Over the last three years, Gazprom has only managed to centralize management. Yet the gas monopoly has a chance to turn from state concern to market company in the near future. Until this happens, the development of large new natural gas deposits and other strategic plans are out of the question

Ivan Rubanov

In late June, the regular meeting of Gazprom shareholders took place. Gazprom’s final reports and public documents demonstrate that it has taken a step forward as far as business transparency is concerned. At the same time, interesting details have come to light. Some time ago, it seemed Gazprom did nothing but set and accomplish strategic goals such as the construction of new main pipelines and the development of new export areas and non-traditional markets. In fact, the gas monopoly quietly dealt with more banal matters. The company’s documents state that “centralization of commodity and financial flows was the major objective of the first stage” of its plans. Now Gazprom is moving to the second stage and turning from Soviet-style ministry legally posing as a joint-stock company into a modern industrial corporation.

First-stage results

Alexei Miller’s team has been toiling at centralizing power at Gazprom for three years. They succeeded in establishing full control over all key financial flows in the holding just late last year. Managers from St. Petersburg took almost all the important posts in the company. Only the head of Gazexport, the gas company’s operator on foreign markets, went to Alexander Medvedev, who evidently despite his lack of Petersburg roots is still loyal to the Kremlin.
Miller’s team spent three years restoring state control over Gazprom. By 2001, the state had lost formal control over the monopoly, as some stock was sold to foreign investors and some was distributed among Gazprom’s subsidiaries, which were not under the control of top management. Miller’s team managed to rectify the situation, and now the state directly owns 38.3% of the stock and Gazprom subsidiaries under full control hold at least 12%.
Miller’s team is also striving to establish control over non-core assets. According to various estimates, the group spent $1.5-2 billion to acquire these assets at the time. By using a bankruptcy procedure, they kept Sibur assets from slipping out of Gazprom’s hands (incidentally, Sibur owns Russia’s largest natural gas-processing plants). Several gas companies, including Severneftegazprom and Zapsibgazprom, as well as oil-and-gas company Stimul were returned to the Gazprom fold. Miller’s team regained control over a number of small but profitable assets, in particular natural gas-filling stations. Control over the agrochemical corporation Azot and gas company Vostokgazprom is being restored: they were set up using Gazprom funds once upon a time.
The team has also seen its share of failures. For example, Gazprom lost control over two enterprises in ferrous metallurgy. To prevent assets withdrawal, Gazprom has approved standard bylaws of associated companies, under which deals in stock require the approval of the parent company’s board of directors.
The company’s sales operations have undergone fundamental restructuring as well. Distribution, which brings real money to the monopoly, suffered especially heavily from centrifugal trends. Through incredible effort, Gazprom has managed to restore its control over part of its export supplies, which had floated into the hands of Itera, Sibur, and other intermediaries.
Lest subdivisions disperse their efforts and resources on non-core activities, the top management has decided to set up a number of large subsidiaries responsible for the company’s main areas of activity, such as prospecting, gas production, oil production, hydrocarbon processing, transportation, electricity generation, underground storage, and distribution.
Finally, Miller’s team has managed to cope with the problem of the company’s huge debt, without which normal development and large capital-intensive projects would hardly have been possible. Gazprom has succeeded in improving the structure of its debt portfolio. The percentage of debts to be paid off in more than five years has increased from 10 to 31%, whereas the amount of debt has nearly been cut in half over the last three years.

Second-stage problems

Having centralized control, Miller’s team has yet to turn Gazprom into an efficient business organization. The monopoly has only recently put some issues on the agenda that smaller companies have to deal with from day one. Take, for example, the issue of cost minimization. Inefficiency of state monopolies in terms of costs is one of the main strikes against them according to market companies. Gazprom is now considering production cost reduction as a source of required investment resources. It plans to cut costs by combating in-house corruption. The company’s board of directors has approved provisions under which all purchasing activities must take placed via open competition and tenders rather than individual decisions made by managers. According to estimates, this measure alone will enable the company to cut prices by 8-9% versus the reference price.
Diversification of distribution markets is another important task the company needs to address urgently. Although Gazprom is often regarded as an export-oriented company, it sells almost two thirds of its products in Russia. After 1998, the average selling prices in Russia were below production and transportation cost, and thus its largest market was unprofitable. The company has succeeded in lobbying for considerable price increases, and it has already reached the breakeven level for domestic market sales. Gazprom was lucky. On the one hand, the EU made the same demands at negotiations regarding Russia’s admission to the WTO. On the other hand, the increased cost of an extremely cheap energy resource fit the government strategy of moving away from a natural resource-based, energy-intensive economy (in Russia, power consumption per GDP unit is 10 times as much as in developed countries). Clearly, Gazprom will continue to lobby for price increases until sales become profitable, which will enable the company to create investment potential.
Gazprom has many more problems on foreign markets. Although sales are currently very profitable and gas is mainly supplied by long-term contract, the company’s export position is still somewhat shaky. In the next few years, the company will have to diversify export and build new relations with major contracting parties. Russia inherited a unidirectional export channel from the Soviet era. Almost all Russian gas used to go to the West. Russia still sells 80% of its natural gas to Europe, while the rest goes mainly to neighboring CIS countries. Natural gas has to travel across the several international borders, so part of its value settles in other countries in the form of transit charges. What is worse is that as the EU strengthens and expands, risks are growing. Many countries are now able to put up a united front within the EU, and in the next few years, the buyers, not the sellers, could be dictating the natural gas market. The first warning signs have already appeared. Due the requirements of the European Commission, now trying to liberalize the natural gas market by any means necessary, Gazprom had to revise its contracts and abandon some paragraphs of fundamental importance. For the time being, Gazprom is only increasing its dependence on European markets. In the near future, it plans to construct a north European pipeline, while eastern-oriented projects are matters for the distant future. 

Strategy can wait

It’s absolutely clear that Gazprom needs to resolve some very important day-to-day issues. But it is equally evident that strategic problems involving major investment will be on the back burner for at least another two to three years.
These problems are well known. Prospecting and new deposit development have not returned to previous levels, which poses a threat to the company’s development in the long term. In the next few years, production output at the company’s three largest fields, which yield 80% of the total gas produced by the company, will decline by 8% a year. The company will have to turn to large deposits in Yamal or Eastern Siberia, develop Asian markets, or to do both once.
Gazprom should not simply reform; it should do so quickly to attract substantial investment for new projects in the shortest possible time. About $100 billion will be required to develop deposits on the Yamal Peninsula to replace current main deposits.

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