A Russian Gas Giant May Get Some Foreign Fuel

During the recent Kremlin Cup tennis tournament, executives from Germany's Ruhrgas had plenty of reason to ply officials from Gazprom, the Russian gas monopoly, with vodka and cognac. Gazprom is Ruhrgas' biggest supplier. But the Russian company hasn't been behaving very nicely, lately. Hoping to grab a bigger share of the European market, it has linked up with one of Ruhrgas' major competitors and is now stealing business and denting Ruhrgas' profits. "All of the top people at Gazprom were our guests," says Reiner Hartmann, chief of Ruhrgas' Moscow office. But Gazprom isn't backing off.

Gazprom, the world's largest gas producer with a huge 38% of global reserves, is a monster in the German market and the rest of Europe. And Gazprom's output dwarfs the combined world production of the biggest Western producers, including Royal Dutch/Shell, Exxon, Mobil, and British Petroleum.

SOCIAL CONCERNS. Russian gas was a huge issue in the 1970s as the U.S. unsuccessfully tried to prevent Europe from becoming dependent on the Soviet bear. Now it's about to be a hot topic again because this big, mysterious company is planning to sell a 9% chunk of its equity to foreign investors. The planned sale, which is being quietly orchestrated by the London-based investment bank Kleinwort Benson Group PLC, has sparked a debate about Gazprom's prospects and its real worth. Staggering estimates of the value of its assets are being bandied about, ranging from $250 billion to $740 billion. "The truth," says Gazprom Deputy Chairman Valery V. Remizov, "is somewhere in between."

If Gazprom were a Western company, one could determine its value by assigning a dollar figure to its reserves in the ground. But it's a much more complex animal. It can't be separated from Mother Russia and all the risks and problems there. It's owed at least a billion dollars by Ukraine and other former Soviet republics. It has huge social and political obligations, such as providing housing, schools, and health care for its 320,000 employees, many of whom are not directly engaged in the gas business. Remizov says that some 3.7 million people depend on the company. "It is not clear what their assets and their liabilities are," says Julia Nnay, an analyst with Petroleum Finance Co., a Washington consulting firm, or "where the money from this offering will go."

INTRIGUING PLAY. Gazprom's options are trading on the Vladivostok Stock Exchange at $5 per share--a price that would give a $125 billion total valuation--bigger than Royal Dutch Shell's $101 billion. Some market participants think Gazprom could go for a price in that range--although insiders and the Russian public have been able to buy in for much less.

Pricing issues aside, Gazprom definitely is an intriguing play. With its vast 140,000-kilometer pipeline network, it controls nearly 100% of the Eastern European market and about 25% of the Western. The volumes it pumps westward will likely expand in the coming years as demand for cleaner fuels increases. By 2010, European demand for gas is likely to grow by about 50%, to almost 600 billion cubic meters, according to energy consultants Purvin & Gertz Inc. "We see tremendous scope in Russia's increasing exports to Europe, but that does depend on them remaining a reliable business partner," says London-based managing partner Michael Corke.

At home, Gazprom is a political powerhouse. Its former boss, Viktor Chernomyrdin, is now Prime Minister, and he stays in close touch. Gazprom's present boss, Rem Vyakhirev, is a career Chernomyrdin protege. With that kind of clout in the Kremlin, Gazprom officials push economic policies that favor their interests. Unlike their counterparts in the Russian oil patch who are courting Western companies, they are trying to keep foreigners out gf the gas industry--except in areas where specialized technology is needed. As Russia's leading hard currency earner, Gazprom can also call on Kremlin backing to pursue its aims in the former Soviet Republics and Eastern Europe.

Despite being a holdover from the old Soviet economy, Gazprom gets good marks from many executives who have dealings with it. While critics chide its projects for taking on Soviet-style gargantuanism, Gazprom is generally regarded as well managed and sophisticated. Says a Western energy executive in Moscow: "Of all the companies we've come across in Russia, Gazprom is definitely the most professional."

COSTLY RISK? Foreign investors will soon have a chance to express their interest in Gazprom. The company and its advisers at Kleinwort Benson are hoping to entice Western energy companies such as Amoco, Texaco, Conoco, Italy's ENI, and British Gas, as well as institutional investors.

But privatization is not expected to keep Gazprom from going ahead with the big, risky projects that some energy specialists think are a mistake. Much of the money from the upcoming stock sale in the West is expected to go toward the $35 billion Yamal-Europe project that would produce gas from new fields in the Yamal Peninsula in western Siberia. Yet some institutions, notably the World Bank, question whether producing and delivering the gas from Yamal will be too expensive.

Gazprom, like its counterpart in the oil industry, Lukoil, is also playing hardball in the former Soviet republics. After spending up to $1 billion of its own funds helping develop the big Karachagank fields in northwestern Kazakhstan, Gazprom is insisting on participating with British Gas and Italy's AGIP in a $7 billion project there. Russia is also making it clear through diplomatic channels that anything behind the former Iron Curtain is Gazprom's turf.

Some European gas suppliers worry that Gazprom could use alliances and its size to eventually dominate their home markets as well. "Gazprom is a seriously large company, and there are some concerns of an unholy alliance between Gazprom, British Gas, and Ruhrgas. If these players teamed up they would be in a position to influence price," says John Astrop, commercial director of Kinetica Ltd., a British-based pipeline and supply joint venture between Conoco and PowerGen.

If Gazprom can get the financing to develop its huge projects and upgrade and build pipelines, it seems destined to play a pivotal role in Europe's energy supplies. It also might well prove a shrewd stock play--unless its problems at home cause it to flame out.