In the high-stakes drama of Russian economic reform, the “red director” is the acknowledged bad guy. Popular wisdom has it that the presence of the Soviet old guard is an impassable roadblock to industrial restructuring. The quicker they are swept away by corporate raiders, whether foreign or Russia’s own young financial Turks, the better. The stereotype is eloquently defined by raider par excellence, Boris Berezovsky: “These are production guys whose one thought is whether the press is stamping,” he sneers.
Yet reality has proved more complex. The one Russian industry privatized according to IMF orthodoxy – aluminium – became a mess. The battles for control of the giant, cash-spewing Siberian smelters produced dozens of corpses. The winner of the war was a secretive newcomer to the world economy called Trans-World Group (TWG), based in London but controlled by two Uzbekistan-born brothers, Lev and Mikhail Chyorny, who have taken up Israeli citizenship.
The Russian and foreign press reported at great length on the tactics of TWG and its once official protector, former vice-premier Oleg Soskovets. The group has so far milked its acquisitions through tolling operations, investing little in plant modernization.
The Russian oil industry has become an enormous laboratory for two kinds of privatization. One is exemplified by companies such as Lukoil and Surgutneftegaz, which were taken over by the incumbent management. The other is typified by Yukos, Sidanco and Sibneft, which fell into the hands of the Moscow banks.
Although it is too early to draw firm conclusions, investors seem to prefer the old guard. Lukoil, valued at well over 20 times earnings, is champion of the Moscow stock market. Surgutneftegaz, whose executives bought the company with its own pension fund, has Russia’s fourth largest market capitalization – around $4 billion. Yukos, controlled by Bank Menatep and Berezovsky’s Sibneft which are valued at less than $3 billion each, lag significantly.
“Things tend to work best in this country when you’ve got an old-time, no-nonsense kind of general director,” observes Patrick McCollum, who ran the Moscow office of American oil equipment producer Dresser Industries.
But the biggest test of the old-style Soviet bosses in the brave new market world will be at the natural gas monopoly Gazprom. Sitting on one-third of the world’s known gas deposits – six times the reserves of Shell and Exxon combined – Gazprom is a colossus among giants. It provides 25% of Russia’s federal tax revenue and represents 15% of the country’s equity market capitalization. It already supplies one-third of western Europe’s gas – a share which will increase as the stocks of its chief competitors, Norway and Algeria, dwindle.
Gazprom vice-chairman Pyotr Rodionov remarks with quiet satisfaction: “If the other countries stop supplying gas tomorrow, we could make up the difference. But the opposite is not true.”
Rodionov, the rock-like, gravel-voiced industry veteran, is one of these old-time, no-nonsense directors. Like his boss, Gazprom president Rem Vyakhirev, Rodionov spent decades climbing the ladder of the Soviet gas system, rising to manager of Lentransgaz, the most important of Gazprom’s 14 pipeline divisions. After a two-year stint as Russia’s energy minister, he returned to the mothership this year.
Gazprom’s gleaming new 35-storey headquarters on Moscow’s outskirts is the most convincing of new Russia’s attempts to create the impression of old money.
Gazprom’s leadership has survived the turbulent past decade by embracing revolution. At the dawn of Mikhail Gorbachev’s perestroika, gas industry managers were plotting the creation of the USSR’s first kontzern – a state-owned but free-standing company run by executives, rather than ministry and Communist Party bureaucrats. The insurgents’ leader was Viktor Chernomyrdin, now serving his fifth year as Russian prime minister. Vyakhirev and other current company directors were his deputies. (Lukoil was also born of a management-hatched kontzern, but not until 1990.)
The Russian government and foreign securities analysts now debate whether the Chernomyrdin team succeeded too well. While the Soviet oil industry imploded after 1988, natural gas kept flowing, bringing in desperately needed cash. Gazprom has continued to prop up Russia through troubled times. It keeps the country (and CIS neighbours) from freezing, despite receiving cash payment from only 10% of domestic customers and nothing from most other customers. It fills the treasury from its annual export revenue of about $10 billion.
But the lords of Gazprom have not overlooked their own interests. The company’s privatization in 1993/94 was a murky business. A 40% stake remained with the state, while 10% was set aside for a subsequent sell-off to meet future capital needs. Part of the remaining 50% was sold through voucher auctions, allowing management to claim that it works for the future of 850,000 individual Russian shareholders. But a much larger chunk, estimated at 30% of corporate equity, was transferred through closed auctions to organizations which enjoyed management’s blessing, if not its direct involvement. At Gazprom’s current valuation (artificially reduced by draconian trading restrictions), this totals about $4.8 billion.
The impression that Gazprom officials helped themselves to the country’s national wealth has left ordinary Russians blind to the company’s better side. The Our Home is Russia political party, launched by Chernomyrdin before the 1995 parliamentary elections, was popularly known as “Our Home is Gazprom”. This association was not unconnected to Our Home’s dismal 10% showing at the polls or to the Communist Party’s triumph at its expense.
But Gazprom’s success, and Chernomyrdin’s political protection, allowed it to come through privatization in one single – but complex – piece. The Russian oil industry, by contrast, was broken into a dozen new companies in a painful and chaotic process which is beginning to bear fruit in the competition for everything from drilling rights to petrol stations. Gazprom remains a hybrid, somewhere between a corporation and a medieval principality. One-quarter of its 400,000 employees work in farms, banks, airlines, sanatoria and other offshoots of dubious value to a natural gas producer. A “unified accounting system” throws all the firm’s disparate costs and revenues into one pot. Although it is audited by Price Waterhouse, Gazprom remains a financial black box for analysts, regulators and, say critics, its own managers.
This chaos needs to be addressed. For Gazprom to fulfil its destiny as the dominant provider of the next century’s fuel of choice, it needs a grand alliance with world capital. The entente was launched in earnest this year when Dresdner Bank arranged a $2.5 billion syndicated loan for Gazprom, which was three times oversubscribed. Further packages of similar size are promised by a Dresdner-Crédit Lyonnais alliance and by ABN-Amro. Deutsche Bank and partners have also lent a further $1 billion.
But Gazprom’s capital requirements are beyond the means of any banking syndicate. Its most pressing project, a pipeline from the Arctic wastes of the Yamal peninsula to Germany, will cost an estimated $25 billion, with drilling costs adding $15 billion to the total. Next on the agenda is a new pipeline to Turkey, which last year contracted in principle for large purchases of Russian gas. To avoid the politically volatile Caucasus, the company is talking of tunnelling beneath the Black Sea, an ambitious underwater transport challenge. “It’s still important to Gazprom management to do things that are the biggest, the deepest or whatever,” says Nikolai Arutyunov, an analyst at Moscow’s Brunswick Securities. “It’s a drawback.” Once the west and the Middle East are squared away, Gazprom has long-term ambitions to fuel south-east Asia.
Gazprom’s management cannot fulfil these ambitions without bringing in equity investors and, over time, sharing control. Meanwhile, the company’s composure has been disturbed closer to home. Gazprom’s neglect of public relations cost it dearly in its recent showdown with new reformist dynamo, vice-premier Boris Nemtsov.
When the 37-year-old Nemtsov arrived in Moscow last winter promising to shake up Russia’s “natural monopolies”, experienced capital hands thought that Vyakhirev would eat him for breakfast.
But, as governor of Nizhny-Novgorod, Nemtsov mastered a political weapon the Gazprom gang had seldom considered – public opinion. Russia’s media quickly lapped up less-than-fair diatribes about how grandma’s pension was late because those nasty Gazprom plutocrats were dodging their taxes. Vyakhirev beat a quick – and expensive – retreat. Gazprom poured Rb9 trillion ($1.6 billion) into the state pension fund in June, enough to cover all the fund’s arrears. (Dresdner Bank lent the company another $1 billion to soften the blow.) The government did nothing about paying the tens of trillions of roubles Gazprom is owed by state enterprises, from hospitals to the military.
Nemtsov also unearthed and made void a secret trust agreement between Vyakhirev and Soskovets, which gave Gazprom management permanent proxy on the government’s shareholding. Next he overhauled the Federal Energy Commission, replacing incumbent cronies of Gazprom with his own appointees.
Having won these early battles, the vice-premier called a truce. Boris Nadezhdin, Nemtsov’s adviser on Gazprom affairs, now speaks magnanimously of the firm: “Thanks to the efforts of Vyakhirev, Gazprom is one of the few companies in Russia which is developing,” he told Euromoney. “We have no differences on how to manage the company.”
Yet government reformers will press their long-term goal of, in Nadezhdin’s words, “carving out from Gazprom what is genuinely a monopoly and transferring all the rest into a competitive regime”. The nub of the conflict is access to Gazprom’s pipeline network. In theory, the lines have long been open to independent gas producers – regional gas companies at Norilsk and Yakutsk, and the Siberian oil companies which extract gas as a by-product. In practice these competitors logged on with Gazprom’s reluctance – and at Gazprom’s price. The result is a Gazprom stranglehold on more than 93% of Russian gas production and, consequently, precious gas flares wastefully into the skies over Surgut and Nefteyugansk.
Nemtsov harbours a greater ambition still: open tenders for new gasfields – open at least to Russian companies – once the pipeline is wedged open. Such is the strength of Nemtsov’s political tail-wind that Chernomyrdin has ruled against his own creation by signing government resolutions enshrining these two market principles. But a government resolution is the weakest of Russia’s legal instruments – far less forceful in practice than a Yeltsin executive order, not to mention a law. Weakening Gazprom’s grip on gas drilling and distribution promises to be a long, hard slog.
Nor did the Gazprom bosses walk away empty-handed from their first horse-trade with Nemtsov. They kept control of their board. The weeks before Gazprom’s late June annual meeting were rife with speculation that the government would team up with the private sector Unexim Bank, which was reportedly raiding Gazprom stock, to seize a boardroom majority. “I think the government was intentionally using Unexim to scare Gazprom,” Arutyunov says.
With the Rb9 trillion safe in the treasury, however, the dogs were called off. Gazprom officials kept seven of the 11 board seats. Unexim’s lead candidate, former deputy finance minister Andrei Vavilov, polled only 4% of the vote. When two weeks later Vavilov became the subject of a criminal investigation into bond fiddles at the finance ministry, many felt the timing was more than coincidental.
Second, Nemtsov agreed to back Gazprom’s defence of its domestic stock from foreign investors.
The Gazprom leadership fended off outsiders between 1993 and 1996, when all trades in company stock required written approval from management. The policy left Gazprom so illiquid it did not figure on the Russian stock indices, an omission which led international investors to underestimate the entire market.
Last year, having watched rival Lukoil turn bits of equity into substantial cash infusions, Gazprom relaxed its policy. Some 2% of the company’s stock was floated abroad, mostly through an American Depository Receipt (ADR). But Gazprom priced the ADR at a fat premium to domestic shares -$1.80, as Euromoney went to press, instead of $0.60.
A new raft of bylaws was meant to keep foreign investors from picking up “Russian” shares on the sly, but this ring fence quickly proved breachable. Gazprom became irritated with Regent Securities, a small British house based in Hong Kong, which was grabbing domestic stock through Russian proxies and feeding its mutual funds by reselling abroad. Gazprom persuaded Regent to back down and sell back much of its “illegal” shareholding. But stronger medicine was required to control the market’s future.
In return for Gazprom’s bail-out of the pension fund, the government pitched in to help. A Yeltsin executive order drafted by Nemtsov’s staff raised the bureaucratic barriers around the cheap domestic shares. Whereas previously foreigners could buy through a fully-owned Russian subsidiary, any nominal shareholder now must be majority-owned by Russians. Gazprom yanked its share listing from the Russian Trading System, the over-the-counter network which facilitates most of the country’s securities trading. This happened on July 4, which wags dubbed Gazprom Independence Day.
Henceforth, the company announced, its stock could be traded only at four official exchanges – in Moscow, St Petersburg, Yekaterinburg and Novosibirsk – where in practice virtually no trading takes place. The first day of trading in Moscow yielded 12 deals with a minuscule net volume of $116,000. Much of the trade trickling through involves Gazprom as buyer.
Nevertheless, both Nemtsov’s and Gazprom’s people profess confidence that domestic shares will trade up to the international price, though they set different deadlines. Nadezhdin predicts confluence by 1999, when the Yeltsin edict expires. Meanwhile, he is sure international markets could swallow 7% more of Gazprom at $3 a share. Gazprom’s Rodionov envisages a five- to seven-year time frame.
Both men are adamant that abandoning the two-tier system tomorrow would harm Russia’s national interests. “If you let the foreigners in now,” Nadezhdin explains, “the money will go not to Gazprom but to its Russian shareholders” – a bizarre argument if you believe that executives are paid to make their shareholders richer.
ADRs sold abroad come from the company’s own 10% equity reserve and so address capital needs directly. Also, Nadezhdin admits, the new share restrictions were an implicit payback for Gazprom’s tax money.
Whatever the internal rationale, however, investors are not amused. “These guys may know about drilling gas, but they certainly don’t know anything about stock markets,” says Peter Halloran, head of equities for Credit Suisse First Boston in Moscow.
None of the mainstream Moscow financial houses will provoke the powers that be with a Regent-style run around the new Gazprom rules. But no-one is clamouring for ADRs at $3 either. “I think the ADR is fairly valued now, at between eight and nine times cash flow,” says Halloran.
Yet these intricacies merely amount to the awkward first date in a relationship which promises to be enduring and in some ways fruitful. There is a global preference for natural gas as a basic source of power over coal and nuclear energy. Russia has more gas than any other nation and, despite its problems, will not call Exxon or Enron in to drill it. National pride and know-how run too deep.
In the long term, Gazprom may see internal competition from Russia’s new oil companies. It has already lost one major tender for gas in Irkutsk Oblast, the gateway to east Asia, to Sidanco which is controlled by Unexim Bank – creating one more blight on relations between the two companies. But Gazprom’s hegemony will be chipped away very slowly, if at all. Vyakhirev and Rodionov are, in every sense, men to be dealt with. They will have to sell more shares to bring more of their reserves to market. But as they do (the company is still small), its $16 billion valuation will rise. This is one of the surer bets you can make in modern economics.
Not that Gazprom is waiting passively for history’s rising tide. Vyakhirev is slowly emerging from his apparatchik’s shell. He reportedly gave an impressive performance at the World Gas Conference in Denmark this summer. Soon afterwards, 50 western securities analysts and investors got a VIP tour of Gazprom operations.
Within Gazprom, younger men are filtering into the middle to upper ranks. An important internal reform took place earlier this year as the firm’s chaotic Russia/CIS sales operations were consolidated in a new subsidiary, Mezhregiongaz. Vyakhirev has also endorsed the goal of shedding non-core operations, although even rabid reformers agree this cannot be done immediately.
It is easy to sympathize with Rodionov’s observation: “We may be not fully up to working in the economic conditions of the US. But no American management structure could function normally today in Russia” – at least not while Gazprom is forced to carry $10 billion in bad debt, prevent national fiscal disaster and expected to make a profit into the bargain.
“We cannot run faster than events in the whole country,” Rodionov adds. “And the country cannot jump in a few days from one state of being to the other.”
If and when Russia completes economic transition, it will find its richest possession in capable hands.
