Decline and Fall: Gazprom “out of gaz” Reviewed by Momizat on . [caption id="attachment_5450" align="alignnone" width="615"] In addition to the current recession and its mounting operational risks, such as falling production [caption id="attachment_5450" align="alignnone" width="615"] In addition to the current recession and its mounting operational risks, such as falling production Rating: 0

Decline and Fall: Gazprom “out of gaz”

In addition to the current recession and its mounting operational risks, such as falling production, falling gas prices, increased competition in both the EU and even in Russia, fraud committed on an epic scale, political interference and responsibility for an array of unproductive social assets such as media entities, Gazprom faces an abundance of substantive legal and regulatory issues.

In addition to the current recession and its mounting operational risks, such as falling production, falling gas prices, increased competition in both the EU and even in Russia, fraud committed on an epic scale, political interference and responsibility for an array of unproductive social assets such as media entities, Gazprom faces an abundance of substantive legal and regulatory issues.

By Chris Weston, CEE Consulting Group

It may seem like yesterday but it was only in 2008 when Gazprom`s CEO would boast that the company would soon be worth one trillion US dollars.

As of August 7, 2015, its market capitalisation was just over USD 50 bln whereas at its peak, in 2008, it stood at USD 369 bln. Such a fall in share value would typically be associated with internet or high tech companies following the “bursting of the bubble,” rather than a natural resource monopoly which still accounts for 30 percent of the EU`s gas needs.

And yet, it still remains to be seen whether Gazprom may not have further to fall. Gazprom`s 2014 Financial Report is titled “The Power of Growth” which sits oddly with the reality, namely a fall in net profits in the year of 86 percent to USD 3 bln.

In addition to the current recession and its mounting operational risks, such as falling production, falling gas prices, increased competition in both the EU and even in Russia (where its market share has fallen to 80 percent from its near total dominance in the 1990s), fraud committed on an epic scale (graft is estimated to cost the company USD 40 bln per annum), political interference and responsibility for an array of unproductive social assets such as media entities, Gazprom faces an abundance of substantive legal and regulatory issues.

First of all is the situation in Ukraine – both an important customer in its own right as well as, notwithstanding Gazprom`s resort to Nordstream, an important transit route for the West accounting for around 50 percent of the gas supplied to the EU.

Naftogaz, its Ukrainian customer, has initiated claims in an arbitration tribunal of USD 6.3 bln for overcharges since 2011, while Gazprom is asking for USD 4.5 bln for gas delivered and unpaid by Ukraine in 2013–14.

On December 11, 2014 the arbitration panel in Stockholm was formed but the hearing is expected late September 2016. Any decision of the arbitration panel is only expected by the end of January 2017.

Interestingly, while Ukraine has been a “cause” of Gazprom`s (largely self-induced) problems, it ironically may actually serve to assist Gazprom (and indeed the Russian government) through its hard times.

This is because buried in the lengthy IMF Report on Ukraine from September 2014 and the expected substantial financial assistance to be provided, subject to conditions (in IMF parlance, conditionalities), is the fact that a significant chunk of the IMF finance will go, not to effect Ukrainian modernisation, restructuring or enhancing the nation`s “safety net” for its poor and disadvantaged, but to repay Gazprom for past amounts owed.

To this end, USD 3.1 bln was placed by the IMF in a restricted account with Ukraine`s central bank for the purpose of settling gas bills with Gazprom upon a decision by the arbitrator in the dispute with Gazprom or if an out of court settlement between Naftogaz and Gazprom is reached.

There is a further outstanding legal risk in progress which also involves a significant amount of money.

Disclosed in Gazprom`s 2014 financial statements (p132 to be exact) is the following innocuous note: “In August 2012 the European Commission initiated an investigation into a potential breach of European Union antimonopoly law by OAO Gazprom. In April 2015 the European Commission adopted a Statement of Objections in the course of ongoing antitrust investigation of OAO Gazprom activity in the European Union […] OAO Gazprom considers the claims brought by the European Commission to be unsubstantiated and expects the situation to be resolved in accordance with the agreement reached earlier between the Government of the Russian Federation and the European Commission.

Specifically, the European Commission has stated that unfair pricing by Gazprom might have resulted in higher gas prices in Bulgaria, Estonia, Latvia, Lithuania and Poland — countries that have long been wholly or substantially dependent on Russian gas. In those countries, the commission said, Gazprom was suspected of charging wholesalers prices that were significantly higher compared with the company’s costs or to benchmark prices.

The commission also suspects Gazprom of quashing competition by restricting gas flows to some parts of Europe. Gazprom seems to be “pursuing an overall strategy to partition Central and Eastern European gas markets, for example by reducing its customers’ ability to resell the gas cross-border,” the commission noted in its statement.

Poland itself faced a cut-off when reports emerged of gas supplies being re-exported on a “reverse path” to Ukraine in the light of its own difficulties with Gazprom over pricing that led to a cessation of gas supplies.

If Gazprom was deemed to be in breach of the European competition rules, it could face a fine theoretically higher than EUR 10 bln, or about USD 10.7 bln.

This is no mean sum in the context of the 2004 net profit and continuing ongoing poor performance. During the first two quarters of 2015, Gazprom’s natural gas production fell by 12.9 percent; Russia’s economic development ministry has predicted that annual production will fall to the lowest level in Gazprom’s history.

Further, Gazprom`s export revenue has fallen by 35.8 percent this year to USD18.8 bln. The competitive outlook for its principal EU market does not bode well.

Procedurally, Gazprom has 12 weeks to respond to the European Commission’s charges. With the “spirit of compromise” not particularly evident on display in either Gazprom`s St Petersburg headquarters or its owner in the Kremlin, Gazprom`s market valuation may yet not fully reflect the considerable future legal and regulatory uncertainty affecting it.

Photo courtesy of Gazprom.

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