Reform the Gazprom way

by Simon Pirani

Gazprom will this year become significantly more transparent, with separate accounting by production, transport and distribution subsidiaries – but will not hive off transport assets into a separate company. Progress on third-party pipeline access, and abolition of the “ring fence” separating domestically- and internationally-traded shares, are two other prongs of new reform plans rolled out after the presidential election.

The importance that President Vladimir Putin attaches to gas sector reform was highlighted by the mention he gave it at his first second-term press conference, in the small hours of Monday 15 March, once his easy victory was confirmed.

Putin’s statement that “we must take care with Gazprom”, and that domestic prices can not rise to European levels “overnight”, were widely publicised. He added that reform must continue, including towards free access for non-Gazprom producers to pipelines but not export markets, and “transparency of the [state] Gazprom shareholding”. (See box.) Three days later, Gazprom ceo Aleksei Miller announced his transparency initiative.

So Gazprom’s prospects during Putin’s second term are now much clearer. Miller will go ahead with Kremlin backing, and reform plans floated by German Gref’s economic development ministry, which envisaged breaking up Gazprom into a transport company and a series of production companies have effectively been dumped.

A senior Gazprom source, speaking to GBI on condition of anonymity, said: “Gas sector reform is urgent. But we don’t believe that breaking up Gazprom will solve the fundamental problems of low domestic prices and the need for transport infrastructure investment. And we have convinced the president of this.”

Progress may be expected as follows:

On transparency, plans to unravel the opaque finances of Gazprom subsidiaries were drafted by a working group on corporate structure headed by Miller himself and one of his senior deputies, Aleksandr Anenkov, and agreed at a meeting with other executives and government officials on 18 March.

All subsidiaries that combine production, transport and other functions will establish divisions corresponding to those areas of activity, a company press release stated – so that work on “separating-out cash flows from production, transportation, processing, storage and sales of gas and liquid hydrocarbons” will be completed by the end of the year.

Low-pressure distribution assets belonging to 17 Gazprom-controlled gas transport companies will be concentrated in a dedicated entity, Regiongaskholding; production service assets will be transferred to production subsidiaries; gas storage will comprise a separate subsidiary. Non-core assets including social welfare and telecommunications will be separated out.

Miller said, in an interview with Vedomosti newspaper, that the changes would make transportation costs “absolutely clear and transparent” by the start of 2005, “which is important for the setting of transport tariffs”.

The announcement was greeted by market reformers have long criticised Gazprom’s internal opacity. Andrei Sharonov, Gref’s first deputy at the economic development ministry, said it was a “vital step towards gas sector reform”. It could also reasonably be interpreted as something akin to the “accounting unbundling” required by the first EU Gas Directive.

A Gazprom source said managers throughout the company had accepted the need for transparency, and discussion is now focusing on how to finance transport infrastructure investment. “If, for example, an independent producer wishes to build and manage a pipeline from its production facility to a trunk line, Gazprom is happy with that. Both Itera and Yukos already have such pipelines.

“But what about other investments, for compressor station construction or trunk line upgrades? Some Gazprom managers say we should finance such projects 50-50 with the independent producers. But how will the independent recoup his investment? The obvious way is by discounting his transport tariff – but the tariff is set in law and there is no mechanism for discounts. Other managers say we should sign long-term ‘take-or-pay’ and ‘transport-or-pay’ contracts with the independents, such as we have ourselves with the Poles, Czechs or Germans – and this argument is gaining force.”

Third-party pipeline access is an area in which opinion among Gazprom managers is also shifting. Deputy ceo Aleksandr Ryazanov said recently that “specific quantities” of independent producers’ gas could be exported, provided they agreed to supply the domestic regulated market.

Igor Plotnikov, head of Gazprom’s information and analysis centre, told GBI that exports by non-Gazprom producers would only start on two conditions: first, that they go “through a single export channel, and that means Gazeksport”. Otherwise, “Russian gas will be competing with itself on the European market, which is great for consumers there, but bad for the Russian gas industry. And we won’t allow that.”

Secondly, independent producers would have to sell to Russia’s regulated domestic market. “Yes, Gazprom gets the advantages of high export prices. But we also have to sell at regulated prices to residential users in southern Russia, where, in some areas, non-payment is as high as 50%. Let the independents share both markets.”

On Gazprom’s shareholding structure, Putin’s remark that it needed to be transparent was greeted with a chorus of excitement by investors. A poll of market analysts by the oil and gas industry information service NGV.ru showed them unanimous in interpreting Putin’s comments as confirmation that the promised abolition of the “ring fence”, separating those shares quoted on the domestic markets and much more highly-priced American Depositary Receipts (ADRs) traded internationally, will go ahead.

Christopher Granville, political strategy analyst at the Moscow-based United Financial Group, said: “The context only allows for one interpretation: the conversion of the so-called treasury stock [about 10% of Gazprom shares held by the company itself] into direct [i.e. state] shareholding as the political precondition for the share market unification.”

The remaining frustration for market reformers is that the increase in Russian domestic gas prices will continue gradually. But at least Putin is frank about it, and Gazprom managers are energetically lobbying for price reform to go faster.

Plotnikov at Gazprom said: “The fact that our gas is sold domestically at fixed state prices, that don’t allow for investment, is our biggest single problem – and the price the state must pay for gas sector reform is the liberalisation of domestic gas prices. That is the key factor in enabling us to raise funds for investment in new production and in transport system upgrades.

“If we had agreed to separate out the transport division before price reform is completed, the industry would have been in an even worse position for raising investment capital. At least as a strong, vertically-integrated company with export revenues, Gazprom can raise substantial loan capital on the international markets. A stand-along transport company couldn’t do that.”

What Putin exactly said

The centralisation of power in Russia means that president Putin’s every word means much more than, for example, those of his predecessor, president Yeltsin. And his decision to mention gas reform at his post-election press conference was significant.

He said: “Gas is sold both to residential and industrial users at prices below world levels, and to a significant extent we ensure the economic growth of other industries at Gazprom’s expense. This is a fact that mustn’t be forgotten. If we introduce world prices overnight, then we would tomorrow have to sell gas to our consumers at the same price as prevails in western Europe, $110 per thousand cubic metres. That’s impossible. And so we must take care with Gazprom.” Putin added that reform would continue, and that meant “free access to pipelines for independent producers, although that does not mean unlimited entry to the export market”; it also means that “there must be transparency of the Gazprom share holding”.

(Source: Prime Tass and NesProm.ru news services, and Russian newspapers.)