| The official headquarters of Eural Transgas, a gas-trading company that handles Russian energy company Gazprom’s gas-transit business between Turkmenistan and Ukraine. |
IT IS A slightly run-down but otherwise unremarkable residential block in the middle-class part of Cluj-Napoca, the capital of the Transylvania region of Romania. From the outside there is not much to distinguish the three apartments in the building from their neighbours.
But they are the official headquarters of Eural Transgas, a gas-trading company that handles Russian energy company Gazprom’s gas-transit business between Turkmenistan and Ukraine. The neighbours might be interested to learn that the firm behind those anonymous doors earned up to a billion dollars in fees last year.
On the day Euromoney drops by, no-one answers the doorbell. But it’s known that the company is an active player in the high-level wheeling and dealing of eastern Europe’s energy business. In June, British company JKX Oil & Gas announced plans to buy a stake in Eural Transgas to enable it to export gas produced by Ukrainian company Poltava, which is partly owned by JKX, beating out Gazprom, which also expressed an interest in buying the stake.
Eural was founded in December 2002 with a mere $12,000. On its first day of operations Gazprom’s deputy chairman, Alexander Ryazanov, signed off on a contract giving Eural Transgas the right to supply Ukraine with Turkmen gas using Gazprom’s pipeline network.
According to the contract, Eural Transgas pays Gazprom $470 million a year to use the pipelines to deliver 36 billion cubic metres of gas to Ukraine and receives 13.7 billion cubic metres as a fee. Eural Transgas’s share of this trade is worth up to $600 million at CIS rates, or $1.5 billion at western European prices. Put another way, the company earns something between $130 million and $1 billion in fees for doing nothing that Gazprom couldn’t do itself.
When the deal was first reported in February this year investors in Gazprom feared a repeat of the experiences with Itera. That company had the same lucrative gas-transit contract between 1999 and 2002 and grew from nothing to become the world’s second-largest gas trader. It has never revealed the identity of all its shareholders, but it is widely assumed that they include many former Gazprom executives.
With the ousting of Rem Vyakhirev, the former Gazprom CEO, in May 2001 the company’s minority shareholders had hoped that an era of transparency and modern corporate governance would begin under the new management, led by Russian president Vladimir Putin’s St Petersburg friend Alexei Miller. However, two years on, minority investors have become increasingly frustrated with Miller.
“Miller is trying to make things as complicated as possible so as to make a possible restructuring difficult,” says Mattias Westman, director of Prosperity Capital, a Russia-based investment fund. “He may have come in with reformist credentials, but he has gone native.”
Gazprom has said little about why Eural Transgas won this lucrative contract, only admitting that it is acting as a middleman. Under the new deal Ukraine’s state-owned natural gas company gets slightly better terms than it did from Itera, but this is offset by a slight increase in volumes sold. The result is that there is no perceptible difference to Gazprom’s profits.
“If Eural Transgas was supposed to replace Itera, then it is hard to believe a newly formed company with only $12,000 in charter capital is going to be any better than the situation under Itera,” says Bill Browder, chairman of Hermitage Capital Management, one of Russia’s biggest funds.
A Gazprom spokesperson tells Euromoney that the company was set up as an incentive for the Ukrainian government to push out Itera as its traditional supplier. He says that Gazprom had reached an agreement with Kiev for the company to be re-registered as a 50-50 owned company between Gazprom and Naftogaz Ukrainy, Ukraine’s national gas company.
“Gazprom’s management are probably not taking money any more, but the Ukrainians are,” says one shareholder. “Eural Transgas was set up to cut Itera out of the loop. But a mechanism was still needed to create the funds that smooth the Ukrainian side of the business, which controls access to the pipelines into the western European markets. Gazprom does not really have a choice in this case.”
More funds leaks Eural Transgas is not the only hole in the dyke leaking funds. The construction of the Blue Stream gas pipeline under the Black Sea from Russia to Turkey has also raised eyebrows. One of three pipelines connecting Russian gas fields to the western European markets via Turkey, Blue Stream went on line at the start of this year.
Gazprom hired construction firm Stroitransgaz to build the Russian land sections of the pipeline, while the Turks built their land section. The section under the Black Sea was built as a joint venture.
The Russians spent more than $1 billion to build their land connections, across a flat open desert, which worked out at $3 million a kilometre. The Turks’ section was 70km longer and ran through difficult mountainous terrain. It cost $400 million ($1.35 million a kilometre). Stroitransgaz hired several subcontractors to carry out the work and the two main companies turn out to be Gazprom subsidiaries.
“Why was Gazprom farming out the work and running up big fees, only to have the work done by its own subsidiaries?” asks Browder. “If the Russians had hired the Turkish companies that built their section, Gazprom could have saved $600 million.”
Browder has a catalogue of other complaints and clearly all is not well with the gas giant, but while Gazprom’s day-to-day operations are still leaking funds as ever, the Kremlin is slowly attempting to change its strategy towards the company.
The Russian government has always struggled to control Gazprom, which is known as a state within a state, a parody of the KGB’s old nickname.
One problem for the government is the contradictory goals it has set for the company. Economic development and trade minister German Gref has the job of getting the economy back on its feet and Gazprom’s energy underpins just about every Russian business. That argues for free-market reform of Gazprom. At the same time, since so many neighbours also rely on its gas, it is a powerful foreign policy tool the Kremlin has often used to bludgeon reluctant former vassals.
Gazprom’s managers play on the contradiction to ensure their autonomy. And at the start of the year they appeared to bring Putin on board. “The state does not support any plans to split or break up Gazprom,” Putin said for the first time during the company’s 10th birthday party. “Gazprom, as a strategically important company, should be kept, and has been kept, as a single organism. Gazprom is a powerful political and economic lever of influence over the rest of the world.”
Gazprom controls a quarter of the world’s proven gas reserves and produces about a quarter of current production from three fields that came on stream decades ago. Gas production stabilized only in 2002 at 521 billion cubic metres, compared with 513 billion cubic metres in 2001. Most of its gas is consumed domestically, with 130 billion cubic metres going to western Europe. However, European demand is expected to rise by another 100 billion cubic metres by the end of the decade.
One of the mainstays of Putin’s economic recovery programme is to integrate Russia’s energy production with its customers. So far this has meant building two new pipelines to supplement the Ukrainian pipeline running to central Europe. The Blue Stream pipeline has already been completed and a third pipeline running through Poland into northern Europe is under way.
But at the start of this year the Kremlin set off a new project that will open up the global market for Russian gas. Plans for two liquefied natural gas plants – one on the west coast and another on the eastern seaboard – were launched and work on the eastern plant has already begun. LNG can be carried by ship, removing the need for yet more expensive pipelines.
Miller says that he wants to sell directly to the US, the world’s number two gas producer, whose reserves are running out. In June Miller said LNG was becoming “one of the major directions” for Gazprom.
“Russia has been locked into its client base for some time, while in the US they have started to talk about strategic shortages of gas and higher prices,” says Westman. “But these gas liquefying plants are very expensive to build and it is not clear if they will be economically viable.”
Gazprom says producing LNG is more economical than building pipelines from the Arctic to Europe, with the bonus of opening up the US market to Russian gas.
LNG may help speed up reforms of the industry. In July the Kremlin took a rare step towards gas market liberalization by approving its LNG reform blueprint, slated to come into effect in 2006, the same time as the electricity reforms finish.
The plan is for independent gas producers to be given limited access to Gazprom’s pipelines from next year. Starting in 2005 LNG can be traded at prices set by the market and restrictions on exports will be dropped. The domestic retail market for LNG will be freed in 2006.
In March, Gazprom agreed with US company ConocoPhillips a joint plan to build a $10 billion gas liquefaction plant in Murmansk that will serve Gazprom’s 3.2 trillion cubic metre Shtokman field in the Barents Sea. The western LNG plant is still on the drawing board, while the Pacific route is much closer to being realized.
In June, the Sakhalin Energy oil and gas consortium, led by Anglo-Dutch oil company Royal Dutch/Shell, announced it had raised the $10 billion of financing to build an LNG plant on the Russian far eastern island of Sakhalin. It has awarded the first $2 billion-worth of contracts to Japanese and Russian companies.
Gazprom last year expressed an interest in participating in this project. It is now negotiating to join in the work that has already begun at Prigorodnoye, a largely ice-free bay in the south of the island.
Sakhalin Energy’s chief executive Steve McVeigh, after the announcement that the project financing had been secured, said: “This is what the project is really about – to anchor LNG sales and then build this first LNG plant in Russia, which to me is historic. Not only the fact that it’s the first LNG plant, first offshore project in Russia, but that it’s also the first gas supply ever to be generated from Russia to the whole Asia-Pacific region.”
The plant will produce 9.6 million tonnes of liquefied gas annually. Half will be shipped to Japan when the plant comes on line in 2007. In May, Sakhalin Energy followed up with a second deal to supply Tokyo Electric Power Company with 1.2 million tonnes of LNG for the next 22 years. Russia’s gas will meet about 15% of Japan’s demand, while the rest will go to South Korea, China and Taiwan.
If the two LNG plants can be built at a reasonable price they could make good business sense, but this rationale could still be upset by Gazprom’s political role as pipeline politics continue unabated.
Thanks to Eural Transgas, Gazprom’s deliveries to western Europe via Ukraine seem to be running smoothly enough, but Blue Stream deliveries to Turkey hit problems almost as soon as gas started flowing.
Turkey, Gazprom’s third-biggest customer, overestimated domestic demand and turned away Russian gas deliveries earlier this year. The brand-new pipeline has been idle since April as Ankara pushed for lower prices. Gazprom threatened to take the case to arbitration.
After much behind the scenes arm-twisting, Turkish energy minister Hilmi Guler announced at the end of July that deliveries would resume in August. “We have a notification from Turkey that they’ll restart gas purchases in line with existing contracts,” a Gazprom statement said.
There are similar problems with the Yamal pipeline that will carry Russian gas via Poland to northern Europe. The Poles are concerned that they are committing themselves to too much gas and are complaining about Gazprom’s restrictions on reselling to third-party countries.
To add to the confusion Miller is still pushing for a 3,000km pipeline under the Baltic Sea direct to the German coast and he has attempted to raise the $5.7 billion financing several times without success.
Gazprom has also been extending itself to bring the energy-rich central Asian countries under its sway. It continues to sign supply contracts with the central Asian republics, buying gas at around $45 per thousand cubic metres, when the price on the domestic market is closer to $23, with the justification that the company makes profits from exports to the west, where the price is over $100.
And the pipeline politics is even rougher here than that to the west. Russia has been aggressively protecting its patch. In June, Miller threatened to cut the republic of Georgia off on the pretext of unpaid bills, unless Georgia diverted gas transits into Gazprom’s new Blue Stream pipeline.
This effectively kills the Americans’ own plan to build an independent gas corridor that bypasses Russia through the region. The US is backing a new line from the massive Shah Deniz gas field in Azerbaijan across Georgia and into Turkey.
Likewise the plan first proposed in the 1990s by US company Unocal to build a pipeline from Turkmenistan through Afghanistan and on to Pakistan and India has been dusted off. This would again bypass the monopoly out of central Asia that Gazprom still enjoys.
Countering tactic The Asian Development Bank has started a feasibility study for this pipeline, but Gazprom is already countering this move. In 1997 it took on the second and third stages of developing the South Pars field in Iran’s Persian Gulf – one of the biggest in the world with reserves of over 12 trillion cubic metres. Under orders from Gazprom, Stroitransgaz has already begun to build a pipeline that would run from Iran to India. If it is completed on time, the more difficult to build Afghan pipeline will be hit.
The gas-supply deals with central Asia seem doubly perverse when all of Russia’s oil companies are keen to start selling the gas that they now flare off. All the major companies have invested in production and over the first half of this year production shot up, albeit from next to nothing.
However, without access to Gazprom’s pipeline system, there is little they can do with their production apart from selling it to a few local factories.
The management of Gazprom has repelled all efforts to liberalize the gas market. Even the modest goal of splitting the production and transport functions into two wholly owned subsidiaries inside the company proposed by economic development and trade minister German Gref last year was met with resistance.
Gref told Russian daily Vedemosti that the first changes at Gazprom will take place after the presidential elections next March. The EDT is to submit a long-overdue restructuring plan in September.
“There will be no changes at Gazprom until they have a clear idea of what they want to do and given the difficulties over the electricity reforms they are taking their time,” says Westman. “No one wants to do anything before these elections have passed, but if they don’t want to be making reforms in the middle of the next elections then reforms will have to start very soon.”
Natural gas output (bcm)
Source: Reuters
