This Will be the Year That Makes or Breaks Gazprom

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There is no energy company more closely associated with Russia’s status as a resource superpower than Gazprom (NASDAQOTH: OGZPY.PK). Controlled by the state and chaired by people closest to President Vladimir Putin, the energy giant saw its finest hours in the mid-2000s when global energy prices skyrocketed, giving it and the Kremlin incredible sway over European affairs. As a testament to the power and wealth Gazprom brought to the state, Moscow gave the energy company exclusive rights to the export of natural gas in July 2006. By 2008, the company was worth $250 billion and its vice-chairman, Alexey Miller boasted that the company would be worth $1 trillion by 2015.

Steep Decline

But now the company is a shadow of its former glory. The global recession slashed three quarters of Gazprom’s stock value and now the shale gas boom in the US is threatening Russia’s exports to Europe.

The company’s diminishing revenue stream has not escaped the attention of the Kremlin, which is desperately seeking to rebound from the economic downturn by expanding the country’s energy exports. Revealing his frustrations over Gazprom’s inability to expand output, President Putin suggested in February of this year that the state terminate Gazprom’s privileges as Russia’s sole exporter of liquefied natural gas (LNG). Many analysts believe that this will occur by the end of this year and Gazprom’s domestic competitors have already begun to invest aggressively in building export capacity, further strengthening the case for restoring competition in Russia’s energy market.    

In the midst of all the changes, Gazprom has not stayed idle. Faced with competition from US shale gas, the company scrapped the project to tap into the gas reserves at Shtokman and has shifted its attention to building an LNG plant in Leningrad Oblast that will eventually connect with the Nord Stream pipeline and deliver gas to Europe via Vyborg. However, as many analysts have rightly pointed out, the project will not access new markets in Europe and its existing share will invariably diminish as US natural gas exports to the region begin to pick up.

Race for the Asian market

Gazprom recognizes that the big push needs to happen in Asia and has invested $46 billion on its Power of Siberia project which will connect the Chayandinskoye oil field to Vladivostok where a new gas liquefaction plant is being built.  In addition, the company plans to explore and expand operations at Yuzhno-Kirinskoye field near Sakhalin Island to increase output for the Asian market. A semi-submersible drilling rig arrived there on June 21 to begin that project and two additional exploratory wells will be constructed in 2014.

Meanwhile, Gazprom’s biggest domestic competitor is Novatek, which has partnered with the French company Total SA (NYSE: TOT) to develop a gas-liquefaction plant on the Yamal peninsula and ship gas by tanker to Asia and Europe via the Arctic Ocean. Although Alexey Medvedev, CEO of Gazprom Export, claims that exporting from Vladivostok will be more competitive than liquefaction at Yamal, Novatek has already proven itself to be extremely efficient, generating 30.9% returns from investments last year opposed to Gazprom’s 10.7%, and has acquired tax cuts from Moscow for its operations. Given these records, Mark Gyetvay, finance chief of Novatek, suggests that even with freezing conditions in Yamal raising delivery costs, his company will remain more competitive than other energy exporters.

Meanwhile, Total also entered the Asian market on June 18 with a deal with China National Petroleum Corp. (CNPC) to develop petroleum and gas assets in Tajikistan. The previously untapped area is estimated to contain as much as 3.22 trillion cubic meters of gas. According to Total's Exploration & Production Senior Vice President Michael Borrell, this deal "positions Total in one of the world's most prolific gas basins" and will allow the French company to begin directly exporting to China as early as 2020.   

At the same time, Rosneft is also looking to enter the LNG market with a partnership with ExxonMobil (NYSE: XOM) and is planning to explore fields in Russia’s Pacific and Arctic coasts to expand output. Exxon brings vital experience to Russia from its other LNG-related projects in Australia, Indonesia, and Papua New Guinea. In addition, with the development of LNG tankers that have 80% more carrying capacity than conventional ships, Exxon has the infrastructure needed to efficiently ship gas in a market that is overly reliant on pipelines. Further bolstering Rosneft's prospects, its executive chairman, Igor Sechin, is a close adviser to President Putin, which also suggests that Gazprom’s loss of its export monopoly is more or less assured.

Given the efficiency and political ties of Russia’s other domestic LNG producers, analysts simply don’t see Gazprom as a dynamic company that could turn things around in the near future. Long-time observers like Igor Mikhailov, portfolio manager at Uralsib, a Moscow investment bank, see Gazprom’s $46 billion investment on the Power of Siberia project as something that will never be able to pay itself back.  

Gazprom’s last big opportunity will come in September of this year when it might potentially finalize an extremely lucrative deal with China. In March, Gazprom signed a memorandum with Beijing to deliver 30 billion cubic meters of gas per year starting in 2018. However, the deal is not yet finalized because of long standing dispute over pricing. Recently China did offer to make an interest-free advance payment for gas supplies, which, according to Keun-Wook Paik at the Oxford Institute for Energy Studies, “radically improve[d] prospect for the deal.” Nonetheless, China is also looking to develop its own domestic natural gas and its influence in East Africa may persuade its leaders to invest more heavily in gas operations in Mozambique instead. 

The bottom line

Gazprom faces a lot of challenges going forward. By 2014, Rosneft and Novatek are most likely going to be competing with it for market access in East Asia. Likewise, sunk investment in the South Stream and Nord Stream projects will become more costly as they compete with US shale gas in Europe. Unless Gazprom can serious turn its operations around before relinquishing its export monopoly, the once leading energy giant might turn into Russia’s biggest deadweight. 

Yong Kwon has no position in any stocks mentioned. The Motley Fool recommends Total SA. (ADR). Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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