Sunday, January 16, 2011

Wikileaks, Gazprom, the Putin Wealth Tax, and the Chinese Counter Example

Buried in the Wikileaks releases is an account of a rare meeting of Moscow Embassy officials in September of 2008 with the reclusive management of Russia’s largest company, Gazprom. In the meeting, the Gazprom official stated that Gazprom’s first priority is to provide reliable and affordable gas to the domestic population. The second priority is to "fulfill Gazprom’s social obligations," including charitable projects. The American envoys asked whether the maximization of shareholder value and its market share were also goals? Yes, was the perfunctory answer, but the official added a third priority: to maximize "control over global energy resources." Gazprom, the official said, is “a socialist rent-seeking monopolist."

Despite the fact the Gazprom official was speaking for the official record, his remarks are remarkably candid. Translated into clear language, he was stating that Gazprom is not run as a company that creates shareholder value for its owners (the Russian state and favored billionaire oligarchs). Its job is to exploit its monopoly position to generate “economic rents” for “society” and to act as an instrument of state power, while keeping the people happy with low gas prices and the sponsorship of sports teams.

As Soviet managers used to quip: “Under socialism, property belongs to everyone and no one. Therefore it might as well belong to me.” The veiled language of “socialist rent seeking” really means that Gazprom is to be used to make the life of the elite extremely comfortable. If it is not interested in or feels a sense of responsibility to minority shareholders, it is legitimate to ask why they should buy Gazprom stock?

“Control over global energy resources” tells us that Gazprom intends to maintain, at all costs, its monopoly over the export of natural gas from the former Soviet Union, including gas-rich Central Asia. It will use its economic power along with the diplomatic and military might of the Russian state to prevent rival pipelines from threatening its monopoly.

In order to keep the people on board with these first two goals, Gazprom must offer them cheap energy, even if that means a severe loss of potential profits. Again, the last person in line appears to be the minority shareholder.

The Russian state is the majority shareholder of Gazprom and the Russian Oil Company (Rosneft). The shares of each trade publicly. Gazprom is an almost obligatory holding for funds that invest in Russia. It accounts for more than a quarter of Russia’s meager $500 billion stock market capitalization. Other energy companies are owned by control-exercising oligarchs favored by Putin’s Kremlin. They also have minority shareholders, and their shares trade publicly.

The example of the jailed former owner of the now-defunct Yukos oil company, Mikhail Khodorkovsky, taught these “private owners” that they must also run their companies according to Gazprom’s guiding principles. Maximizing shareholder value is not among their top goals. It need not be: These private owners can benefit more from siphoning company resources into their own pockets than by creating value through efficiency gains, innovation, and investment. This is entirely rational. Who knows when they will find themselves on the wrong side of the Kremlin.

Putin’s intentions for Russian energy concerns did not become clear until 2007. They were not clear even after the 2003 arrest of Mikhail Khodorkovsky and the destruction of his Yukos oil company (One of the few that sought to maximize shareholder value).

Between 2003 and 2007, Putin was thought to be pursuing a “liberal” policy of rationalizing Russian energy concerns, “liberalizing the energy market, and encouraging cooperation and even joint ownership with international energy giants. During this spurt of optimism, Putin even spoke of making Gazprom the world’s most valuable company – even worth more than ExxonMobil – with a target market capitalization of over one trillion dollars. International investors responded to such talk by driving up Gazprom’s shares, and in the second half of 2006 Gazprom’s market capitalization briefly ranked it as the third most valuable company in the world (but still a hundred billion behind ExxonMobil).

Investor optimism was spurred by the fact that Gazprom had the world’s largest reserves with huge likely but unproven reserves. It should be remembered that the share prices of Gazprom and other publicly traded energy companies are determined in stock markets by international investors. These prices reflect the stream of future profits and dividends anticipated by investors.

Gazprom’s share price plummeted as investors began to understand Putin’s real intention. Russia’s energy reserves were to be strictly off limits to outsiders, Russian energy companies were to be run in the interests of the Russian state by its favored elite. There would be little difference between private and public management. Putin’s deputy was to run Gazprom; trusted Oligarch Vagit Alekperov could run Lukoil. Putin’s blatant and unapologetic use of tax authorities, environmental agencies, and the prosecutor’s office to threaten and blackmail foreign energy concerns could not go unnoticed even by the most bullish investors.

Putin’s energy policies enriched the favored elite, including Putin himself, and they have transformed both public and private Russian energy companies into instruments of state power. They have prevented new technology and investment from entering the industry, and output is stagnant or declining. These policies have had remarkable economic effects in the form of lost wealth and, more importantly, missed investment opportunities.

There is a consensus that Russia’s energy sector has a creaking infrastructure and that its remote and inaccessible reserves require huge capital investments. Russian energy companies lack the will and capital to make these huge investments. High share prices mean that Russian companies could tap international capital markets to obtain “cheap” capital. If Gazprom’s share price is $60 dollars, it can raise $60 million dollars by issuing a million shares. If the share price is $20, it can raise only $20 million by issuing the same number of shares.

It is relatively straightforward to calculate the wealth destruction and lost investment opportunities of Putin’s energy policies. Currently, the market value of Russia’s six largest energy concerns is some $317 billion. They constitute almost 65 percent of the market capitalization of publicly traded companies in Russia. Proven reserves are a major determinant of share values, and currently Russian energy company shares are valued between $1 and $4.50 per barrel of reserves, with Gazprom having the highest current valuation (and the small Tatneft having the lowest). At the peak of optimism concerning Putin’s energy policy in May of 2006, Gazprom traded at $10.40 per barrel of reserves, remarkably close to the world’s foremost run state-owned oil company (Statoil of Norway).

Simple calculations show that if Russian reserves were valued today at these rates of peak optimism, the market value of the top five Russian energy companies would almost triple from $317 to $1.1 trillion – an $814 billion increase that is 1.5 times the current market capitalization of the entire Russian stock market. Gazprom’s market cap alone would rise by 175 billion. This $814 billion destruction of wealth is a massive “Putin Tax” levied as a consequence of inefficiency, corruption, and political objectives. The $814 billion figure also represents the huge investment opportunities that well managed companies and a proper investment climate could yield.

It should be a major embarrassment to Putin that an energy company with much more modest reserves located in China is closer to fulfilling his goal of making Gazprom the most valuable company in the world. In September 2010, Petrochina ($329 billion) briefly surpassed ExxonMobil ($316 billion) as the company with the highest market capitalization in the world. Although Petrochina has only three quarters of Gazprom’s reserves, it is more than twice as valuable (at times three times as valuable) and its reserves are valued as highly as those of Statoil. If Putin’s energy industry had matched the achievements of Petrochina, its value would be $211 billion higher than it is today.

The valuation of Petrochina’s reserves as highly as Statoil’s may suggest an overvaluation, but it does show the huge chasm between investor sentiment concerning China’s versus Russia’s investment climate.

Again, Russia is the loser and China is the winner, although property rights are far from perfect in China, and China is embarking on its own “national champions” program. The world investment community looks at Petrochina and Gazprom through quite different lenses. These lenses say that Russian energy concerns are going nowhere but down, that property rights are insecure, that corruption is rampant, that assets are being diverted to private hands. In this regard, international investors appear to have an accurate picture of Russian reality.

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