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At 20, Russia's Gazprom Struggles To Stay Dominant

Gazprom employees at the launch of production at the Bovanenkovskoye gas field in the far northern Yamal-Nenets Region in October 2012
Gazprom employees at the launch of production at the Bovanenkovskoye gas field in the far northern Yamal-Nenets Region in October 2012
MOSCOW -- Russia's biggest company turned 20 this year. But at Gazprom, there appears to be little cause for celebration.

The state-controlled natural gas monopoly, which was established as a publicly traded corporation in 1993, recently announced that its net profits fell by 11 percent last year and its valuation dipped below $100 billion for the first time since 2009.

Moreover, Gazprom's books are currently being audited by the Russian authorities and its business practices investigated by the European Union. Some key Kremlin insiders are reportedly even pushing for something that was once unthinkable: splitting up Russia's gas behemoth into smaller units.

Sensing the vulnerability, Gazprom's longtime critics have been quick to pounce on the once-untouchable company.

"Gazprom is in a very profound strategic crisis that began to emerge a long time ago," opposition figure Vladimir Milov, a former deputy energy minister, said during a recent interview with the online news site "They were warned many times that their inflexible, unwavering and shoddy policies would lead them into trouble. That trouble has now begun."

Questioning Its Strategy

Analysts say Gazprom was slow to react to potentially revolutionary changes in the energy market, such as the emergence of shale gas and liquefied natural gas (LNG).

The United States, which has abundant reserves of shale gas, and Qatar, the world's largest LNG exporter, have become more active in the European market, cutting deep into Gazprom's profits. The United States has significantly increased its coal exports to Europe.

Ildar Davletshin, an oil and gas analyst at Renaissance Capital, says that despite the changing market Gazprom continued to insist on costly long-term gas contracts pegged to the price of oil.

"They only care about prices and the strength of the price as opposed to the strength and healthiness of demand," Davletshin says of Gazprom's leadership. "Given the [poor] state of the European economy, that is probably not the best strategy."

Many of Gazprom's European customers are turning to other suppliers as a result. Last year, for example, Norway’s gas sales in Europe rose by 16 percent despite the Eurozone crisis, while Gazprom’s fell 8 percent, according to the European Commission.

Late last year, Gazprom finally began to react to the market pressure and lower prices for some European customers. According to a Gazprom official cited by the daily "Izvestia," the company expects to be paid an average of 14 percent less for its gas this year. The price Poland pays for gas is expected to fall 27 percent, the official said, while Hungary will pay 2 percent less.


But this only served to illustrate another contentious issue: Gazprom's wildly varying pricing policy, which has plagued the company in Europe.

In September, the European Commission launched a probe to establish whether Gazprom was stymying the diversification of supply, pricing gas unfairly, and preventing the free flow of gas between customers.

The investigation strikes at the heart of Gazprom’s business model and its cherished method of pricing gas -- via expensive oil-pegged contracts. Its findings are expected later this year.

In an interview with the Russian weekly "Gas Week" in February, Gazprom spokesman Sergei Kupriyanov said the market was "in a state of change" due to "regulation" and "the appearance of new technologies." He acknowledged that this had created "problems" for Gazprom that the company is working to address.

Analysts say many of Gazprom's problems are rooted in the company's dual role as a commercial venture and as a blunt instrument in the Kremlin's foreign policy tactic of using energy as a means of rewarding friends and punishing foes.

Not only has Gazprom's political role led more European states to diversify their energy supplies; it has also forced the company to spend money on costly pipeline projects with dubious commercial value.

Analysts point to the South Stream pipeline and new vectors of Nord Stream that are expected to provide more pipeline capacity to deliver Russian gas to Europe while bypassing troublesome Ukraine, with whom Moscow has had bitter political disputes.

Putin's Proxy?

There is a widespread perception that such ventures are driven primarily not by Gazprom's commercial interests but by President Vladimir Putin's geopolitical needs.

"People at Gazprom are not stupid. They can see what's happening," Jonathan Stern, chairman at the Oxford Institute for Energy Studies, says. "But Putin is forcing them into all kinds of crazy projects and refusing to allow them to adapt to market conditions. If you look at all the major announcements that Gazprom has supposedly made about projects, they're all Putin announcements. They are all things that Putin has led on in the public domain.... Why is Gazprom talking about building all these pipelines to Europe? Because Putin wants to do it."

Earlier this month, for example, Putin raised eyebrows when he ordered Gazprom CEO Aleksei Miller to complete the second section of the Yamal-Europe pipeline at a time when demand and prices are down in Europe and diversification is up.

Estimates suggest that Gazprom already has the capacity to deliver 244 billion cubic meters (bcm) of natural gas through its current pipeline network to Europe. But last year it used only 155 bcm of this capacity, bringing into question plans for extra capacity via South Stream and Nord Stream, let alone a second branch of Yamal-Europe.

Gazprom also appears to be on the defensive inside the halls of power, where other powerful energy players are seeking to capitalize on the company's troubles.

In a nine-minute video posted on YouTube, Kremlin-friendly journalist Mikhail Leontiyev slammed Miller for ignoring the threat from the shale-gas boom, calling him a "dangerous lunatic" and an "illiterate madman."

Break It Up, Fellas

In an interview with the "Financial Times" in March, Kremlin-connected oligarch Oleg Deripaska suggested Gazprom should be split into separate entities.

According to media reports, powerful Putin cronies like Igor Sechin, CEO of the state oil company Rosneft, and businessman Gennady Timchenko, founder of the commodities-trading company Gunvor, are also pushing for the gas giant to be broken up.

Moreover, Russia's second-largest natural-gas company, Novatek, which is connected to Timchenko, has been lobbying the government to break Gazprom's export stranglehold, allowing it to be handed the right to LNG exports.

Analysts say that despite Gazprom's current difficulties, the company is unlikely to be broken up anytime soon.

"We can all think of ways in which Gazprom can be broken up," Stern says. "We've all suggested it and we've all said this would be far more efficient. But we're not looking at the political reality. The political reality is that the Russian government and Putin want Gazprom to perform certain functions and most of those functions are not commercial."

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