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Gazprom continues to aim high

The towering ambition of Gazprom’s capex programme is matched only by the height of its controversial new St Petersburg headquarters

On 4 September, Russia's gas export monopoly announced it was hiking its capex for 2018 by 16% to a record 1.5 trillion rubles ($22bn) due to an increased budget for its pipelines to China, Europe and Turkey. That's a 17% jump from the capex figure published by Gazprom's board in December and analysts are now questioning the wisdom of this decision.

"Prior guidance for 2018 capex was 1.28 trillion rubles," Luis Saenz, head of equities at BCS Financial, told Petroleum Economist. "This is negative news, especially given its high tax burden and plans for new borrowings."

Stretching out to 2025, Gazprom tops the list globally across the oil and gas value chain with $160bn expected to be spent on 84 projects—almost double the capex of Shell and China's Sinopec.

Gazprom, which holds nearly three-quarters of Russia's gas and 17% of global reserves, has always spent big. Its vast distribution network takes gas to consumers in Russia and more than 30 other countries, but its exploding capex is increasingly drawing the ire of investors and analysts.

Contractors are happy

A report published by Sberbank CIB in June said Gazprom isn't badly run, as many minority shareholders have concluded after studying the monopoly's huge capex and underwhelming revenue growth. In fact, the company is simply performing for the benefit of a different group of stakeholders-namely, Gazprom's contractors.

The report argued that all of Gazprom's major pipeline projects—the $55bn Power of Siberia to China, the $20bn TurkStream to Turkey and the $17bn Nord Stream 2 to Germany—only make sense from the contractors' perspective.

Sberbank CIB analyst Alex Fak said that an alternative pipeline to China would've cost Gazprom at least five times less money than the Power of Siberia. Fak speculated that the company went with the more expensive option because it was favoured by its two biggest contractors: Stroygazmontazh and Stroytransneftegaz, which divided up "almost equally" the main contracts to build the pipeline. Both these contractors are controlled by billionaires Arkady Rotenberg and Gennady Timchenko, who are close personal friends of President Vladimir Putin.

The other two pipelines create over-capacity where the Ukrainian transit route would've served perfectly well, according to Fak, who claims TurkStream won't be profitable for 50 years and Nord Stream 2 for 20 years.

"The contractors and the company are united in their desire to promote any and all boondoggles, at least within the boundaries of Russia, where their activities will face less scrutiny," wrote Fak, who has since lost his job due to the criticism of Gazprom.

In September, Gazprom said its Power of Siberia pipeline from Russia to China is 93% complete and now the company is discussing yet another pipeline. Gazprom has a contract to supply up to 38bn cubic metres of natural gas of gas to China from Eastern Siberia through this pipeline, with deliveries starting in December 2019.

Rising gas demand

The Power of Siberia 2 would source gas from Western Siberian gasfields and connect China via Russia's Altai region. "The new pipeline means that Gazprom's capex will remain elevated after 2020, while the payback for the project is unclear at the moment," said Kirill Tachenniko, senior energy analyst at BCS Financial.

Alexey Miller, a close Putin ally who has run Gazprom since 2001, said the company needs to make "substantial investments" in capital-intensive pipelines in response to rising demand.

"In order to meet increasing demand, Gazprom realises substantial investments to develop new gasfields, transport routes, storage facilities and trading hubs across Europe," Miller said in a conference in June to mark 35 years of Russian gas deliveries to Germany.

Europe indeed remains reliant on Russia for cheap gas. Gazprom said the company's share of the European gas market, where it generates most of its revenue, increased last year to a record high of more than 35%, up from about 30% in 2014.

Last year saw a record of 194bn cm volumes of Russian gas sold to Europe. Gazprom has had a strong start to 2018, with volumes climbing 8% from January to August and gas exports to Europe rising 5.6% year-on-year to 133bn cm.

One of the biggest fears for Gazprom was the potential threat of a liquefied natural gas glut amid a ramp-up of projects in Australia and the US; but the market proved to be tighter than expected, with demand from Asia surprising on the upside.

High European prices

"Gazprom remain confident in their ability to hold on to the current market share in Europe, with a need for aggressive pricing," said Ilkin Karimli, senior energy analyst at Credit Suisse. "Security of supply is once again an issue and as such, negotiations with China continue around potential new supply contracts, in addition to the Power of Siberia."

European gas prices climbed to record highs for a summer season, which will positively contribute to Gazprom's profitability this year after a harsh winter. Second-quarter profits surged five-fold to 259bn rubles.

Gazprom, which hasn't been subjected to Western sanctions resulting from Russian interference in the Ukraine conflict, finds itself threading a political quagmire in the US and Europe.

The company could yet be hit by a US sanctions "bill from hell", even if President Donald Trump is reluctant to act. US policymakers are threatening to sanction Western partners involved in financing Gazprom's $9.5bn Nord Stream 2 pipeline.

A Swedish appeal court reversed itself on 12 September, allowing enforcement of last February's Stockholm Arbitration decision to compel Gazprom to pay Ukraine's Naftogaz $2.6bn for violation of a transit award. However, a UK court on 13 September overturned an 18 June order to freeze Gazprom assets in England and Wales in relation to the same case.

Gazprom hasn't halted its borrowing programme, but the company has decided to hold onto some debt instruments to exclude any risks of cash possibly being frozen by new sanctions. Nevertheless, the company says it doesn't see any risks of the borrowing programme slowing down or ending.

No big dividends

On 30 August, Gazprom's market cap of $48bn was overtaken by privately-owned gas producer Novatek for the first time. Back in 2008, Miller boasted that Gazprom would soon be the most valuable company in the world with a market cap of $1 trillion.

Investors hoping for a dividend windfall to compensate for the lagging share price are likely to be short-changed as well. Analysts at VTB Capital say Gazprom is hell-bent on spending money on "value-destructive" investment projects, rather than complying with a Kremlin decree to raise dividends to 50% of earnings, as defined under International Financial Reporting Standards (IFRS)

Gazprom, the biggest contributor of dividends to Russia's federal budget, has previously sought and obtained two waivers to avoid paying higher dividends.

Miller said he expects Gazprom's current total dividend payment of 190bn rubles ($2.8bn) to remain steady until 2020. That's about 20% of profits, under IFRS, so well below the threshold required by the government decree.

While Gazprom might not have the biggest company in the world, it can now boast the tallest building in Europe.

In 2005, the company shocked conservationists by proposing a 403-metre-high skyscraper right in the heart of St Petersburg's World Heritage Site. Unesco's threat to strip St Petersburg of its World Heritage status forced Gazprom into a rethink after a Russian court ruled in 2010 that the existing height limit couldn't be violated.

The tower was subsequently moved to a new and less historically sensitive site on the outskirts of the city—with another 60 metre defiantly added to its height for good measure. The Lakhta Centre tower, which will open next year and house about 8,000 employees, has already overtaken the Shard in London as Europe's tallest skyscraper.

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