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Gazprom's friends in high places

The Kremlin has killed plans to increase dividends at state firms. Gazprom is off the hook again

Firmer oil prices have left the Kremlin feeling generous—to its friends. Russia's government has decided not to fulfill a decree to force state companies to pay out dividends worth 50% of profits. Gazprom is a major beneficiary. Investors who took the plunge on the back of the government's pledge lose out.

A move to double the company's dividends was described last year by Citigroup's veteran Russia analyst Ron Smith as "a potential game changer". But that potential won't be realised and the big losers are portfolio investors who piled into Gazprom, Rosneft and Transneft, each state controlled, expecting that payouts would rocket from their current levels.

The Kremlin's calculus changed after a pact by Opec and the Kremlin to cut production brought a lift in oil prices. Higher dividends—which would have let the state squeeze more cash from producers—are now no longer an imperative as the additional revenue from crude sales helps to shore up the federal budget and replenish depleted reserve funds.

The dividend plan, which would have raked in an additional R200bn ($3.4bn) for the government, was proposed by the Federal Property Management Agency late in 2015. Prime minister Dmitry Medvedev then signed the order in April mandating eight state-controlled entities to hike their dividends to 50% of earnings under International Financial Reporting Standards.

Advocates of the initiative included finance minister Anton Siluanov and economy minister Alexei Ulyukaev. However, the former doesn't have the clout of his predecessor Alexei Kudrin and the latter was arrested in November on suspicion of taking a $2m bribe in a privatisation deal involving Rosneft.

At an investor forum in mid-January, Siluanov and his deputy Alexey Moiseev were still insisting that the 50% dividend payouts would go ahead—without any exceptions. But ever since Russia's annexation of Crimea in 2014, the influence of the liberal economic bloc in the Kremlin has been on the wane as the so-called siloviki nationalist hardliners have gained the upper hand.

Russia's politically powerful companies, such as Gazprom, have proved themselves more than capable of lobbying their interests successfully at the expense of wider government policy objectives like fiscal tightening. Rosneft, headed by the leader of the siloviki Igor Sechin, has won several key battles over the past year, including the contest to acquire Bashneft—a privatisation that ended up with one state-controlled firm buying the assets of another state-controlled firm.

The finance ministry had sought to reduce the budget shortfall by one percentage point each year in a bid to balance the books by 2020. It brought the deficit below 4% last year by tapping one of its reserve funds and selling some state assets, including a stake in Rosneft.

If oil prices remain at $50 a barrel or higher, the deficit may shrink to just 2% in 2017 as Russia returns to growth after two and half of years of recession.

With talk of US and EU sanctions easing this year, Russia may have other ways to earn revenue. The Kremlin, which struggled to sell a $1bn sovereign bond last year, is looking to tap international capital markets for three times that amount, according to bankers in Moscow.

Shoring up

Likewise, Gazprom is considering tapping the bond markets and may raise $6bn through asset salesa way to shore up its balance sheet as income from exports diminishes.

"Despite the positive outlook for 2017, the company might have to boost borrowings and sell off assets to finance massive international infrastructure projects," says Dmitry Loukashov, senior analyst at VTB Capital, a bank.

An increased dividend payout would have put a large dent in the capital spending programme for Gazprom. In 2017 alone, the gas-export monopoly may have to fork out €4.6bn on Sila Sibiri, an expansion of the Nord Stream II Baltic Sea pipeline to Germany, as well as the Turkish Stream pipeline across the Black Sea.

Gazprom is expected to freeze dividends at current levels until the end of 2019 and boost borrowings threefold in 2018, to R705bn, from R288bn planned for 2017, according to a plan approved by the company's board of directors in late January.

Last year, both Gazprom and Rosneft won waivers from the rule obliging them to pay dividends worth half of their earnings. Gazprom paid a divided last year worth 23.5% of its income, which netted the company a saving of about R210bn. Rosneft paid a dividend worth 35% of its profit after securing its waiver.

Gazprom, which has been run by Alexei Miller since 2001, lobbied hard for lower dividends "to the very top", according to business daily Vedomosti.

While Gazprom delivered solid revenues and earnings in the third quarter of 2016, the company's free cashflow fell well short of analysts' expectations.

The company trades at a rather pitiful five times earnings, which reflects its notorious inability to control costs and optimise spending. Herman Gref, the current boss at state-controlled lender Sberbank, was supposedly being lined a few years up to replace Miller in a bid to transform Gazprom's awful corporate governance.

Politics and strident nationalism have since hijacked any reform agenda and it is understood that Gazprom won't be changing its spots any time soon.

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