By Jason Bush Is Russia using gas as a political weapon? That's been a hot topic in both Europe and the U.S. ever since state-controlled behemoth Gazprom cut gas supplies to Ukraine for three days last January in a dispute over prices. Europe depends on Gazprom (OGZPY) for 26% of the gas it consumes and 61% of the gas it imports—so any hint that Russia could turn off the tap for political or other reasons is a sure cause for major concern. Even Vice-President Dick Cheney jumped into the fray in May when he denounced Russia's energy empire building in a speech in Lithuania—an ex-Soviet nation 100% dependent on Gazprom's gas. "No legitimate interest is served when oil and gas become tools of intimidation or blackmail," Cheney declared.
Yet pure economics—more than any designs of the Kremlin—may prove to be the most serious risk to Gazprom's reputation as a stable energy supplier. Critics inside and outside Russia claim that Gazprom is still run inefficiently and is simply not investing enough to meet all its current and future commitments to customers. Recently, Anatoly Chubais, CEO of Russian electricity utility UES—Gazprom's largest domestic customer—slammed the gas company for its failure to supply power stations sufficiently even at the height of summer. (Gas was in short supply last winter, when Russia experienced subzero temperatures, too.) "The country is facing a real gas deficit," Chubais warned at an investor conference in June. "The reliability of gas supplies both to the domestic and European market will be at risk," adds Vladimir Milov, head of the Institute for Energy Policky, an independent think tank in Moscow.
UNTAPPED RESERVES. What's the root of the problem, according to these critics? Most of Gazprom's production comes from a handful of mature fields, where production has been sharply declining. To keep up growth in the future, Gazprom will have to develop big new fields—mainly in the Yamal Peninsula, an area of the far north where most of Russia's untapped gas reserves lie. Yet development of Yamal has been repeatedly delayed. "Gazprom has been working on Yamal for 15 years already and doesn't seem to get anywhere," says Anders Aslund, a senior fellow at the Institute for International Economics in Washington.
Why so slow? Overall, the Yamal fields require huge investments of around $70 billion. Even mighty Gazprom doesn't find it easy to stump up that kind of money. True, in recent years Gazprom has benefited from a huge financial windfall because of high international energy prices. Between 2001 and 2005, Gazprom's revenues increased from $19.4 billion to $48.9 billion. And yet because of soaring costs, only $12 billion of that $30 billion increase went into increasing Gazprom's earnings. Economists argue that big state monopolies like Gazprom are inherently poor at controlling costs.
For its part, Gazprom brushes aside concerns that it isn't investing enough. "Every year we invest $10 to $11 billion. So [$70 billion] is not some kind of supernatural figure," says Sergei Kupriyanov, Gazprom's spokesman. He points out that in the past five years, Gazprom has increased its production by 37 billion cubic meters. "That's half of the annual consumption of Italy, or the entire annual consumption of Argentina," he boasts.
OUT OF ITS LEAGUE.Still, critics counter that most of Gazprom's investments aren't going where they are needed most: into the development of new gas reserves. Milov notes that out of $60 billion invested by Gazprom between 2000 and 2006, just 20% went into developing new gas production. Instead, Gazprom has been pouring billions into new areas such as oil and electricity or to build expensive new pipelines that will be hard to fill without new production. "They have huge challenges in their core business?nd still they spend billions of dollars entering new businesses where they have no professional knowledge or experience. You cannot build a global energy company on the basis of that," he argues.
It's quite possible that Gazprom will feel the pressure to step up investments in time to meet rising demand??articularly rising demand from the export market, which is the key source of profits. On the positive side, Gazprom's financial position has never been healthier. Despite rising costs, record energy prices mean that Gazprom's net income is forecast to reach $20 billion this year on almost $62 billion in revenues. Gazprom is also getting a significant boost because of its new pricing policy for ex-Soviet countries such as Ukraine. Ironically, a policy that has sparked so much concern in Europe about energy security may actually help secure supplies, if it means Gazprom will have more funds for crucial investments.
STRONGER MANAGEMENT.?ptimists also believe that Gazprom's efficiency will improve now that the management team of Alexei Miller, whom Putin tapped for the CEO job in 2001, has at last established a firm grip over the company. Under previous management in the 1990s, the company was poorly run and it has taken a while for Miller to assert control. "We see the company going through changes—and changes in the right direction," says Per Brillioth, portfolio manager at Vostok Nafta, a Swedish fund heavily invested in Gazprom.
Yet it's too soon to say whether the recent improvement in Gazprom's financial performance can be sustained. Although energy prices are forecast to remain high for the immediate future, they are sure to fall one day. When that happens, Gazprom's finances could suddenly look less healthy. And if the critics are right, the company's failure to invest more in the good years could yet come back to haunt it. Bush is BusinessWeek's Moscow bureau chief