves in Libya or Burma. "We were not happy with the valuation of our reserves in comparison with the reserves which have been offered to us by our potential partners and [the] valuation of reserves of comparable caliber in other parts of the world," he said. "We believe that the time will come when the Russian reserves will be properly valued."

But Deutsche Bank, which downgraded its recommendation for Gazprom, said that downside risks, included prolonged domestic subsidies, cost overruns, loss of market share in Europe and "the controlling shareholder (i.e. the state) forcing the company to implement decisions based on its political agenda rather than the company's financial best interests."

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