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. Last Updated: 07/27/2016

Gazprom Tightens Its Grip on Energy Sector

MTGazprom has been swallowing assets and mapping out expansion plans.
Less than a year after the world's largest gas producer began gobbling up assets, Gazprom's trademark blue flame is set to engulf Russia's entire energy sector.

The gas monopoly has spent billions of dollars buying chunks of various industries. It has swallowed shares in the electricity, nuclear power and oil sectors, and is setting its sight on other lucrative assets.

Some investors are cheering Gazprom's overarching ambitions. Others regard its strategy with reservation, pointing at mediocre gas production rates and doubting Gazprom's ability to integrate new assets into a smoothly functioning holding.

Yet, when the government scraps the limits on foreign ownership of the gas monopoly's shares, which will likely be as soon as next year, investors will be buying as much into the state's ambitions in the energy sector as into a publicly traded company. On the one hand, Gazprom is a company meant to turn profit for shareholders. On the other, it has become the government's vehicle for consolidating the energy sector as well as a tool in geopolitical strategy.

Between the state itself and management close to the Kremlin, over 50 percent of Gazprom's shares are government-controlled. The state's holding is set to increase even further later this week, when the government officially announces the renationalization of a 10.7 percent stake for $7.1 billion.

Moreover, as the largest company in Russia, Gazprom has always had to carry out many economic and political chores.

It subsidizes the whole country with cheap gas. When Putin said last week that the company must spend at least $1 billion on the unprofitable business of delivering gas to the regions, Gazprom took it as an order.

The gas giant also acts as the ultimate enforcer of the federal government's will in countries of the former Soviet Union. Cross Russia, and your gas bill will skyrocket, as Ukraine and Moldova experienced earlier this month after their leaders made friendly approaches toward the West. In February 2004, Russia cut off gas supplies to Belarus for three days after President Alexander Lukashenko committed what Russia's Foreign Ministry called "systematic mistakes in internal and foreign policies."

However, the government lacks a unified vision for Gazprom's future. One faction would like to consolidate Russia's entire energy sector under Gazprom's umbrella, with a view that this would make it both more powerful and easier to control. Another -- led by the Economic Development and Trade Ministry -- argues that diversification of the monopoly would lead to murky cross-subsidies and inefficiency.

"The government is torn apart by vastly different interests -- geopolitical, social, macroeconomic, plus the interests of various industries. And it is supposed to worry about ensuring long-term profits at Gazprom, too?" said Vladimir Milov, president of the Institute of Energy Policy, a Moscow-based consultancy.

While the government continues to squabble, Gazprom's management is busy pursuing its strategy of expansion and centralization, on a quest to "become a global energy company with diverse business interests," "involved in the entire value chain, from extraction to sale," it says.

Last year, Gazprom bought some $2 billion worth of shares in the national power company Unified Energy Systems and the Moscow utility Mosenergo, and it is eying the electricity generation companies that will become available once UES is broken up in 2007. In October, the gas giant added nuclear assets to its empire, acquiring a controlling stake in the country's main nuclear power company, AtomStroiExport.

Gazprom also purchased Rosneft's stake in several Barents Sea projects for $1.7 billion in December, including the Prirazlomnoye oil field. It is pursuing major stakes in three offshore oil fields off the coast of Sakhalin Island. Oil firms Rosneft and TNK-BP both said they had been approached by Gazprom about selling some of their assets, though Gazprom would not comment on reports that it sought to buy Sibneft, Russia's No. 5 oil producer.

In December 2004, Deutsche Bank advised Gazprom to buy up everything it could in the domestic oil sector. Due to perceived political risks, shares in the oil sector are undervalued, and now is the perfect opportunity for Gazprom, the government's darling, to snap them up at a comfortable price.

Vostok Nafta Investment, a Stockholm-based fund that owns some $950 million worth of Gazprom shares -- out of $68 billion in total capitalization -- says expansion into generation makes sense insofar as the gas giant is already a source of subsidies to the electricity sector.

"Getting into electricity generation is an opportunity to upgrade capacity, control electricity costs and save ... gas for more profitable exports," said Sergei Glaser, director at Vostok Nafta.

And since most gas fields yield liquid hydrocarbons like oil, Gazprom ends up producing oil and gas condensate "without getting full benefits from exporting them," Glaser said. So Gazprom is naturally positioned to get into the oil business, he said.

Critics, however, say that the company would first have to digest what it has swallowed before moving on with the feast.

"We would prefer the company to focus on optimizing its core business rather than moving off into something new and totally unrelated to gas," said Vadim Kleiner, research director at Hermitage Capital and a candidate for a Gazprom board seat.

According to Hermitage, which is an international fund manager representing a significant number of Gazprom's minority shareholders, the company's operating costs leaped by 28 percent in the year to September 2004, and net debt swelled to $18.5 billion by the end of 2004. Even though Gazprom's output inched up by 1 percent in the same period, its overall production volume so far has failed to reach the levels of 1999. This is despite the takeover of Purgaz, a large independent gas producer, in 2002.

And while Gazprom is concentrating on new assets, its core fields are running out of gas and pipelines are rusting, analysts say.

The company is acting "like a person who has no running water or electricity but goes out to buy his third large-screen TV," said Milov of the Institute of Energy Policy.

The limitless swelling of Gazprom could also have a negative effect on Russia's overall economy.

Gazprom is on a mission to rejoin the disparate pieces of the planned Soviet economy, but the biggest loser from "Gazprom's empire creep" will be Russia, said Michael Lelyveld, a senior analyst at the Washington-based PFC Energy think tank. As it monopolizes more and more of the energy sector, Gazprom will kill off competition and spread bloat, mismanagement and inefficiency in its wake, he said.

Independent gas producers, who account for 14 percent of Russia's output and have nearly doubled their production in the past five years, are currently barred from exporting their product because they are denied access to Gazprom's pipeline network. They are confined to selling gas at artificially low domestic prices set by the government.

The plan floated by Economic Development and Trade Minister German Gref in 2002 to split up Gazprom and ensure competition in the sector now appears to be dead in the water.

"People have taken their eye off the ball because they are concentrating on making money off of Gazprom shares," Lelyveld said.