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. Last Updated: 07/27/2016

Struggles Should Not Sink Gazprom

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Last week, the government agreed to acquire an additional 10.7 percent equity stake in Gazprom for $7.1 billion. This transaction, once completed, will see the state's direct holding in the world's biggest energy company increase to just over the 50 percent level required to formalize control. This event has been eagerly anticipated by stock market investors for several years, as it was considered a likely trigger for a major rally not just in Gazprom's stock market value, but also in the overall equity market.

Instead, the announcement was met with a mixture of apathy and suspicion. This was because of the perception of increased state meddling in the company and because of the conflicting signals sent by Gazprom's role in the Yukos auction and the now aborted merger with the state-owned oil company, Rosneft. Instead of acting as a major boost to stock market sentiment, the whole process has revealed just how indecisive the Kremlin is. It showed the extent of internal squabbling at the highest level of government.

Consolidating control over key industries is clearly an important part of the government's strategy to exert greater influence over the economy. Taking majority ownership of companies, like Gazprom, that represent the commanding heights of the economy facilitates this goal. For investors, the state's acquisition of majority control also seemed like good news: President Vladimir Putin had promised that once the state gained majority control it would then proceed with removing the current restrictions on foreign ownership in Gazprom local shares. In turn, this was expected to provide a major boost not to only the price of Gazprom shares but also to the overall stock market.

Currently, the Gazprom shares that trade on Russia's local exchanges are "ring-fenced" to prevent foreign investors from buying them. That means that international investors are effectively limited to buying only those shares that are traded on the London stock exchange, which equal just over 3 percent of the total number of shares in issue. This limits the representation of both the company's shares and of Russian companies in general in the important global investment benchmark indices that major international investors use as a guide when buying shares.

In short, when the ring-fence is removed, the pool of Gazprom shares available to international investors will rise from 3 percent to about 25 percent. In monetary terms, this means an increase in the value of shares available from just over $2 billion to $18 billion.

Almost a year has passed since Putin announced that the government would work to remove the foreign ownership restrictions. To facilitate the process, one of Putin's close associates in the "new politburo" that now controls the Kremlin, deputy chief of staff Igor Sechin, was appointed chairman of Rosneft. The very straightforward plan was to swap the state's 100-percent holding in Rosneft for extra shares in Gazprom. The creation of a combined oil and gas holding under the Gazprom umbrella also fit well into the government's plan to establish a national champion energy company to rival those in OPEC. This kind of national oil company would also allow the Kremlin to consolidate its geopolitical relationships with countries like India and China, and also to work out bilateral trade deals, including favorable entry terms when Russia joins WTO, in exchange for increased energy cooperation with Western consumer countries. This week's agreement to supply Mexico with liquefied natural gas provides a clear example of how the government is using energy to this end.

But instead of speedily proceeding with that transaction, a split at the top of the government emerged between those who wanted to create this new combined holding and those who, while favoring state control, wanted to keep Rosneft, as well as former Yukos production unit, Yuganskneftegaz, separate and nontransparent so as to be able to control to financial flows from their oil operations.

As we now know, the latter group has prevailed. In the process, the message was sent to investors that there was a new elite group in power in the country and they did not wish to share the spoils of victory. While few believe that there is anything more serious than a disagreement over tactics and intermediary priorities at the top of government, nevertheless the investment climate is being damaged due to the risk posed by political instability as the two or more groups in the Kremlin squabble over control of financial flows from state assets.

Gazprom's attractiveness to investors may be further damaged by the increased politicization of its business that has emerged over the past year. The government is tightly controlling gas tariff increases at the expense of Gazprom's domestic profitability, as a major part of its effort to keep inflation as low as possible. This approach will likely remain a key political priority for the next three years until the March 2008 presidential election.

Yet while Gazprom's role in the upcoming election is now merely confined to inflation policy, other recent deals hint that this role may expand. Gazprom recently agreed to acquire the stake in the major daily Izvestia that is currently held by Vladimir Potanin's Prof-Media holding. There is no clear business rationale for this acquisition, but it appears to be an important part of the Kremlin's strategy to contain political criticism over the next three years.

One thing is very clear about sizing up Gazprom as a major global energy company, however: If left alone, the value of the company would certainly be substantially higher than its current $70 billion stock market valuation. The problem is that while waiting for the government to honor its promise to remove the foreign ownership restrictions, investors have come to realize that the company's business model has become much more complicated due to the Kremlin's domestic and international political priorities. Hopefully, however, the risks of politicization will soon be balanced by a firm timetable for tearing down the ring-fence and by progress on new export-oriented projects that would benefit state and investors alike.

Christopher Weafer is chief strategist at Alfa Bank. He contributed this comment to The Moscow Times.