Russia’s Energy Giant Implodes

By via

It was not too long ago that Gazprom, the state-controlled energy conglomerate, was one of the Kremlin’s most potent geopolitical weapons. But those days now seem like a distant memory: Gazprom is a financial shadow of its former self.

The speed of Gazprom’s decline is breathtaking. At its peak in May 2008, the company’s market capitalization reached $367.27 billion, making it one of world’s most valuable companies, according to a survey compiled by the Financial Times. Gazprom’s deputy chair, Alexander Medvedev, repeatedly predicted at the time that within a decade the Russian energy giant could be worth $1 trillion.

That prediction now seem foolhardy. Since 2008, Gazprom’s value has plummeted. As of August 3, it had a market capitalization of $51.12 billion. A little over four years ago, in April 2011, the figure stood at $194.5 billion. No company among the planet’s Top 5,000 has suffered a bigger collapse in market capitalization, according to Bloomberg Business News.

Indicators suggest Gazprom is nowhere near hitting bottom, and lingering uncertainty raises questions about its survivability. During the first two quarters of 2015, Gazprom’s natural gas production fell by 12.9%. In addition, Russia’s Ministry of Economic Development predicts that annual production will fall to 414 billion cubic meters (bcm), the lowest level in Gazprom’s history, and well below the company’s 2015 target of 485 bcm. Last year, production declined by 9% to 444 bcm, which, at the time, was the lowest on record. Industry experts forecast that production will remain low over the next few years.

Not only production is sagging, export revenues are also taking a big hit. During the first five months of 2015, export revenue shrank by 35.8% to $18.768 billion, according to Russia’s Federal Customs Service. Last year, the company’s net income plummeted by over seven times in ruble terms to 159 billion rubles from 1.139 trillion rubles in 2013, and by whopping 12.5 times in dollar terms to $2.8 billion from $34.8 billion in 2013.

So what happened? Why is the company with the largest proved oil and gas reserves among publicly traded energy giants, and operating in a country bordering on two of the world’s top energy consumers – the European Union and China – performing so badly?

The Kremlin, which holds a controlling stake in Gazprom, tends to blame the sharp drop in oil prices and “warm winters.” However, energy giants ExxonMobil and Petro China, Gazprom’s financial contemporaries back in mid-2008, have remained top performers. As for falling demand in “warm winters,” while Russian supplies to Western Europe shrank, Norway boosted its market share and, for the first time, significantly beat Russia – by more than 50% – in terms of supplies to this critical region in the last quarter of 2014 and first quarter of 2015, according to the latest data available.

Experts say that Gazprom’s main problem is that it continues to serve as the Kremlin’s favored geopolitical weapon, rather than be allowed to act as a purely commercial enterprise. President Vladimir Putin’s administration keeps forcing the company to serve its political interests. Examples include Gazprom’s purchase of major Russian media outlets that were then turned into Kremlin mouthpieces, bullying or buying the loyalty of neighboring states for Moscow’s geopolitical benefit, and sponsoring the egregiously expensive Olympic Games in Sochi.

Gazprom’s “plunge has become emblematic of the malaise that has overtaken President Vladimir Putin’s economy,” noted a commentary published by Bloomberg Business in 2014. Russia will finish 2015 as the second biggest loser in global economic growth, according to forecasts of economists surveyed by Bloomberg.

Most ominously for the company, the Putin administration still keeps pushing Gazprom to implement new projects that are “geopolitically important,” but risky from a financial viewpoint. Two prominent examples of such projects concern Ukraine and China.

The Kremlin’s sponsorship of separatists in eastern Ukraine has cost Gazprom dearly. Gazprom’s exports to Ukraine fell from 36.4 bcm in 2010 to 3.7 bcm during the first six months of 2015, before stopping altogether on July 1. Moscow’s efforts to effectively mount an energy blockade against Ukraine in 2014-2015 did not work, but ended up costing Gazprom close to $6 billion in lost revenue and fines, while pushing European customers to diversity their energy imports.

Moscow still wants to stop transit supplies of gas via Ukraine to Europe (or at least cut them from 60-62 bcm in 2014 to 10-30 bcm) by 2019. The alternative for Russia is to channel gas via Turkey and two new lines via the North Stream network. Analysts are not thrilled with these plans, seeing them as more about politics than economics.

The estimated construction costs for two new lines of North Stream stand at €9.9 billion ($10.9 billion), while the first of the total of four Turkish Stream lines could cost €3.3 billion ($3,6 billion). Thus, the total costs of the projects, without taking into account the likelihood of cost overruns, will reach about €23.1 billion ($25.4 billion).

Beyond the construction expenses, transit costs for North Stream appear to be significantly more expensive than shipping energy via Ukraine. Experts estimate that in 2014 Gazprom’s transit costs per bcm via North Stream amounted to $43 compared to $33 via a Ukrainian route.

When it comes to Gazprom’s commitments to Chinese exports, the news for the company may not be much better. Initially, when the $400-billion, 30-year deal was announced in May 2014, it was widely seen as a major geopolitical victory for Putin and Russia. But details of the agreement remain a secret, suggesting that there is little good news for Gazprom in it. The limited information that has emerged supports this assumption.

The project is expensive, with cost estimates ranging from $55 billion, as mentioned by the Kremlin, to $100 billion or more cited by Gazprom’s specialists. In addition, Gazprom is reportedly obligated to cover the costs of building infrastructure to extract, process, store and deliver gas to China on its own. China was initially supposed to help out with a $25-billion payment, but it never happened. Meanwhile, Gazprom moved ahead with the project on borrowed money, increasing the price tag and risk. Adding to the risk is the fact that the project poses significant technological challenges, including difficult terrain along the planned route.

While it was initially announced that the deal could be worth upwards of $400 billion for Gazprom, Russian officials now estimate the deal could reap significantly less due to low oil prices. A benchmark barrel of oil cost roughly $100 at the time the deal was announced; these days the oil price is hovering in the $50-per-barrel range.

Analysts at Merrill Lynch estimate that Gazprom needs to sell gas to China at a price of $340-380 bcm to turn a small profit. Currently, however, Gazprom is receiving about $200 per bcm for its gas exports. For the third quarter, for example, Gazprom is charging Moldova a price of $210 per bcm. With revenue potentially falling to about $200 billion, and construction costs of $100 billion or more, the China deal could potentially turn toxic for Gazprom.

Overall, the price tag of the new geopolitically driven pipelines could exceed $125 billion, or about 2.5 times Gazprom’s current market capitalization. Given the company’s financial situation, Gazprom executives have a lot to worry about in the immediate future. By via

So in the US, the oil & gas sector isn’t exactly in a rosy environment either, with a number of companies in a “liquidity death spiral.” Read… Oil Re-Bloodies the “Smart Money”

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  13 comments for “Russia’s Energy Giant Implodes

  1. Stavros H says:

    The article gets things the wrong way round. The reason why the Kremlin uses Gazprom as a geopolitical tool is because it has no other choice. The west has no interest in treating Russia as just another trading partner on a free-market basis, but has to treat Russia as a geopolitical enemy (which is exactly what they have been doing forever, and especially now) due to the fact that Russia has the strategic depth, the natural resources and the military know-how to emerge as a mighty geopolitical force bestriding Eurasia. The reason EU countries are buying as much gas from Norway as they can, and as little from Russia as they possibly can, is strategic, has absolutely nothing to do with efficiency. Experts believe that Norway’s gas output will plummet by at least 40% within the next 10 years, this will play directly into the hands of Gazprom (possibly the Iranians as well)

    As for the current low energy prices (which are genuinely hurting Russia) we all know that they cannot last for too long (at the maximum for another couple of years) since the marginal cost of producing oil (or gas) is much higher then the current price environment.

    The Russians are playing the long game, and will be rewarded unless renewable energy keeps growing by leaps and bounds for years without end (hugely unlikely)

    In any case, resisting pressure and blackmail is better than surrendering your natural wealth to western predators.

    • Wolf Richter says:

      The Gazprom problems go back years and predate the sanctions by years. I first wrote about it in 2012 when it had to lower its guidance due to sharp sales declines with Europe. Its stock was already dropping at the time. The author of this article didn’t get “things the wrong way around.” Gazprom has been bled and ruined by Russian politics for years. What the article didn’t get into is how domestic politics and policies have been bleeding Gazprom dry in Russia as well.

      The lesson is this: if you’re a shareholder in a company that is controlled by the Russian government (majority stockholder), be ready to have your pockets emptied out.

      • MC says:

        One thing that always struck me about Gazprom is how “differently” it’s run from the rest of Russian State-owned enterprises.
        Rosfnet and Rostec have long been considered traditional cash cows: in short they have to make money the old fashioned way so that the Russian government can get hard currency. Sure, they have many Russian peculiarities but it’s evident to everybody they are there to fill the Kremlin’s coffers.
        Gazprom… is something on a different level. I had dealings with Gazprom people in the past and even by Russian standards they struck me as really odd.
        For starters their ranks are filled by retired career military, something you may expect in a defense contractor such as IzhMASH but which is very odd in a supposed energy conglomerate.
        Second, they seem to care nothing for money. We have all heard stories of Russian oligarchs and member of Putin’s faction spending with complete abandon, but they usually do this for themselves to buy cars, personal jets, villas etc. Gazprom instead throws money around on company projects with complete abandon. But they are not above cutting contracts short and without explanation, even if this means paying hefty penalties. I remember being told plainly that they weren’t interested in overpaying when buying abroad as long as they got exactly what they wanted… what kind of company does that?
        Third, while all large Russian companies have their own security services, Gazprom looks more like an extension of the Russian State. Their executives abroad cut a completely different picture from your run of the mill oligarch, with his armored cars and personal guards. Their security “details” (which can number dozens of men) are far too professional and discrete to be hired muscle.
        I’ve also heard rumors Gazprom security forces in Russia number in the thousands, and they have access to military grade gear, such as armored personnel carriers, attack helicopters and anti-tank weaponry. Sounds just like the kind of personal army you may need during an internal power struggle…

        While I usually have no problem dealing with Russian companies (some of which are among the most honorable and reliable I’ve dealt with), my brief dealings with Gazprom could not end soon enough. It was one of the few times I was thankful no deal was reached.

        • Jerry Bear says:

          I would be reluctant to share food or drink with them. Only the nuclear technology of a major power has the scientific moxie to produce usable amounts of polonium210, the deadliest poison science can produce. One micro gram will do you in. Its use is about as discrete as assassinating somebody with a flame thrower. I have no doubt Gazprom is full of Putin’s cronies and I wouldn’t put something like this past them.

      • Jerry Bear says:

        the Russian people have traditionally regarded government the same way they regard plagues and forest fires and blizzards and earthquakes etc. They think of it as one of those inevitable calamities you can’t avoid and can only endure. I read a description of a speech that Gorbachev, after his retirement, gave to some provincials. He was touring all over Russia making his case for democracy directly to the people. Before he could open his mouth, a former Soviet Air Force Colonel suddenly stood up and shook a fist at him shouting, “You traitor! You bastard! You destroyed the Motherland! How dare you think you can just stand there and lecture us!” This was met with mutters of approval from all over the room. Gorbachev did not react but patiently explained that Russians were used to having a dictator to rule over them and tell them what to do. But in a democracy, the people had to decide what to do for themselves and they had to have the wisdom and discipline to choose a good government and this was something the Russians were just not used too. His audience was none too happy to hear this but they could not disagree with him.
        This is Russia’s basic problem. They have to stop electing corrupt quasi dictators like Putin and start electing honest and competent officials. Oh well don’t hold your breath!
        Americans need to take note also. Refusing to vote at all or voting for corrupt and incompetent demagogues will bring this nation crashing down into ruin, and probably in less time then it took to burn down Rome.

      • popov says:

        Exactly correct; the Kremlin has been “at it” since 1917 at the least, and things are not getting better in RU. Costs keep going up, wages are stagnent except for the upper crust, and pensioners have to pay more out of their meagre monthly incomes. And, the food produced in RU is not so good as before. The oligarchs and corporate swine make sure the good elements are removed and replace by “junk”. To wit: five years ago, American beer was quite good, then additives were put in to create…wait for it…poison such as formaldyhide, which is cheaper per bottle/can at the wholesale level. Good for the oligarchs eh? Lastly, I was there for a number of years, and noticed the degredation first-hand. And, when leaving for the last time at an airport, I was stopped and asked how much money I had. The officials/customs were more interested in euros than in dollars or roubles. Hard currency is what they wanted, just like in Soviet times.

    • Warwick Robertson says:

      The big concern for energy producers like Russia and Australia is Thorium.
      In 30 years, the Chinese will build hundreds of these new nuclear fission designs ( 50 times more efficient than Uranium solid fuel) and become completely self sufficient in energy including liquid hydrocarbons. The world will forget about oil,coal and gas as the end of the fossil fuel era. Russia will need to radically balance its economy away from oil/gas and develop more balanced sectors.

      • Jerry Bear says:

        There is a new nuclear technology (fast neutron, helium cooled reactor) that can utilize any fuel as long as it somewhat enriched. It burns the nuclear fuel completely, making it nearly 100 times as efficient as a standard nuclear technology. It does not leave long term nuclear pollution. The radioisotopes of cesium and strontium it primarily produces are easily handled, industrially useful and gone in a couple of centuries. This technology would gradually use up all the bomb grade material in nuclear weapons and by combining uranium and thorium based technologies could meet all our major energy needs for the next 2000 years. It is inherently a much simpler, safer and more reliable technology and can be run effectively at a smaller scale. You could have an installation in a small city attached to a power plant that would pretty much run itself while running the power plant. You would just need to switch out the sealed ceramic module every twenty years to be replaced by a new one.
        Our current technology is extremely inefficient, unreliable. extraordinarily dirty and inescapably dangerous. It was not designed to generate power originally, It was designed to create fissionable material to make atom bombs.
        I think you can imagine just how dire a threat a technology like this is to the fossil fuel industries. I don’t expect to see it happen here, but I find it interesting that the Chinese appear to making tentative steps in the right direction.

  2. James says:

    @ Wolf
    Your comments re Gazprom could equally apply to any large Stock on the criminally manipulated USA market. Try this for size:

    “if you’re a shareholder in a company that is controlled by the USA government, be ready to have your pockets emptied out.

    • Jerry Bear says:

      Wasn’t it Plato who said the punishment suffered by good men who refuse to take part in public life is to be governed by bad men?

  3. unit472 says:

    Good article and it doesn’t even have to get into the impact US LNG exports to Europe set to begin later this year from Cheniere’s Sabine Pass terminal or the even better situated Cove Point, Md terminal Dominion Resources will have operating in 2017. How Gazprom can profitably develop arctic gas fields, send it by LNG ( tankers can only operate in the summer) or immensely long pipe lines into central Europe and do it profitably with US gas selling at for less than $3/per million BTUs is doubtful. BP and Conoco have never found a way to get gas from the North Slope to North American markets profitably and the distances are less.

    Over in Japan the projected exploitation of methane hydrates from the ocean floor could be a game changer too if that comes to pass.

    • Jerry Bear says:

      Wasn’t it Plato who said the punishment suffered by good men who refuse to take part in public life is to be governed by bad men?

  4. Julian the Apostate says:

    It’s fascinating to hear first hand about things like this. I’d sure never get it in a truckstop. The insights here at Wolf Street make it a killer app.

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