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. Last Updated: 07/27/2016

Gazprom Given A Dose of Reality

The nation's most powerful company wanted to spend $5.2 billion next year on development, exploration and upgrades, but on Thursday the government said no.

At a Cabinet meeting devoted to Gazprom's investment program for 2002, the government called into question the state-controlled gas monopoly's ability to fill the cash gap between projected income and badly needed investments, saying that expenses would have to be cut.

The decision was a blow to the new leadership of the energy giant. But it represents a turning point in President Vladimir Putin's quest to get a handle on one of the world's most Byzantine corporate empires -- one that accounts for a tenth of the national economy despite being stripped of assets over the years on a scale massive even by Russian standards.

Never before has the government paid so much attention to the internal workings of Gazprom, which was created by Russia's longest-serving prime minister, Viktor Chernomyrdin, and run by his close associates before Putin orchestrated a boardroom coup in May and installed his trusted ally, Alexei Miller, at the helm.

Just the fact that the government discussed Gazprom's investment program with a great degree of transparency is an achievement in itself, said Valery Nesterov, oil and gas analyst at Troika Dialog. "Independent experts looked at it. And for the first time there is an internal logic and clearly formulated goals, such as stabilizing the company, improving efficiency and managing investments more clearly," Nesterov said.

The government did agree to raise domestic gas tariffs 35 percent next year as part of a longtime strategy to end subsidized energy supplies in Russia, where gas sells for just a fraction of world prices. But the mechanism and the timing of the price hike, which will be felt across the entire economy, were not specified.

Even with higher tariffs, however, analysts said Gazprom would not be able to come up with the 92 billion rubles of the 161 billion rubles called for in the investment program.

At Thursday's meeting, the Cabinet suggested that Gazprom break the program into sections based on priority.

"A list of investments that do not raise questions from the government will be confirmed soon, presented again by Jan. 10 and be approved by [the Cabinet] on Jan. 20," Deputy Economic Development and Trade Minister Andrei Sharonov told Reuters.

He said the issues on which Gazprom and the government disagree would be passed by March 1.

Apart from objecting to the lack of guaranteed funds, the Economic Development and Trade Ministry said total spending should be no more than 140 billion rubles.

Whatever the final number, the debate has highlighted a significant change in policy -- the new management team wants to invest 70 percent more money in the company next year than it invested this year, including 14 billion rubles on exploration, a seven-fold increase.

Sharonov said the figure was too high and questioned Gazprom's estimation of its non-core assets, which the company says are worth 20 billion rubles. Sharonov called the figure a "very optimistic estimation," and said it was more like 9 billion rubles.

Miller said in a recent interview that Gazprom has hundreds of non-core businesses that it plans to shed, investing the proceeds back into the company.

Gazprom is already preparing to sell its media assets, which include national TV broadcaster NTV, second-tier TV station Prometei, radio stations Ekho Moskvy and Open, and the newspapers Trud and Tribuna. A divestiture strategy is being drawn up and the company has contracted investment house Dresdner Kleinwort Wasserstein to evaluate the assets and organize their sales.

But even if Gazprom manages to get top dollar for its media holdings, Sharonov said it wouldn't be enough to fill the gap in the investment program, which can only be achieved by doubling tariffs, which the government won't allow because it would stoke inflation.

Gazprom did not make an official comment Thursday, but a source in the company said it would probably try to change the government's mind on a few key issues, including exploration.

"Thinking about the future now is a must," the source said.

While applauding the greater degree of attention being paid to a company with annual sales of some $20 billion, analysts said the government did the right thing in rejecting Gazprom's wish list.

"The government sent Gazprom to do more work and prepare proposals with which it can agree," said Vladislav Metnev, oil and gas analyst with Renaissance Capital investment bank. "It would have been strange for the Cabinet to pass a program that is not feasible."

Despite the snub, analysts said Miller and his team are on the right track and pointed to 2001 as the year the company finally turned the corner.

"Miller's arrival [in May] was certainly a very positive move. He replaced previous CEO [Rem Vyakhirev] who, by that time, had already lost not only the trust of private shareholders but even the state," said Dmitry Avdeyev, oil and gas analyst at United Financial Group.

Investors have responded, as Gazprom's local share price has nearly doubled since January and it now has a market capitalization of some $12 billion. And the initial enthusiasm over Vyakhirev's ouster has given way to a more realistic assessment of the prospects for speedy reform.

"There was a hope that the replacement of the management would lead to sharp changes. But to do it in six months or a year is simply impossible," Metnev said.

There have been major victories, however. Metnev said Miller's team passed the two biggest tests -- recovering a 32 percent stake in major gas producer Purgaz and strengthening its grip on petrochemical holding Sibur.

Gazprom's board this month voted to exercise its right to buy back a 32 percent stake in the Purgaz gas producer from Itera for a nominal price before its option to do so expired Jan. 1. Purgaz supplies about 70 percent of the gas extracted by Florida-registered Itera, which bought the stake from Gazprom in 1999 for next to nothing.

Earlier, the Gazprom board also voted to bail out financially troubled Sibur, once Russia's largest liquefied gas producer. And although most of Sibur's assets have been transferred to other companies, letting it go bankrupt would have further weakened Gazprom's position in the petrochemical industry.

Under the new management team, Gazprom also managed to reduce its debt by some 10 percent. According to UFG, the company's debt, which is currently more than $11 billion, was reduced by $1 billion to $1.5 billion this year.

Another major achievement was the opening of the massive Zapolyarnoye gas field. With reserves estimated at 3.3 trillion cubic meters, Zapolyarnoye is the first field of its kind and scale to come online since the fall of the Soviet Union.

Zapolyarnoye is the main reason Gazprom expects to boost production from 511 bcm this year to 520 bcm next year.

Analysts point out, however, that even bigger challenges lie ahead.

The mechanisms for the liberalization of Gazprom's current two-tiered share system have yet to be worked out. Miller has said that ending the double system, which penalizes investors who buy the company's stock on Western markets, should vastly increase the company's market capitalization, which some say could be as much as 20 times higher.

Another major issue is the restructuring of the company, which the government has said it is committed to but has yet to finalize a concept for. Options on the table are still as varied as breaking the company into two, separating some of the units, or doing nothing but allowing easier access to the pipelines for other market players.

Meanwhile, on the tariffs issue -- a key to the future financial viability of the company -- Gazprom remains completely dependent on the state.

Despite all its problems, however, Gazprom remains the crown jewel of Russia's economy.

"Regardless of everything, Gazprom is still the world's largest gas producer and holds a third of the world's gas reserves. It has contracts for at least 20 years. And its potential is huge and growing, especially with shaking world oil markets," Nesterov said.

Editor's note: This is the second of three stories about the country's natural monopolies.