Merkel Salvages Nord Stream, But Is Putin Losing Russia's Gas Monopoly?

The European Union took a first step with its February 8 vote towards turning Russia’s gas monopoly, Gazprom, from an instrument of Russian power politics into a regulated utility, deprived of its monopoly power. In an odd twist, Germany, the self-proclaimed guardian of European unity, found itself politically isolated from the rest of Europe, which sided with U.S. President Donald Trump. A bitter pill for Germany to swallow.



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The Real Colluder With Russia Isn't Trump -- It's Germany

Germany postures itself as the conscience of Europe. Besieged by floods of refugees, Germany takes them in and scolds those who do not. Germany claims to guard European unity against the insidious forces of the nation-state. Germany ridicules the United States for electing a right-wing novice, a real estate developer, no less. It is Germany that stands in the way of Trump’s purported plans to weaken NATO and break apart the European Union. But Germany, the self-declared paragon of European values, finds itself fighting an isolated battle to give Putin’s rogue state its political objectives for the benefit of Germany, Inc.

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How Much Is Saudi Aramco Worth? It Depends On The Country's Institutions

Capital markets are harsh judges. They lay bare the immense social costs of the poorly-run and corrupt energy companies of the world, such as Gazprom, Petrobas, and Rosneft. We now await its judgement on Saudi Aramco.

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Putin in the Dock

Putin has overplayed his hand. In addition to its exposure to liability for damage caused during the conflict in Ukraine, Russia faces legal penalties totaling roughly 4% of its GDP – roughly what it spends on education. Putin may have been able to bring his country’s legal system under his control, but he remains vulnerable to international rulings. With Russia too enmeshed in the international legal and financial system to cut ties and become a rogue state, its president is increasingly likely to face the consequences of his actions.


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EU's Antitrust Charge Against Gazprom: Another Putin Disaster

The trashing of Russia’s most valuable economic asset adds to Putin’s growing list of major policy disasters. By attacking Ukraine, he has alienated the Ukrainian people for generations to come. By saber rattling beyond the borders of Ukraine, he has rejuvenated NATO and given it new purpose. Putin has succeeded in pushing traditional sympathizers in the European community, such as Germany’s foreign minister; they’ve decided that the danger he poses trumps their business interests. Instead of raising Russia’s prestige and national pride, he has turned the country into a pariah state with a tottering economy and declining living standards.
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Russia’s Natural Gas Sales Plummet: Is Russia Captive To European Buyers?

The received wisdom is that Europe cannot offend Russia because it depends so much on Russian natural gas. We have this backwards. It should be: Russia cannot offend Europe because it depends too much on sales of natural gas sales to Europe. Despite efforts to conceal the decline, Gazprom’s 3^rd quarter sales to Europe declined 15 percent and fell to zero for Ukraine. Cash-strapped Russia can ill afford such losses.

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Confused Survey Says Two Russian Energy Giants Top Google And Apple In Corporate Transparency

Transparency International ranks Russia’s two state-owned energy giants in the middle of the top 124 world companies for “transparency” because both have adopted detailed anti-corruption rules. The rankings do not ask whether these companies actually comply with their rules. Stock market valuations show the nonsensical nature of the Transparency International rankings. Investors are not willing to bet on the Russian energy giants because they are non-transparent on the most important risks, and they operate as instruments of Kremlin domestic and foreign policy. As such, they must pay the price for Putin’s adventurism in Ukraine and elsewhere.

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A Bad Gas Deal For Ukraine As Europe Looks After Its Own Interests

The BBC headline tells it all: Russia-Ukraine gas deal secures EU winter supply (via Ukraine). European officials also confirmed the message of the headline. Commission President Manuel Barroso triumphantly declared: “There is now no reason for people in Europe to stay cold this winter,” and European Union energy chief, Guenther Oettinger, announced he was confident that Ukraine would be able to afford to pay for the gas it needed (Says who?). Where are Ukraine’s expressions of gratitude and relief? They are lacking for good reason.

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Stress Tests Conclude That Europe Can Call Putin's Energy Bluff And Win

The European Commission study suggests that Europe is in a position to call Mr. Putin’s bluff. Europe can ignore his threats to cut off countries, like Slovakia, Norway or Poland, which supply Ukraine with gas. Market forces will transfer gas to those most dependent on Russian gas under the market solution.

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As Russia Intimidates Europe, Obama Fiddles On Energy Policy

Vladimir Putin watches the evening news from his Sochi villa: “In an election move, Barack Obama approved the Keystone pipeline and opened offshore public land to drilling. Mexico’s Pemex announced a 50 percent increase in production. Five LNG tankers docked at European ports today, including Riga and Klaipeda. Poland and Lithuania announced significant discoveries of shale gas. In a surprise move, Germany renounced its Energiewende and reopened three nuclear power plants. Russia’s Gazprom competed today with five other suppliers at the annual auction of natural gas contracts in Rotterdam.”

Vladimir Putin awakes in a cold sweat. His gymnast girl friend assures him: Vova: It was just a bad dream. Vova  retorts in a foul mood: No, it

is not a dream. They can crush me if they get their act together.

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As The Sanctions' Noose Tightens, China Grabs Russian Energy Assets At Bargain Prices

When I wrote on August 28 that “Western sanctions are strangling the Russian economy,” I had second thoughts about using such strong language. Events of the last two weeks convince me, however, that I understated the case, especially with the introduction of new sanctions on Friday. The Russian economy faces a severe liquidity crisis, collapsing investment and a severe recession. Putin has jeopardized his “safe” European gas market and faces legal problems that he cannot avoid. His sanctions against the West have simply made his own people worse off.

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Buy Shares of Russian State Companies: This Time We’ll Behave

Russia’s advertising supplement in the New York Times carries an amusing headline: “New Russian Government to Back Privatization Effort.” Apparently the new Russian government wants to sell minority shares in ten state companies, including Sberbank, United Grain, and Novorosiisk Port. The article immediately below it is entitled “Moscow Welcomes Foreign Business.” The red carpet is out for foreign investors, so it seems.

The lead article explains that First Deputy Prime Minister Shuvalov is prepared to go ahead with the sale but that “influential” Deputy Prime Minister Sechin wants to wait until the prices are higher. I think Sechin would have to wait quite a while.

Sechin might be asked why share prices of Russian state companies are so low?  Gazprom, for example, has more reserves than ExxonMobil but sells for a tiny fraction. Why? Everyone knows how corruptly and incompetently Russian state companies are run. Gazprom is among the worst. Now the new Russian government expects naïve foreign investors to forget that there are no real audits of the companies to be sold, that the true owners are masked, and that these companies are run in the interests of the insider shareholders from Putin’s inner circle. Do not forget the past history of dilution and other cavalier treatment of minority shareholders. But the new Russian government is promising that this time will be different. Let’s wait and see.

The only reason to consider buying shares of Russian state companies is to wager that the corruption and mismanagement have been more than fully discounted. Investors cannot invest for value considerations.

If any one doubts what I am saying go to Alexei Navalny’s publication on his web site of the official audit commission report that shows that the management of the state pipeline company stole $5 billion. Navalny is not citing secret documents, but publicly available documents. This news did not seem to turn any heads. This is business as usual in Russia.

Consider United Grain and Novorosiisk Port. Both engage in activities that invite corruption and embezzlement by management. Tales of the corruption of Novorosiisk port have been floating around for a decade.

We’ll see how many foreign investors will walk down Russia’s new red carpet.

Dr. Gregory's latest book can be found at Amazon.com.

A Tale Of Three Thefts: China, Russia, And The U.S.

The denial of the rule of law for the few may affect the economic actions of many.

Russia 2006 
In December of 2006, Gazprom, the Russian energy monopoly, "accepted" control of Sakhalin-2 from Royal Dutch Shell (RDSA - news - people ). Sakhalin-2 is a drilling venture off Sakhalin Island in Russia's North Pacific. Shell negotiated the offshore drilling rights with the Russian government to be Sakhalin-2's owner and operator along with its two Japanese partners. In return, Shell agreed to invest $8 billion. Shell's deal was unusual because it included no Russian partner, but it was approved at the highest levels in 1994. As the end of 2006 approached, Sakhalin-2 was ready to go into production. Shell's investment had grown to $20 billion

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Putin Retakes the Commanding Heights “Communism is Soviet power plus electrification” Lenin

Nothing symbolizes Russia’s economic problems better than its creaky electricity network.  Russia’s electricity generation and transmission capacity was already stretched to its limits during the Soviet period. Most equipment dates back to the electrification drive of the 1930s. Electricity supply is unreliable. Few customers pay enough to cover costs. There is no real regulatory framework.

With the collapse of the USSR, the state-owned Unified Energy System (UES) succeeded the Ministry of Electricity. Prior to 2003, there was virtually no domestic investment in the electricity system. Electricity remained a political football. Regional and municipal governments sold electricity below costs or gave it away free to households. Providers covered their costs, if they were lucky. There were no funds in national or regional budgets for investment in electricity infrastructure.

Russian reformers, headed by UES chairman Anatoly Chubais, saw the electricity system’s salvation in privatization and competition. They peddled promises of market liberalization, deregulation and government assurances to bring in Western investment.

From 2003 to 2008, the government broke up UES and drew in billions of dollars in foreign investment to modernize the industry and create a competitive market for power. The Russian state sold generating and transmission assets to Russian private companies and to European energy giants, such as E.ON,  Enel SpA and Fortum Oyj. The primary concern of investors was whether the Russian government would really allow rate increases to pay off the investment, but these deals were not negotiated in a back room. E.ON’s six billion dollar investment in the Urals and Siberian electricity generating company OGK-4 was signed in the presence of Vladimir Putin and Angela Merkel.  

I can imagine the shock of E.ON and other Western investors to learn that on July 7   Russia announced its intention to de facto re-nationalize the electricity market. Russia’s natural gas giant Gazprom and “privately-held” IES Holding agreed to combine their electricity assets. The new company will supply 70 percent of Russia’s electricity.

The majority shareholder of Gazprom is the Russian government. The Kremlin-friendly billionaire Viktor Vekselberg owns IES. In addition to Gazprom and IES, InterRAO, a state-controlled electricity trader created during privatization, has also been buying power assets to bring more of the industry under state control.

In the announcement of the Gazprom-IES deal, Veksleberg stated that the new company could save billions because “it can buy natural gas cheap from Gazprom.” In other words, over seventy percent of Russian electricity will be produced by a monopoly that uses subsidized natural gas to produce at much lower costs than competitors.

So much for increased competition  and deregulation of Russia’s electricity market. This announcement should send Western investors scrambling for the exit.

As in oil and gas, Putin has recaptured the “commanding heights” of Russian electricity for the Russian state. This is not good news for the Russian economy. It is another slap in the face for Western investors.

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.