Gazprom’s position on the Russian gas market weakening

As the difficulties Gazprom has faced in recent years on the European market have multiplied[1], so more and more symptoms have appeared which may suggest that the company’s dominant position is deteriorating. The decision made by the Russian government in June 2011 to double the tax Gazprom has to pay on the extraction of gas, which was later approved by parliament, was the first time in many years when the company’s fiscal privileges were withdrawn.The process of Gazprom’s assets being taken over by private companies and business partners from within Vladimir Putin’s closest circle is underway. More and more frequently attempts are being made to challenge the company's monopoly in areas of key importance for the functioning of the entire gas sector, such as Gazprom’s exclusive right to dispose of the Russian gas transportation system and its exports monopoly. Competition from independent gas producers on the domestic market is growing, and Gazprom is gradually being pushed out of some of that market’s most profitable segments (industrial clients).

The emerging tendencies in the Russian gas sector derive from a number of factors – from the situation on the European gas market, through difficulties hampering the development of the sector in Russia itself, to the private interests of the current ruling class and its business partners. The plans for a structural reform of the monopoly (including isolating gas transportation system from Gazprom), presented since 2000 by the Ministry for Economic Development and since 2003 by the Russian Association of Industrialists and Entrepreneurs (RSPP), suggest a direction for the changes necessary to stimulate the sector’s development and improve the efficiency of Gazprom itself. However, the monopolist’s current business model gives the government full control over this strategic enterprise, which is a core of Putin’s concept for developing Russia as a global energy power. Despite Putin’s recent statement that he “does not rule out privatising Gazprom in the future” (made at a meeting with political scientists in Moscow on 6 February this year), any structural reform of Gazprom (and consequently, a weakening of the state’s control over it) seems unlikely in the foreseeable future. Still, the developments on the domestic market – growing pressure from other gas companies (oil corporations and independent producers) and changes on the European market[2] – may result in the weakening of Gazprom’s monopoly privileges and a gradual deterioration of its special status within Russia.

Putin’s oligarchs – a new chapter in the redistribution of Gazprom’s assets

In 2001 Alexey Miller – Gazprom’s CEO, newly appointed by President Putin – started his term in office with a spectacular campaign aimed at regaining Gazprom’s former assets which had been taken over in the 1990s by private companies and business people associated with his predecessor, the company's long-time CEO Rem Vyakhirev. The largest beneficiary of Gazprom’s assets, the Itera company, was deprived of the concessions, companies and shares in the company's extraction companies (Rospan, Severneftegazprom, Purgaz, Sibneftegaz etc.) which it had obtained for a very low price. Gazprom regained the control it had lost during Vyakhirev’s term in office over Sibur, Russia’s largest chemical holding, and Stroytransgaz, a company involved in the construction of pipelines, whose major share packages had been taken over by relatives of the former managers (including Vyakhirev) and the company's political protectors[3].

In line with the rules of property redistribution followed by subsequent Kremlin-based groups, after Vladimir Putin assumed the presidency, the regained Gazprom assets (along with many other properties) were redistributed to people associated with the new ruling class. The most valuable parts were acquired by Putin’s friends, collaborators and business partners whom he had worked with during his career in St. Petersburg city hall, or his close allies from the period of his KGB service. Other, less impressive items fell to relatives and acquaintances of people associated with the ruling group and the new Gazprom executive team.

What differentiates the current process of dividing up Gazprom from that performed in the 1990s is its much larger scale during Putin’s second term in office, which accelerated in its final months and is still continuing today. Some of the controversial transactions were made at Putin’s direct request (such as the sale of the insurance company Sogaz to Bank Rossiya in 2004 for an exceptionally low price). The takeover of the assets – in non-transparent, multilevel transactions – involves a network of mediator companies registered in tax havens, which makes it difficult or almost impossible to identify their true owners. The assets isolated from Gazprom some time ago and regained by the team led by Alexey Miller currently form an important part, and in many cases the initial start-up capital, of the dynamically developing new oligarchic empires. The biggest beneficiaries of the current phase of dividing up Gazprom’s assets include the following persons:

• Gennady Timchenko

Novatek: the gas part of the empire[4]

The profitable purchase of Gazprom assets has contributed to the spectacular growth of Novatek – Russia’s second largest (after Gazprom itself) and the largest of all independent gas producers (its expected total extraction volume was 52 billion m3 in 2011)[5]. A jump in quality for Novatek happened when in 2009 a major package of the company’s shares (23.5%) was acquired by Gennady Timchenko, whose acquaintance with Putin dates back to their KGB intelligence service and his cooperation with St. Petersburg city hall in the oil trade[6]. Since then the Russian state has supported the transformation of Novatek into a strong actor on the Russian gas market by any means possible. Among the assets which Novatek purchased from Gazprom were share packages in the Severenergiya (25%) and Sibneftegaz companies (51%); these were reclaimed from Itera, whose total resources are estimated at 1.6 trillion m3, together concessions to exploit several fields. Another important asset purchased by Novatek was the Yamal LNG company, along with its property, the Yuzhnoye Tambeyskoye field (over 800 billion m3). In July 2011, in order to win foreign investors and ensure the profitability of the Yamal LNG project, the government granted it significant tax reliefs (zero tax rate on extraction (NDPI)), and lifted the export duty on any LNG produced in the future[7].

In August 2011, as the only participant in the tender procedure (potential competitors were not allowed to take part), Novatek gained concessions for another four fields in Yamal (estimated at over 2 trillion m3). So in less than two years, the confirmed volume of resources owned by Novatek increased six-fold – from 690 billion m3 (at the end of 2008) to over 4 trillion m3 (as of 2011).

The company’s prestige has increased due to its international contracts, including its alliance with a strategic partner, the French company Total, which purchased slightly over 12% of Novatek’s shares with the option to increase its package to almost 20%, and which since November 2011 has been a shareholder in the Yamal LNG project (20%). The Norwegian company StatoilHydro and Qatar Petroleum International can be considered as other strategic partners.

Novatek is the only independent gas company in Russia which can compete with Gazprom on the EU gas market and acquire shares in Western concerns. In July 2011, the German energy concern EnBW offered to sell Novatek 25% of its shares (more than half of its package)[8] in VNG, one of the largest gas importers and distributors in eastern Germany (negotiations are underway). Several other European enterprises have also expressed interest in Novatek as a possible shareholder. Novatek’s potential partners expect cheaper supplies of gas compared with that delivered by Gazprom under its long-term contracts. Novatek’s own extraction costs (similar to the costs borne by other independent gas companies in Russia) are several times lower than the costs borne by Gazprom. This would harm Gazprom’s export monopoly, however.

Timchenko also, within a short period of time and for symbolically low prices, bought other Gazprom assets which the monopoly had considered unrelated to its basic business. He consolidated 80% of shares in Stroytransgaz, a company created by Gazprom specialising in the construction of oil and gas infrastructure objects, with profitability guaranteed by large contracts realised for the gas monopolist and other energy companies (including Inter RAO UES). In late October 2011, another Gazprom asset, Russia’s largest chemical holding Sibur, became the property of Timchenko and his business partner Leonid Mikhelson. Its new owners purchased a package of nearly 50% of Sibur’s shares from Gazprombank, thereby increasing their total share package to 95% (in 2010 Mikhelson bought a total of 46% of the holding’s shares). The purchase of nearly 100% of Sibur’s shares was possible mainly thanks to a loan provided by Gazprombank.

• The Rotenberg brothers[9]

Stroygazmontazh: the pipeline business

In 2006, the brothers Arkady and Boris Rotenberg – Vladimir Putin’s childhood friends and fellow sportsmen from a St. Petersburg judo club (and members of the Yarva-Neva club, whose honorary president is Vladimir Putin) – received a profitable contract from Gazprom concerning pipe supplies. The next year, Gazprom introduced the brothers to big business by selling its gas pipelines construction companies to them. The Stroygazmontazh company created as a result of their consolidation is Gazprom’s largest contractor, carrying out multi-billion-dollar strategic projects of transfer hubs like Nord Stream, Sakhalin-Khabarovsk-Vladivostok, Dzhugba-Lazarevskoye, and so on. In 2010 Stroygazmontazh and Stroygazkonsulting (a company owned by a Jordanian Ziyad Manasir, the brothers’ acquaintance) won two-thirds of the tenders for the construction and modernisation of sites owned by Gazprom.

The companies owned by the Rotenberg brothers are also Gazprom’s pipe suppliers. In 2005–2010 they won 45 of the 48 tenders announced by the company to supply pipes and other elements for the assembly of gas pipeline networks. Since 2009 they have owned 50% of Eurotube, a steel trading company registered in Germany, which is the largest supplier of pipes (over a third of the total market share) to Russia. Eurotube’s main client is Gazprom, although it also supplies pipes to Transneft, Rosneft and other Russian businesses.

In April 2010 the Rotenberg brothers were mentioned on the Forbes list of billionaires, and Gazprom sold them another non-core asset – the company Gazprombureniye, which implements 70% of the company's contracts (involving geological analyses, construction, renovation, maintenance of oil and gas wells and underground gas storage facilities) and carries out work in the Bovanenkovo gas field in the Yamal Peninsula.

• Yuri Kovalchuk

SOGAZ, Gazprombank, media: a financial and media empire

Some of Gazprom’s assets have formed the basis for a spectacular surge in the holdings and influence of Yuri Kovalchuk, another of Putin’s acquaintances from St. Petersburg and the co-founder (alongside Putin) of the Ozero co-operative society for summer residences. Gazprom’s shares were gradually acquired from 2004 at bargain prices by the commercial Bank Rossiya, which Kovalchuk controls; these have multiplied the bank’s capital from US$216 million in 2005 to US$9.6 billion as of the end of 2010[10].

In 2005 Gazprom sold its company SOGAZ, one of Russia’s largest insurance companies, to Bank Rossiya for around US$100 m. Under the bank’s control SOGAZ’s premium rates increased dramatically, due to the insurance contracts it entered into with large state enterprises (Russian Railways, Rosenergoatom, etc.). For example, the premium rate for its recent contract (November 2011) with Gazprom for the period 2012–2016 amounted to nearly US$3 billion. The subject of the contract is the insurance of the company's property (over US$1 billion) and additional medical insurance (US$1.2 billion). According to SOGAZ’s annual report in 2010, the value of its assets exceeded US$3 billion, and the value of contracts concluded last year was US$2 billion.

In 2005 Bank Rossiya purchased another valuable asset from Gazprom, the company LIDER, which among other activities manages the company's pension fund and the Gazfond investment fund. As Lider’s owner, Bank Rossiya acquired the company’s Gazprombank package (43%) along with shares in various subsidiaries of Gazprom which it transferred to Gazprombank’s assets[11]. This enabled Kovalchuk, the largest shareholder in Bank Rossiya (30.4%) to acquire, among other items, significant media assets important for the Kremlin in the run-up to the electoral campaigns, and thus in effect control over the Gazprom-Media holding. On this basis, he has created Russia’s largest media holding (including the national TV stations NTV, TNT, REN TV, Petersburg, 5-Kanal, the Izvestiya newspaper, the Video-International company – a giant on the Russian media advertising market – and many others).

The market situation demands Gazprom’s privileges to be curbed

During his two periods as President (2000–2008), Vladimir Putin significantly strengthened the position of the gas company in both Russia’s economy and its politics. In 2006 the Duma adopted a law which guaranteed Gazprom exclusive license to export all types of gas. In the same year, in order to prevent potential competition from Central Asian gas on the European market, a ban was introduced on the international transfer of gas via the territory of the Russian Federation. The government made every effort to improve the monopolist’s financial situation. In 2003–2010 the share of excise taxes and duties in Gazprom’s export revenues was reduced from 26% to 16%. The future profitability of the company's undertakings on the domestic market was guaranteed by a government programme involving a gradual increase in the wholesale price of gas in Russia (on average by 15–20% per year); this was launched in 2007, and is aimed at levelling out the profitability threshold of the domestic and European markets.

It became apparent that all changes on the gas markets, both domestic and European, both good and poor economic situation, posed serious challenges to the company's monopolist position. For example, the problems Gazprom faced during a period of prosperity on the EU’s gas market (2005–2008), which were related to maintaining the volume of extraction necessary to meet demand from domestic clients as well as the expected increase in exports, mobilised other gas producers (oil companies independent of Gazprom) to increase their production. This posed a challenge to the privileges enjoyed by the monopolist, involving very significant reduction of the profitability of gas production outside of the Gazprom system (in particular the lack of access of independent companies to the gas transportation system and export contracts, which hampered the sector’s development).

Despite a major change in the market situation after 2008 (a drop in demand for gas in Europe caused by the economic crisis), there was an upsurge in the extraction of gas by Russian producers independent of Gazprom. This resulted from the growing profitability of the domestic market, which translated into greater expectations for those companies regarding the conditions for operation on the domestic market.

The pipeline monopoly. Gazprom’s exclusive right to dispose of the system of Russian pipelines is its most widely criticised privilege[12]. The monopoly hampers or blocks other companies’ operations by limiting or refusing to accept supplies provided by independent producers to its pipelines, eliminating the possibility of connecting new fields to the system, etc. One of the few exceptions was a long-term contract concluded in 2010 with Novatek, enabling the latter to supply10 billion m3 of its gas to the pipeline network per year.

The Gazprom leadership's reluctance towards any projects to split up the company has gained unequivocal support from Vladimir Putin. During his presidency Putin repeatedly rejected proposals to restructure the company and projects to transform the gas transportation system into an independent structure modelled upon Transneft (with continued state control over the transfer infrastructure).

Prime Minister Putin’s comment on this suggestion (in February 2011) came as a surprise. He criticised Gazprom for excessive use of its monopoly rights to dispose of the gas transportation system; he did not question the principle of Gazprom’s exclusivity in this area, but he returned the issue of liberalising access to Gazprom’s network to the public debate. On 7 July 2011 the Federal Antitrust Service (FAS) filed a bill with the government concerning non-discriminatory access for all gas producers to the gas transportation system. Despite the undisputed need to adopt such a solution (Gazprom’s extraction programme is stagnating, and there is a need for independent companies to stimulate the growth of gas production[13], limit the consumption of petroleum gas, and increase the competition on the domestic market, and so on), it seems unlikely that the gas transportation system will undergo real isolation from Gazprom in the foreseeable future. For example, the recent FAS bill filed with the government (in October 2011) merely obligates the monopoly to disclose information on available transfer capacity on individual routes and on the number of registered applications for gas transfer and connection to the system. On the one hand, the incompleteness of this proposal testifies to the power of Gazprom’s influence concerning its privileges over the legislative process; but on the other, it suggests that the very fact that the issue is being dealt with at such a high level is a sign that pressure on the company is growing.

The export monopoly. Under the law, the only exceptions from Gazprom’s export monopoly have been those projects carried out on the basis of Production Separation Agreements (PSA). However, none of the companies which carried out two such gas projects in Russia has been able to sell gas to foreign clients independently. The first project, Sakhalin-2 (with Shell as its operator), was taken over by Gazprom together with the contracts for the export of LNG, already signed at that time. The gas part of the other project, Sakhalin-1, was suspended. Despite the plans laid by the investors (the American company Exxon Mobil as the operator, Japan’s SODECO, India’s ONGK and Rosneft) – who as early as 2006 had signed a preliminary agreement with the Chinese company CNPC to export gas to China – Gazprom decided that the gas from Sakhalin-1 would be used for domestic consumption. In February 2012 Exxon offered to sell Gazprom its gas assets in the project.

The first crack in Gazprom’s export monopoly was caused indirectly by Novatek. The agreement between Gazprom and Novatek (signed in March 2010), concerning conditions for exporting around 15 billion tons of liquefied gas per year from the Yamal LNG project operated by Novatek (which is scheduled to launch in 2016) stipulates that Gazprom will formally maintain its exporter status and receive its agency fee, whereas Novatek will have a major share in the revenue generated from the sale of gas. Gazprom’s unprecedented consent to split the export revenue would probably not have been possible without the political protection extended to Novatek by the Russian government.

Other gas producers are not so lucky. Despite the lobbying efforts undertaken by the influential deputy prime minister Igor Sechin, the state-owned Rosneft has been applying since 2005 for the possibility to export gas to China, so far without success. The subsequent rounds of talks between the company and Gazprom concerning the proposed creation of an export joint venture have also been futile. Another company, TNK-BP, which applied for the right to export gas to China (from the Kovykta field in the Irkutsk Oblast) had to sell the Kovykta project to Gazprom due to the lack of any such possibility, among other reasons. Other Russian companies have attempted to bypass Gazprom’s exports monopoly. For example LUKoil, without any mediation on the part of Gazprom, signed a memorandum of understanding in 2010 with China’s CNPC which provides for supplies of around 15 billion m3 of gas per year (starting from 2014); however, this concerns gas from projects carried out in Uzbekistan. In May 2011 the Yakutsk Fuel and Energy Company (part of the Summa Capital investment group) opened talks with the Korean company KOGAZ on the possible export of gas to Korea.

Vladimir Putin has not ruled out liberalising Russian gas exports in the future; yet in his opinion, Gazprom’s monopoly in this area prevents Russian companies from competing on various markets, and supports gas price stability.

Increased competition on the domestic market. In the context of the change in the situation on the domestic market, which since 2007 has not generated any losses due to the gradual increase in the price of gas, and has been running at a profit since 2008, Gazprom faces growing competition on the part of other suppliers (Novatek, Itera and oil corporations). Gas delivered by Gazprom, which is also provided on the domestic market under long-term contracts with the ‘take or pay’ clause at regulated prices, is more expensive (by 10–15%) than the gas offered by its competitors. Also, the supply conditions Gazprom offers are less favourable; for instance, the company requires 100% of the due amount to be paid in advance, while other suppliers demand a mere 30% in advance. Prime Minister Putin’s repeated suggestions to eliminate the ‘take or pay’ clause from domestic contracts have so far fallen on deaf ears[14]. In 2009–2011, Novatek acquired a share in the most profitable market of the monopolist’s corporate clients in several oblasts; for example, it entered the market in Chelyabinsk oblast, and in November 2011 it purchased 51% of the company Mezhregiongaz Chelabinsk from Gazprom, with the option of increasing the share package to 100%. The agreement between Novatek’s chief and the oblast’s governor stipulates an increase in the supplier’s share of the oblast’s gas market to 90% by 2020.

In 2009, Inter RAO UES and OGK-1 (power stations and thermal power plants in the Perm and Moscow oblasts and in the Yamalo-Nenets autonomous okrug) availed themselves of the right to terminate their agreement with Gazprom, and since 1 January 2010 have been buying gas from Novatek (under five-year contracts). Furthermore, Itera has taken over some of Gazprom’s clients in the Sverdlovsk and Moscow oblasts. LUKoil and TNK-BP have announced ambitious plans to develop their gas market segments and increase production volumes, and Rosneft is involved in talks with Gazprom concerning the creation of a gas trade company in Russia.

The activity of gas producers and oil corporations independent of Gazprom on the domestic market is growing rapidly. According to estimates, as of 2011 these companies have 100% of the market share in Sverdlovsk oblast, 95% in Kemerovo oblast, 58% in Tyumen oblast, 55% of Novosibirsk oblast, and their share in the Russian market as a whole has exceeded 25%.