Russia's Petroleum Progress Gazprom Follows Unique Course To Privatization

Dmitry Surovtsev
Sibneftegazprom
Moscow

While world attention tends to focus on privatization struggles of the Russian oil industry, the natural gas industry travels a different but also bumpy course toward market economics.

Unlike the oil industry, Russian gas is dominated by an officially sanctioned monopoly-Joint Stock Society (RAO) Gazprom. The company produces, transports, and exports most of the gas in Russia, the world leader in gas reserves.

Two major challenges confront Gazprom as it adapts to existence as a private concern. One is financing of a major pipeline to Europe for export of gas produced in fields under development in the Yamal Peninsula. The other is collection of debts owed it by customers, both in and outside of Russia, for past gas deliveries.

While it grapples with those challenges and the strains of operating a huge gas production and transportation system, Gazprom also must deal with questions about whether it should continue as a monopoly-questions not likely to be answered until Russia's political situation is more certain than it is now.

Gas privatization

Gazprom has been privatized as a monopoly with a legal ownership status much different from that of privatized Russian oil producers.

For oil, former production amalgamations became joint-stock societies. The state then assigned its stake in these societies to the charter capital of integrated oil companies such as Lukoil, Yukos, and Surgutneftegaz.

Most integrated oil companies are purely holding companies that only have controlling interests in their subsidiaries, which, in turn, are the full owners of physical upstream or downstream assets.

Gazprom, having evolved out of a different type of privatization, does itself own physical assets.

State Gas Concern Gazprom (GGK Gazprom) was formed in 1989 upon liquidation of the U.S.S.R. Ministry of the Gas Industry. It received all the assets of the old gas-related production amalgamations.

GGK Gazprom became Joint Stock Society Gazprom (RAO Gazprom) on Nov. 5, 1992, under a presidential edict. The state reserved a 40% stake in the company, articles of association for which were approved Feb. 17, 1993.

RAO Gazprom's charter capital under those articles of association include physical assets such as field development licenses, gas wells, pipelines, and supporting facilities. Most former gas-producing, transportation, and service amalgamations, which had been subsidiaries of GGK Gazprom, became Gazprom daughter enterprises based on what Russia calls the "right of full economic control." This makes them legal entities with restricted property rights; they cannot sell, pledge, or otherwise dispose of assets without consent of the owner, Gazprom (Table 1 [44147 bytes]).

Exceptions to this are the production amalgamations Yakutgazprom and Norilskgazprom, which became separate entities.

Gazprom functions as a natural monopoly within Russia's "Unified Gas Supply System." Political efforts to change its monopoly status have so far been unsuccessful.

Pipeline finance

The gas export plan Gazprom needs to finance would be based on indicated reserves totaling 6.5 trillion cu m (225 tcf) in the Yamal Peninsula's three giant fields-Bovanenkovskoye, Kharasaveyskoye, and Kruzenshternovskoye-plus at least another 3.5 trillion cu m (120 tcf) in 21 other fields in the area. Yamal production could reach 175 billion cu m/year (16.6 bcfd) by 2010.

Gazprom plans a 4,107 km trunk line from Yamal crossing Russia, Belarus, and Poland and connecting to the German gas transportation system. Three 56 in. pipelines would connect Yamal to Torzhok, 200 km northwest of Moscow, with a design working pressure of 7.5 Mpa (1,070 psia).

Design throughput capacity from Yamal to Torzhok would be about 83 billion cu m/year. The export section of the pipeline from Torzhok to the German border would be able to carry 67 billion cu m/year through two 56 in. lines at a working pressure of 8.5 Mpa (1,210 psia).

Capital requirements for this project would easily exceed $14 billion (Table 2 [27470 bytes]).

Parts of the export section of the system could connect with Russia's existing gas transportation system and thus become operational well ahead of the entire route. For example, construction of no more than 874 km of pipeline across Poland and part of Belarus (Nesvizh in Belarus through Kondratki and Lwowek, Poland, to Frankfurt an der Oder, Germany), would end Ukraine's monopoly on Russian gas transit to Western Europe. Planning for this section is indeed well advanced, and financing is considered imminent.

Polish company

In Poland, a special company established in 1993, Europol Gas, is coordinating design, construction, and management of the Polish section of the pipeline. The main owners are Polsko Gurnistvo Naftowe i-Gazownistwo (Polish Oil & Gas Co., or PGNiG) and Gazprom, with 48% interest each. The remaining 4% stake is owned by a joint Polish-Russian-German venture, Gas Trading.

As pipeline contractor, Europol Gas will not cover alone the construction costs estimated at $2.4 billion. Under a Russian-Polish protocol signed Feb. 18, 1995, and ratified by Poland on Aug. 18, the Polish government will provide guarantees for $300-350 million, or 15% of the capital outlays of the project. This is roughly proportional to Poland's imports from the project-14 billion cu m/year-as a share of maximum throughput of the section.

That leaves $2.1 billion of the capital for the Polish section to come from outside of Poland. The sum will not come from the financially strained Russian government, and Gazprom itself faces a rising fiscal burden and uncertain internal resources. The only alternative is external financing, which would require the company to secure commitments by customers to purchase gas from the project.

The current company strategy is, therefore, to prolong or expand sales contracts with traditional customers such as Ruhrgas, Wintershall Erdgashandel West GmbH (Wingas), Gaz de France, and SNAM and redirect shipments through the new system.

In 1995 Gazprom's contract export volumes to Western Europe totaled about 70 billion cu m. Only 6 billion cu m/year of that is currently contracted for beyond 2010.1

If Gazprom finds West European buyers for an additional 10 billion cu m/year through the new export route at current prices, the $2.1 billion could be recouped by 2010. This assumes that fiscal charges on the company would not exceed 50% of its revenues.

Staged construction

Financing should be helped by plans for staged construction and start-up of the pipeline in three segments.

The first stage is a 102 km, one line leg between Frankfurt an der Oder and Lwowek, Poland, near Poznan, which is to be complete by autumn this year. Europol Gas signed the construction contract for this stage with Wingas last August.

The first stage would be linked to the German gas transport system and Poland's domestic system, allowing transit of as much as 600 million cu m/year of Russian gas. Gas now flows in Poland through laterals from Russia's Northern Lights and Brotherhood pipeline systems. Polish state guarantees could cover financing of construction of this segment, which is estimated to cost less than $150 million.

The second stage would involve construction of the remaining 563 km of the export section's first line by 1997, with annual throughput of 5 billion cu m.

The third stage would be construction of the second line in the export segment, planned for commissioning in 1998. The system would not start carrying full design volumes of 67 billion cu m/year until 2010, when the Russian section of the trunk line would come on stream.

Belarus segment

In Belarus, construction of a 209 km, two line section between Nesvizh and Kondratki is planned for completion in the second quarter of 1997. At Nesvizh, 100 km southwest of Minsk, the pipeline would be fed through a connection with the Northern Lights system.

Pipeline contractors which won Gazprom's special tender offer last November are Belarus's Beltruboprovodstroy and Russia's Stroytransgaz. Although commissioning of this segment is required for operation of Poland's part of the pipeline, Western bankers have been cautious about providing limited recourse financing for it. Estimated cost, however, is relatively small at $500 million.

Part could be financed by Belarus through its state enterprise Beltransgaz as payment for its $430 million debt for Russian gas supplies. Gazprom could finance the rest.

Russian segments

Other sections of the pipeline are at very advanced stages of engineering and design but face large uncertainties about financing. As Gazprom's Chairman Rem Vyakhirev told a news conference last October, "The market will dictate the construction schedule."2

Estimated capital requirements for the Yamal-Torzhok-Nesvizh segments total $11.4 billion. In theory, the capital could come from Gazprom's own funds, a separate consortium involving Western companies, a market placement of Gazprom equity, or new long-term bank loans.

Gazprom has long been regarded as a major source of financing for the Yamal-Nesvizh pipeline sections. Under fiscal regulations and economic conditions of 1995, the company's net cash flow would amount to $4 billion/year, which would cover the required capital costs in 3-4 years.

But this favorable financial position results from an extraordinary tax concession granted the company at the end of 1993. A presidential edict allowed Gazprom to cut its taxable revenues by recording the gas export turnover at Russian domestic prices and directing the difference to the so-called stabilization fund, which could finance the new pipeline.

Last September, however, government officials announced plans to cancel the favorable tax treatment this year. Under common fiscal regulations, Gazprom will need almost 10 years to cover the $11.4 billion capital requirement. It thus will need to approach capital markets.

Involvement in a consortium is unacceptable to Gazprom because it would mean loss of control over the company's most promising assets. The company strictly opposes large-scale gas projects involving foreign direct investment in West Siberia and areas north of European Russia, including offshore.

Equity prospects

Equity financing is also unlikely.

A Russian presidential order of January 1993 provided for sale of a 10% stake in Gazprom on stock markets to ensure development of the Yamal project and others. The shares were assigned to the company until June 1, 1994.

After that deadline passed, Gazprom appointed the British merchant bank Kleinwort Benson as its advisor on the international offering of the shares. Gazprom still holds the interest and is reported to be undecided about whether to sell it.

The company's reluctance evidently relates to uncertainty about share prices and the nature of potential buyers. Under Gazprom's articles of association, shares may not be freely traded without first being offered to the company, deals leading to concentration of more than 3% of the company in a single owner must be approved by the executive management committee, and total interest held by foreign investors cannot exceed 9%. Among other restrictions to shareholder rights are limitations on discussions at shareholder meetings to issues preapproved by the chairman of the board.

Gazprom share substitutes such as shareholder's warrants now trade on informal Russian markets at about 10/share, yielding a ridiculously low market capitalization of the whole company of $2.4 billion. Until recently, the only organized trade in Gazprom equity has resulted from the company's unrestricted, preapproved placement of 0.88% of its shares at a starting price of $5/share on the Vladivostok International Stock Exchange in December 1994. Trading has been negligible and through September 1995 had not exceeded $1 million.

At $5/share, sale of a 10% Gazprom stake would raise $11.9 billion, enough to finance the Yamal-Europe pipeline project. But failure of Gazprom shares on the Vladivostok exchange make the company reluctant to offer shares in larger volumes.

Outlook for loans

Long-term bank loans also raise difficulties.

Limited recourse project financing is available for Gazprom projects in Western Europe but difficult for the Belarus and Russian portions of the proposed pipeline. With the Russian government refraining from providing state guarantees, Gazprom must either find institutions willing to assume political and economic risks of the pipeline or pledge company assets in direct deals with commercial banks.

International financial institutions have either funding limits or sourcing requirements that Gazprom cannot accept.

As a result, Gazprom may be left with pledging its West European corporate assets to obtain loans. The assets include interests in companies owning or set to own physical gas transport and storage facilities: 35% in Wingas, 5% in Germany's Verbundnetz Gas AG (VNG), 10% in the U.K.'s Interconnector Ltd., 49% in Italy's Volta SpA, and 51% in Greece's Prometheus Gas.

Gazprom also holds interests in gas trading companies, including Germany's WIEH, France's Fragaz, Finland's Gasum, Italy's Promgas, and Austria's Gas und Warenhandelsgesellschaft mbH.

Project timing works in Gazprom's favor. The company will have little need for the Yamal-Nesvizh section-and hence loans for construction-before 2000 since gas from the Northern Lights system can feed the pipeline sections from Nesvizh to Frankfurt an der Oder.

By the time Yamal gas is needed for export, not earlier than 2003, Russia's investment rating may have improved, and limited recourse financing may have become available for completion of the Yamal-West Europe project.

Payments crisis

Meanwhile, Gazprom faces a payments crisis with gas customers in Russia and other members of the former Soviet Union.

About 85% of the company's receivables from customers in Russia and Ukraine are 90 days or more in arrears.

Domestic customers' debts increased by 22.7 trillion roubles in 1995 on gas deliveries valued at 44.2 trillion roubles. In all of 1994, debts increased by 7.3 trillion roubles on gas with an invoice value totaling 14.6 trillion roubles. In 1995, therefore, customers paid for 49% of the gas delivered, compared with 50% in 1994.

Gazprom resorted to delivery curtailments to collect on customer bills. In January 1995 it reduced deliveries to Bashkortostan, in May to the Krasnodar and Tver regions, in August to St. Petersburg and the Leningrad region, in September to the Ulyanovsk region and part of Tatarstan, and in November to the Samara and Tyumen regions. Deliveries to curtailed regions go mainly to households, social and medical facilities, and some strategic enterprises, according to priorities established by Russian authorities under the Law on Natural Monopolies.

Last August, Gazprom and the Tatarstan Republic signed an agreement providing for the phased takeover by Gazprom of the local distributor, Tatstroygazifikatsiya, to discharge the republic's debt. Gazprom is negotiating a similar agreement with Bashkortostan.

The Russian government has limited the amount by which Gazprom can raise gas prices to 80% of the inflation rate but is considering limiting the list of gas consumers immune to curtailments undertaken for debt collection.

Other FSU

Gazprom has had similar problems with receivables from other members of the FSU. Last year the company received payment for 82% of the value of its exports to non-Russian members of the FSU, up from 73% in 1994.

The lion's share of debt repayments from FSU governments takes the form of goods and services, however. Of $606 million that Ukraine paid Gazprom by mid-1995 on its 1994 debt, 62% was in tourist and health care services for the company's employees. Cash transfers were less than 27% of the amount.

Gaining interests

Where Gazprom cannot receive cash, it prefers to take large interests in debtor countries' gas transportation systems. It did this last year when it established Gazsnabtranzit, a joint gas company, with Moldova's gas distribution and transmission companies. Gazprom received a 50% stake in the venture worth $52 million as reimbursement for Moldova's 1993 debt.

The Russian company and Ukraine's government have discussed a similar arrangement. They agreed to share interests in a joint stock company called Gaztranzit, whose holdings would include two major gas storage facilities in western Ukraine. Transfer of the interest in Gaztranzit to Gazprom would settle all of Ukraine's gas debt. However, Ukraine's legislature opposed and cancelled the deal.

As an alternative (surely less welcomed by Gazprom), last September Ukraine issued to Gazprom state bonds worth $1.4 billion and due 2007 in exchange for the commercial debts of its gas importer, Ukrgazprom.

Indebted CIS countries are expected to pay the full value of current deliveries of Russian gas supplies and might be able to settle their arrears by various means in 2-3 years. Ukraine announced plans to issue a second tranche of its 12-year state bonds worth $1.14 billion to pay for outstanding gas debts. Belarus may repay its debts either by participating in the Yamal-West Europe gas pipeline or by handing over noncontrolling interests in its privatized oil and gas entities.

Nearly 50% of the debts probably will be settled in goods and services, which have little practical value to Gazprom but which help it improve its balance sheet to raise financing internationally.

Slower payments

Meanwhile, Gazprom apparently slowed its payments to suppliers and contractors last year to keep the buildup in its receivables from eroding cash flow.

The company's accounts payable rose from 5.5 trillion roubles at the beginning of 1995 to about 20 trillion roubles in July. The increase exceeded the period's increase in receivables by 2.2 trillion roubles.

Debt to federal and local governments increased insignificantly, from 1.5 trillion roubles on Jan. 1 to 2.7 trillion roubles on Oct. 1.

References

1. "Oil, Gas & Coal Supply Outlook," Organisation for Economic Cooperation and Development/International Energy Agency, 1995, p. 80.

2. Interfax Oil & Gas Report, Oct. 6, 1995.

The Author

Dmitry Surovtsev is an economist with Sibneftegazprom, Russia's oil and gas supply, processing, and trading company. He received a graduate diploma (MS equivalent) in international economic relations from Moscow State Institute of International Relations and attends post-graduate courses at the same university with a specialization in petroleum economics.