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Company Perspectives:
OAO Gazprom follows a complex strategy, designed with the following goals in mind: an increase in the stable fulfillment of Russia's energy needs, the transformation of the domestic gas market, the reform of the sector to raise its investment potential and attraction, and the widening of our role in foreign markets in the course of their worldwide diversification.
The company's strategy is assumed to include the uninterrupted supply of gas to Russian consumers and the strict fulfillment of all intergovernmental agreements and export contracts. The goal of our strategy is an increase in the market value of the company by means of the perfection of corporate management and the growing efficiency of our commercial activities.
OAO Gazprom is the largest natural gas company in the world and the largest company in Russia. It controls one quarter of the world's known natural gas reserves and accounts for 8 percent of Russia's gross domestic product. The company and its numerous subsidiaries are active in all areas of the gas industry, including exploration, extraction, processing, transportation, and marketing. Gazprom was privatized in 1993, although the state still holds a 38 percent stake in the company and controls a majority of the seats on the board of directors. This fact has contributed to an unusually high degree of political involvement at Gazprom. The company is alleged to have received special treatment from the Kremlin, and, in return, to have used its considerable influence and assets for the government's benefit. Not only does Gazprom have tremendous importance for the economy of the Russian Federation, but foreign dependence on Russian gas, especially in countries of the former Soviet Union, allows Gazprom to be used externally as a diplomatic tool. The company's history is peppered with incidents of apparent cooperation with the Kremlin as well as power struggles when interests clashed. Like most companies in Russia, Gazprom is trying to navigate the economic instability of the country, the insolvency of many of its customers, and the pressure to do business according to Western standards. The company controls 149,000 kilometers of gas pipelines, 22 underground storage facilities, six gas processing plants, 69 producing gas-condensate fields, and 253 compressor stations. Gazprom's holdings also include assets unrelated to the gas industry, from shoe factories to stakes in media companies, some of which the company has received in lieu of cash to settle debts.
Natural Gas in the Soviet Era
Many of the pipelines and facilities controlled by Gazprom were developed in the Soviet era under a succession of state gas ministries. Russia's natural gas reserves were first exploited on a large scale shortly after World War II, when an 843-kilometer (km) pipeline was constructed from Saratov, on the lower Volga River, to Moscow. The success of the Saratov-Moscow project led to more pipeline construction in the 1950s, with the development of a localized network around Leningrad and Moscow as well as pipelines stretching into the Ukraine and Central Asia. Soon the majority of homes in the U.S.S.R.'s largest cities were connected to the natural gas network, decreasing the country's reliance on wood and coal for energy and lessening the burden on the railroad system.
In the late 1960s the gas industry made a major advance by beginning to tap the huge natural gas reserves in western Siberia. Despite the challenges of working in arctic conditions, a pipeline was successfully constructed from the Urengoi gas field to Moscow. By 1983, western Siberia was producing more than half of the U.S.S.R.'s natural gas, and in 2000 Siberian gas fields accounted for more than 70 percent of natural gas production in Russia.
Exports to Western Europe got their start in 1970, when a Soviet export agency signed a contract to supply natural gas to the West German company Ruhrgas. The first Russian gas reached Germany in 1973. The second Western firm to buy Russian gas was Fortum of Finland, which initiated contracts in the 1970s. Exports, especially to Germany, increased through the succeeding decades. In 1982 Soyuzgasexport, the exporting arm of the gas ministry, signed a contract to construct a 5,000 km pipeline from the Urengoi gas field to the West German border. The pipeline was projected to carry 40 billion cubic meters of gas a year to Western Europe.
In the 1980s the development of west Siberian gas fields continued with the opening of the extensive Yamburg reserve. Explorations showed many large untapped gas reserves in the area. As experimental projects relating to crude oil and nuclear power faltered, the U.S.S.R.'s massive natural gas resources took on increased importance. By the time of the breakup of the U.S.S.R. in 1991, it was clear that natural gas would be critical in fulfilling Russia's future energy needs, as well as in supporting the nation's new capitalist economy.
Post-U.S.S.R. Privatization
In 1989 the Ministry of the Gas Industry was transformed into the state gas concern "Gazprom." The name "Gazprom" comes from a contraction of the Russian words for "gas industry." Minister Viktor Chernomyrdin, who had risen from a position as a machinist, became chairman and CEO of the state concern.
After the breakup of the Soviet Union in 1991, government decrees effected the privatization of Gazprom. A November 5, 1992 presidential edict called for the formation of a company to explore and produce gas and to build pipelines. Articles of association for the company were approved by the Council of Ministers on February 17, 1993, and the Russian joint stock company (RAO) Gazprom was formed. A condition of privatization was that the government retain a 40 percent share in the company. Gazprom workers received 15 percent of shares and 28 percent went to people living in Russia's gas-producing regions.
Meanwhile, Chernomyrdin became President Boris Yeltsin's prime minister in 1992 and picked Rem Vyakhirev to succeed him as Gazprom CEO. Chernomyrdin was rumored to have used his political position to grant Gazprom certain tax breaks and unusual privileges during the privatization process. For example, Gazprom retained the right of first refusal, meaning it had the first opportunity to purchase any of its shares that came on the market. In addition, all sales of shares were to be approved by Gazprom management. U.S. News & World Report suggested that Chernomyrdin may have received large amounts of stock in exchange for these concessions, although both Vyakhirev and Chernomyrdin denied the allegation. In any case, the privatization process set a precedent for close ties between the state and the gas industry.
The newly formed RAO Gazprom inherited all the assets of the former gas ministry. Various subsidiary production, transportation, and service amalgamations became Gazprom daughter enterprises. The mammoth company produced 578 billion cubic meters of gas in 1993, more than twice the combined output that year of Royal Dutch/Shell, Exxon, Mobil, Amoco, British Petroleum, Chevron, and Texaco. But because of secrecy surrounding the company's financial situation, financial analysts were unable to pinpoint the value of the company. Gazprom clearly had extensive assets, but its market capitalization was low.
Another blight on Gazprom's financial standing was difficulty receiving payments. Many customers inside Russia and in the former Soviet republics were insolvent, leading to large amounts of outstanding debt. Gazprom, while still a state concern in 1992, had attempted to address this problem by cutting off gas to the Ukraine. The plan backfired, since Russia's major pipeline to Europe ran through the Ukraine, so Ukrainians took for themselves gas that was meant for German customers. Customers inside the Russian Federation, such as electrical utilities, were also unable to pay debts. Gazprom often took in-kind payments in return for gas, accepting anything from vacations and healthcare services for its employees to meat packaging plants and textile factories.
Without hard cash payments, it was difficult to finance new projects. For example, Gazprom had completed a feasibility study for the development of gas fields on the Yamal Peninsula, in western Siberia, in 1988. The company hoped to build a Yamal-Europe pipeline along a northern route, running 4,107 km from Yamal through Belarus and Poland to Germany. The pipeline would bypass the Ukraine and reduce that country's control over exports to Europe. In an attempt to raise funds, the government in 1994 granted Gazprom permission to sell one quarter of state-owned shares, or 9 percent of total shares, to foreign investors. The venture failed, however, because investors found Gazprom to be overvalued under the terms of the offering. Gazprom did make some profitable international connections in 1994. In a partnership with Gaz de France, the French company agreed to assist in the modernization of Russia's natural gas technology and transportation systems. In addition, a contract with Fortum confirmed the supply of Russian gas to Finland for 20 years.
In May 1995 Gazprom held its first shareholders meeting. The board of directors was elected and PricewaterhouseCoopers was chosen to be the firm's auditor. In some respects, Gazprom occupied an enviable position as it developed into a privatized company. The company had an estimated 1.5 trillion cubic feet of gas reserves, a natural monopoly in Russia, and control of much of Europe's export market. Despite these advantages, Gazprom's revenues in 1994 were only $13 billion, compared to $100 billion for the smaller Exxon. Another cause for concern was a deteriorating infrastructure. A November 1995 study, reported in Oil and Gas Journal, cited the need for more than $3 billion to improve inefficient compressor stations, leaking valves, corroding pipes, and inadequate environmental protections. Vigilant development was needed to keep Gazprom on a stable course.
The Late 1990s: Increasing International Partnerships
As Gazprom entered 1996 it still faced the tough problem of financing maintenance and construction while having difficulty collecting payments from customers. About 85 percent of the payments from customers in the Ukraine and Russia were more than 90 days in arrears. Foreign investors and customers abroad once again seemed to be the most promising source of capital. In October Gazprom offered 1.15 percent of its shares for sale as American Depository Receipts (ADRs). The offering was oversubscribed by five times. The company also signed contracts with the Italian firm Eni and with Warsaw to bring Siberian gas to Italy and Poland. The proceeds from these deals helped finance the much desired Yamal-Europe pipeline, the first sections of which were opened in Poland and Germany in November. Some of Gazprom's funds, however, were spent to further political ends—the company generously supported Yeltsin's successful 1996 reelection campaign.
The following year brought conflicts with both the Russian and the U.S. governments. Gazprom owed the Russian government $2.6 billion in back taxes, and the International Monetary Fund had been pressuring Yeltsin to reduce Gazprom's monopoly status as a condition for receiving loans. The two sides reached a compromise in April, when Gazprom agreed to pay a portion of the back taxes, yield its monopoly on gas fields, and divest nonessential operations to independent companies. Separate divisions were created within the company for such activities as production, transportation, and investment, in the hopes that it would encourage competition. In return for those concessions, Gazprom was allowed to continue voting the government's stake in the company.
The conflict with Washington related to a contract between Total S.A. in France, Petronas of Malaysia, and Gazprom to develop parts of the South Pars oil field in the Persian Gulf. Washington claimed that the contract violated U.S. sanctions against European firms that helped Iran develop energy projects. The conflict was resolved when the United States waived the sanctions in May 1998 with the understanding that no companies would assist Iran in developing weapons.
International partnerships in 1997 included the formation of North Transgas Oy, a 50-50 venture with Fortum of Finland to build a northern European pipeline that would take gas to central Europe under the Baltic Sea. After exploratory work, a definite route for the pipeline was chosen by the end of 1999. Gazprom also signed its first formal agreement with Royal Dutch/Shell to jointly develop the Zapolyarnoe field in western Siberia. Finally, in December 1997, the groundwork was laid for the momentous "Blue Stream" project, which would bring gas to Turkey via a pipeline under the Black Sea. An agreement was signed between the Russian and Turkish governments to supply Turkey with $25 billion worth of Russian gas between 2001 and 2005.
Gazprom found its first Norwegian partners in 1998, when in May it signed a protocol to work together with Statoil and Norsk Hydro to look for hydrocarbon deposits in the Pechora Sea. That summer the Russian economy crashed and the ruble collapsed. Despite $16.1 billion in sales, Gazprom lost $7 billion in 1998. Nevertheless, the company's size and its extensive assets helped it survive the crash in much better shape than many other Russian companies. Gas production for the year was 554 billion cubic meters, slightly higher than the previous year. Gazprom also further opened its doors to international investors in 1998, when at the annual shareholders meeting it voted to change its name and status from a Russian joint stock company (RAO) to an open joint stock company (OAO). Ruhrgas AG, a longtime customer in Germany, bought 2.5 percent of Gazprom's shares. The following year Ruhrgas increased its stake to almost 4 percent.
As Gazprom entered 1999 it was still having trouble collecting payments and finding the funds to develop new gas fields and construct new pipelines. The depletion of the mainstay Yamburg and Urengoi fields in western Siberia, as well as the continued disappearance of gas from the Ukraine pipeline, put pressure on the company to pursue new projects. Although Gazprom lost $2.8 billion in 1999, several positive steps were taken in the course of the year. In February loans were secured for the Blue Stream pipeline to Turkey, and the Italian firm Eni became Gazprom's partner in the project. The pipeline was planned to extend 373 km over land from Izobilnoye to a Russian port on the Black Sea, then continue for 396 km under the Black Sea.
In September the Polish and Belorussian sections of the crucial Yamal-Europe pipeline were inaugurated. By bypassing the Ukraine and giving Gazprom an alternate route to the German pipeline grid, the project was expected to make gas deliveries to Western Europe more flexible and easier to direct. In 2000, 14 billion cubic meters of gas were exported along the route, bringing valuable hard currency into Russia's economy.
New Management for the 21st Century
The transition into the new millennium at Gazprom was marked by political involvement, struggles with the government, and allegations of mismanagement. In 1999 the Kremlin made a move to increase its control over Gazprom. At the annual shareholders' meeting in June, former Prime Minister Chernomyrdin was chosen to resume his post as chairman of the board, replacing Vyakhirev, who would remain CEO. Chernomyrdin then demanded that the board of directors be reelected, since the state, despite holding a 38 percent stake in Gazprom, was represented by only four out of 11 directors. A new election, which followed in August, gave the government five seats.
More scandals and political involvement clouded Gazprom's business dealings in 2000. Articles in Business Week and the Economist reported that minority shareholders were concerned that their investments were being depleted by mismanagement and asset stripping. Many of the allegations centered around dealings with Itera, a Florida-based company that acted as a broker for gas export sales. Leaders at Gazprom were suspected of holding large shares in Itera and therefore giving the firm sweetheart deals. In one case, Gazprom paid taxes to a Siberian regional administration in the form of gas valued at a low price. The local administration sold the gas to Itera at the same low price. Itera then made $1.8 billion by selling the gas abroad for up to 30 times the original price. President Yeltsin initiated investigations into these activities, but Itera denied that it was receiving any free assets from Gazprom. Minority shareholders were also concerned that investment at Gazprom was poorly planned, that upper management was transferring assets to relatives, and that money was spent on unnecessary luxury items. At a recent board meeting, for example, management agreed to buy a yacht club in the port of Astrakhan.
In January 2000 Yeltsin abdicated his post to Vladimir Putin, who was then reelected in March. Many of Putin's actions appeared targeted at reducing the power of Yeltsin-era business oligarchies. In May 2000 Gazprom Chairman Chernomyrdin was replaced by Dmitri Medvedev, an official with fairly close ties to the new government. A more radical change followed in the summer of 2001. At the June shareholders meeting, longtime CEO Vyakhirev was replaced with the relatively unknown Alexei Miller. Miller had worked loyally with Putin in the St. Petersburg administration and also served two years as deputy energy minister. He promised to raise the market capitalization of Gazprom and guarantee the full disclosure of investments.
Vyakhirev retained some influence at Gazprom, as he was elected chairman of the board. However, stockholders apparently believed that reform had a much better chance now that the state had more control through Miller. Gazprom's shares rose 10 percent on the London Stock Exchange following news of the switch in leadership.
Also under Putin, Gazprom was mixed up in the struggle between the government and NTV, the only independent television network in Russia. NTV was known for its open criticism of Putin and candid reporting of such events as the war in Chechnya and the Kursk submarine accident. Gazprom owned a 46 percent stake in NTV's parent company, Media Most, and was suspected of acting as an agent of the Kremlin when, in the summer of 2000, it demanded that the media company sell shares to settle millions of dollars in debt to Gazprom. There was some talk of foreign investors helping settle Media Most's debt, but no deals were realized. In April 2001 Gazprom seized control of NTV in a boardroom coup, tossing out the station director. NTV journalists launched a strike, fearing that the era of independent reporting was over. At the July 2001 annual meeting of NTV, Gazprom representatives made no appearance. A decision was still pending on the ownership of a frozen 19 percent share in Media Most, which Gazprom claimed was collateral on a loan to NTV.
Against the backdrop of these shake-ups and scandals, Gazprom projects advanced. The first junction of the Blue Stream pipeline was welded in February 2000. Then CEO Vyakhirev announced that two more parallel pipelines would be built starting in 2003 to increase export capacity to Turkey. The Blue Stream project thwarted U.S. companies, who had hoped to bypass Russia with a pipeline from Turkmenistan to Turkey.
In other international partnerships, Gazprom signed a memorandum in June to work together with Wintershall AG of Germany on the Prirazlomnyi deposit in the Barents Sea. Wintershall had worked with Gazprom on projects in Germany since 1990. In September Wintershall and Gazprom joined in a consortium with Ruhrgas, Gaz de France, and the Italian gas transportation firm Snam to build a pipeline across Poland to Slovakia. In the spring of 2001 work began on the Zapolyarnoe deposit near Yamal, a joint venture with Royal Dutch/Shell. The field was expected to be producing by September 2001. Finally, in August Gazprom and Royal Dutch/Shell agreed to pool their resources to try to win a contract to build a pipeline linking the western Xinjiang region in China to Shanghai on the east coast. Despite concerns over management style at Gazprom, foreign investors could not ignore the tremendous potential of Russia's natural gas reserves. Gazprom forged ahead with the projects necessary to ensure its continued place as a leader in the world gas industry.
Principal Subsidiaries: OOO Astrakhangazprom; OOO Ecological and Analytical Center of the Gas Industry; OOO Gazexport; OOO Gazflot; OOO Gazbezopasnost; OOO Gazprominvestholding; OOO Gazpromokhrana; OOO Gazpromrazvitiye; OOO Informgaz; OOO Mezhregiongaz; OOO Mostransgaz; OOO Nadymgazprom; OOO Novourengoi GCC; OOO Orenburggazprom; OOO Podzemgazprom; OOO Severgazprom; OOO Uraltransgaz; OOO Urengoygazprom; OOO Yamburggazdobycha.
Principal Competitors: BP Amoco p.l.c.; Sidanco Oil; Gasunie; Statoil Energy; OAO LUKOIL; Tatneft; Sibneft; Yukos.
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