Did too much geopolitics spoil Gazprom?

Photographer: Oliver Bunic/Bloomberg

Putin's Energy Giant Falls on Hard Times

Leonid Bershidsky is a Bloomberg View columnist. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.
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Years of mismanagement and politically driven expansion are catching up to the Russian state-owned natural gas company Gazprom. Output this year is forecast to be the lowest in its history, pipeline projects are floundering and it's not doing well in Europe, its key market. 

In June 2008, when Gazprom's market value reached $360 billion, Chief Executive Officer Alexei Miller predicted the company would be the world's biggest enterprise, worth $1 trillion, in seven or eight years. Miller, who worked with President Vladimir Putin in the St. Petersburg mayor's office in the 1990s, was proud of what he had achieved since taking over in 2001. He returned valuable assets stripped from the company by previous managers, expanded production and increased Gazprom's revenue to $94 billion from $21 billion. Miller could be excused for thinking the sky was the limit.

He was wrong. Seven years after his prediction, Gazprom is worth $55 billion. It's not even in the top 100 of global companies. And it's looking like a fish out of water.

The Russian economics ministry predicted this week that Gazprom's output would drop to 414 billion cubic meters of gas this year, lower than ever and one-third below capacity. The company had been counting on growth in both domestic consumption and exports. But the former has slumped because of Russia's recession, and the latter have shrunk because Europe, Gazprom's biggest export market, has diversified its energy sources. In 2014, Gazprom's exports were 90 billion cubic meters lower than in 2008. As exports dropped, the company kept investing in extraction and pipelines.

The Russian business daily Vedomosti estimated that Gazprom, under Miller, may have spent 2.4 trillion rubles ($40 billion) on unnecessary expansion. He may have done this to benefit Gazprom's billionaire contractors, including Arkady Rotenberg and Gennady Timchenko, both Putin friends who are living under international sanctions.

The Russian edition of Forbes says their companies made $1.9 billion just on the abortive South Stream pipeline, which was supposed to supply gas to southern Europe without crossing Ukraine. That investment can still be recouped if the replacement pipeline, Turkish Stream, is built, but so far Gazprom's negotiations with the Turkish gas company Botas haven't yielded a final deal.

Stalled negotiations and scrapped deals are a constant nuisance to Gazprom, which Putin's Kremlin has used as the vehicle for its European expansion. Europe has long been wary of this Gazprom role, especially as it watched the gas company twist Ukraine's arm repeatedly to draw it into Russia's sphere of influence. Ukraine has recently made a special effort to diversify. Last year, according to the energy consultancy Enalytica, it increased European gas imports to 28 percent from 8 percent in 2013. The increase is partly due to Gazprom's overeager expansion: It's pumping more gas into Germany than the Germans and neighboring countries need, allowing them to export to Ukraine.

At the same time, Gazprom is locked in a battle with the European Commission, which accuses it of overcharging clients in Eastern Europe, where Gazprom is the monopoly gas supplier. Gazprom is also struggling to find another way into Europe to carry out its plan to bypass Ukraine by 2019 since the European Union's resistance killed South Stream late last year. 

There are lots of smaller setbacks as well. In its just-released 2014 annual report, Gazprom Germania, a Berlin subsidiary responsible for about 14 percent of revenue, revealed a 31.6 million euro ($34.5 million) net loss after a profit of 286 million euros in 2013. A planned asset swap, in which Germany's Wintershall received an interest in Gazprom's Russian gas fields and Gazprom got Wintershall's shares in the two companies' joint ventures, fell through. Gazprom Germania has also been banned from selling natural gas at German gas stations (it has 25 such outlets); it's appealing the decision.

In the annual report, the company warned that more trouble might be coming:

Current regulatory intervention in the energy sector has the potential to have huge consequences on the group's income and is therefore considered to be a significant factor. The current direction of energy policy in favor of renewable energies -- particularly in Germany -- may severely limit the competitiveness of natural gas. Both current price regulation for grid usage and potential future price regulation for underground storage facilities will have negative consequences on the marketing and trading of natural gas and may limit Gazprom Germania's investment and project activities.

Europe is no longer a friendly market for Gazprom, both for political and regulatory reasons. And while the Russian supplier is still able to sell gas at competitive prices, it can hardly count on growth there. The economic slowdown in China, meanwhile, is undermining Gazprom's grand, costly diversification plans. The company has already scrapped a liquefied gas project in the Russian Far East, which was meant for the Chinese market. Its plans for the Altai pipeline to China, tentatively announced this year, was delayed indefinitely this month (although another pipeline project, agreed to in May 2014, is still in the works). 

Last year, 9 percent of Russian government revenue came from Gazprom. The company is still a cash cow, but it appears strategically challenged, squeezed from all sides by dropping prices, falling demand, unfriendly regulators and politicians suspicious of Putin and his friends. To replace Miller's 2008 dreams of global dominance, it needs a tough cost-cutting plan and a vision of how to proceed in an all-around hostile environment. Soon, it won't be able to shower lucrative orders on Putin's cronies and get involved in political games: It'll be fighting for survival. 

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author on this story:
Leonid Bershidsky at lbershidsky@bloomberg.net

To contact the editor on this story:
Paula Dwyer at pdwyer11@bloomberg.net