Back in September I commented on how the Russian government was concerned that not enough outside investment was being made in exploration and development of new fields, and was considering giving tax incentives to companies willing to invest in these areas. I concluded the piece by saying:
The Russian government is in effect asking investors to put their faith in a Kremlin tax promise. They’d be better sticking their money on a horse.
Now it seems that it is going to be possible to do so as a private investor, as the path has been cleared to allow for partial foreign ownership of Gazprom, Russia’s gigantic state-controlled gas monopoly:
Russian President Vladimir Putin signed documents today to open up share trading in Gazprom, the world’s largest gas producer, moving the company a step closer to becoming the top global emerging markets stock.
Indeed. Just last month a financial adviser suggested I put cash into a BRIC (Brazil-Russia-India-China) fund, the Russian portion of which was 100% Gazprom. I politely declined. The Economist ran a good article on Gazprom back in October, which began with a few facts which left the reader oggling the page:
Gazprom is a leviathan. Last week, it agreed to buy most of Sibneft, the country’s fifth-biggest oil firm, in what will be the biggest takeover in Russian history. But Gazprom’s gas resources are already so big that its new subsidiary barely disturbs the company’s profile. Gas will still constitute 90% of its production next year. One Moscow investment bank calculates that for oil to account for half of its output, Gazprom would have to buy the entire Russian oil industry. Last year, Gazprom produced 20% of the world’s gas. It has 60% of Russia’s gas reserves and 16% of the world’s. If it were a country, its oil and gas reserves combined would rank only behind Saudi Arabia’s and Iran’s.
However, the article soon starts describing Gazprom in language more familiar to those who know a thing or two about Russia:
But at the moment, Gazprom remains a murky empire. Take, for example, the mysterious role that an obscure subcontractor plays in the delivery of gas from Turkmenistan to Ukraine, using Gazprom’s pipes but depriving it of large profits.
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Consider also the extremely high cost of Gazprom’s pipeline construction, compared with projects elsewhere in the world, and the strange intermediaries from which it buys materials.
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After Gazprom pays its taxes, which in 2004 accounted for around 8% of federal and regional tax revenues, the government’s priority is long-term investment rather than paying dividends, which are puny compared with those of most Russian energy firms. State involvement also results in what observers tend politely to term “non-commercial behaviour”.
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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 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. Mr Kuprianov says the media division needed a newspaper to complete its portfolio. But why does Gazprom need a media arm at all?
Obscure subcontractors, strange intermediaries, political interference, and questionable acquisitions of non-core assets? Yup, that’s the Russia we know. I’ll keep my money well away, thank you. The Economist article concludes in similar fashion to how I concluded my piece:
In short, how Gazprom behaves in future will be a key test of Russia’s desire and ability to turn itself into anything resembling a “normal” country. So in a way, all those fund managers rushing into Gazprom are really buying shares in Mr Putin and his (eventual) successor. As Chris Weafer, of Alfa Bank in Moscow, puts it, “If the Kremlin had a stock-exchange listing, Gazprom would be it.”
So in the time since the article was published, let’s see what steps Gazprom – and by extension Russia – has taken to turn itself into a normal country:
Russia took Europe to the brink of a winter energy crisis yesterday when it carried out a Cold War-style threat and halted gas deliveries to Ukraine, the main conduit for exports to the West.
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Moscow turned off the tap at 10am after Ukraine refused to sign a new contract with the Russian state monopoly Gazprom quadrupling prices.
And people are talking about investing in this outfit? The money on the horse is looking like a solid strategy in comparison.
Thank you for this post.
In Italy in the past few days there were quite a lot of rumors about a possible future shortage of gas due to less exportation rates from Gazprom (via Ukraine) and this’s very interesting to me, trying to understand better what’s happening 😉
Tim, here’s something to the exact nature of the Ukraine/Russia gas conflict (from the guy in the know).
Glad to see you back; Happy New Year!
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Happy New Year Tim! I have a mate down at The Curragh if you need a tip on the 3.15!!
Very interesting stuff on Gazprom and its “subcontractors”. No wonder we haven’t a Premier League football team left in the country without a Russian owner!
Tim, I have been watching Russia’s oil and gas sector since 1996 (I even covered it as an equity analyst for a couple of years), and one of the greatest mistakes I have made is not having invested in Russian oils, and above all in Gazprom. My reasoning in the 1990s was pretty much in line with yours — mismanagement, graft, poor strategy, etc. Yet even if I had invested before the 1998 “meltdown,” I’d have reaped good returns by 2000 or 2001. Had I invested in 1999, I wouldn’t have to work now. Even if I had bought some Gazprom in January 2005, it’d have been a good investment. (As a Russian citizen, I have legal access to Gazprom’s locally traded shares as opposed to GDRs, hence the arbitrage opportunity — but non-residents can take part in it too.) With all my common sense, I’m sitting here biting my elbows.
By the way, Gazprom’s new Ukraine tactic has nothing to do with the Cold War (The Economist must be desperately in love with Yulia Timoshenko but that doesn’t make them less superficial). Gazprom is not jeopardizing Europe’s gas supply, that much is obvious. Whether they can force Ukraine to pay what Europe pays for its gas is questionable but at least they have already exposed the Ukrainian importer’s theft of Gazprom gas. It might be the most sensible thing Gazprom has done since Putin installed the new management.
Alexei, there are other reasons for being wary of investing in Russia, besides the ones I’ve listed.
Firstly, little has changed by way of emergence of an independent judiciary prepared to prevent the mafia simply taking ownership of private companies using fair means or foul, as happened with many of the Ural heavy industries in the 1990s. Secondly, most Russians are getting their money out of the country (have a look at the number of apartments in Dubai being bought with Russian cash, for instance) which is never a good sign for those thinking of putting money in. And the Khordorkorvsky affair has given anyone thinking of investing in Russia serious cause for concern, as this was handled in such away that few non-Russians are convinced it was anything to do with non-payment of taxes. What I’m saying in my post is just an opinion, and yes I may be proven wrong – but time will tell.
For what it’s worth, The Economist doesn’t mention the Cold War nor Timoshenko in that article, and has been rather critical of the latter in other articles of late. As for Gazprom’s actions being sensible, you are the first person I have seen to describe them thusly. The sources I am reading are unanimous in thinking that this situation has been handled with the utmost cack-handedness, although to be fair none has commented on how it would affect Gazprom as a company in which to invest.
Tim, everything you say has been valid for ten years yet look at the RTS index in 2005, and see what opportunity you and I missed. In other words, you and I have had good reasons for not investing while others, being more risk-loving, have made a fortune, and relatively few have lost much. Russia has always exported capital, and the courts have never been reliable — nothing is new under the sun. At least minority investors are better protected now than they were in 1996.
(I am talking about investment in major publicly traded companies here; they are seldom if ever targets of mafia attacks unless you count the state as a mafia. Becoming a direct investor is an entirely different matter.)
Alexei, I think that the fact that some people made a fortune in investing in Russia in the mid-90s is down to luck more than anything else. Given the information available at the time, nobody but the most risk loving would have invested. Sure they made money, but they could quite easily have lost the lot – and if there’s one thing which you shouldn’t do when investing money it is looking at a missed opportunity and hoping you can catch it the second time around.
If I had a load of money spare which I could afford to lose, then investing in Gazprom might be a good idea. But investing a portion of my main pension would, given the information available now, be a mistake in my opinion.
Tim, I must apologize for not having made an important distinction from the start. When the Russian government complains there is not enough foreign investment in E&P, this means not enough new foreign money is coming in, mostly as direct investment (FDI). When we discuss the risks and rewards of investing in Gazprom, we are talking about shares already traded as opposed to newly issued stock: buying the former does not make more foreign money available to Gazprom and thus is not the type of investment Putin is concerned about. This is simple portfolio investment. My point is that portfolio investors (such as George Soros and Ken Dart as well as thousands of tiny molluscs) have made quite nice profits in Russia, and not only by mere luck but by access to information others did not bother to gather. But whatever my point, I now see that it’s irrelevant: this is not the sort of investment that concerns Russia’s policymakers.
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