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<b>STRATFOR - Russia: The Politics of Gazprom's Baltic Sea Plans</b>
August 23, 2005 20 46 GMT
Summary
Russian natural gas monopoly Gazprom has begun construction on a multi-billion dollar pipeline to ship natural gas to Germany. There is far more at stake here than a mere pipeline. Gazprom is being used as arm of Russian foreign and domestic policy, and a sometimes unwilling one at that.
Analysis
Russian natural gas firm Gazprom announced Aug. 19 that it had broken ground on a new pipeline project that would ship natural gas under the Baltic Sea directly to Germany. The economics of the project are questionable at best, but that does not mean that the Russians will not proceed with it. Note we said the Russians -- not Gazprom. The project is inherently political and geopolitical and reveals much about what the Russian government is thinking -- and how it is using Gazprom.
By any financial measure, the Baltic Sea project is a white elephant. Since nearly the entirety of the line would lie under the Baltic Sea, there would be almost no pumping stations along the length of the project. The result is an extremely high-cost, and relatively low-capacity, chunk of infrastructure. Gazprom is being deliberately vague about the project's cost and capacity, with estimates -- Gazprom's and independents' -- of costs ranging from $2 billion to $12 billion and up, and capacity from 10 billion to 55 billion cubic meters. One thing is sure: The cost-benefit ratio will be extremely high. On average, undersea lines cost three to five times as much as their conventional land-bound counterparts. Once completed, the line will be the longest sub-sea line on the planet, stretching 1,200 kilometers from Vyborg, Russia to Greifswald, Germany.
Unsurprisingly, no one has expressed a whit of interest in participating in the line's construction. That includes the European Bank for Reconstruction and Development, which was formed to help transition the economies of the former Soviet empire to market status, the European Commission, which helps oversee European energy infrastructure and has an interest in maintaining smooth relations with Moscow, or even German energy firm E.On-Ruhrgas, which actually owns about 6.5 percent of Gazprom. What support has come out of Europe has come from German Chancellor Gerhard Schroeder, who for political reasons wants to appear close to the Kremlin. But even Schroeder has not promised a single euro to the project. We have long noted that if this project is to be realized, it will be because the Russians have chosen to pay for it themselves.
Gazprom is well aware of the project's dubious economic "merits," and has hardly been the loudest cheerleader for the pipeline. Financially, it certainly has reasons not to. Although Gazprom is the world's largest producer of natural gas, the company has severe problems breaking even. The Russian government regularly fleeces the firm -- Gazprom consistently supplies one-quarter of all government revenues -- and forces it to supply the Russian market with as much natural gas as it needs at well below market rates. The result is that 71 percent of all Gazprom production is sold roughly at cost, with all of the firm's profits stemming from the remainder, which is exported.
Gazprom even has the benefit of previous experience to tell them that the project will be a white elephant. In 2002, the company helped finance the construction of the Blue Stream pipeline under the Black Sea to Turkey. In order for the line to operate at a profit, Gazprom had to hike up the costs of the natural gas used to fill it. After carrying out an investigation that revealed that the line was only built because of some hefty kickbacks, Ankara balked at the cost and walked away, leaving Gazprom with an unused undersea pipeline suspiciously similar to the one they have just broken ground on.
Gazprom's announcement that it had broken ground on the pipeline reflects its lack of enthusiasm for the project. The construction that has begun is only the portion of the project that will stretch from the existing Gazprom infrastructure to the Baltic coast. Gazprom plans to take a leisurely six months to construct this short 100-kilometer portion, and then blitzkrieg through the 1,200 kilometers of undersea construction in two to three years. The reason for the odd schedule is simple: Gazprom is hoping that a Western entity will be convinced that the Russians are serious about building the line with or without assistance, and therefore sign on to the project to avoid being left out.
So what are the bigwigs at Gazprom thinking? Surely they realize they are just pouring money into the Baltic. After all, Gazprom's real interest is in transitioning from a "mere" natural gas firm to a global energy supermajor. Specifically, Gazprom wants to expand its portfolio to include large amounts of oil production. In that effort, Gazprom is essentially starting from scratch; while its natural gas production is the largest in the world, it only produces about 220,000 barrels of crude per day.
Getting from rookie to supermajor requires one of two paths. First, it can embark on a decades-long effort to expand its assets and expertise. Second, it can acquire a pre-existing oil firm. Gazprom is in the process of negotiating a loan with a consortium of Western banks to pursue this second option.
But enough about Gazprom's savvy business plans. If Gazprom is not all that thrilled about its undersea pipeline, who is so thrilled that they are able to force Gazprom to build it -- and why?
This project is not about money, and it certainly is not about profitability. It is about geopolitical strategy. Currently Russia's natural gas export lines flow through Ukraine, Poland, Romania and a handful of other states whose histories with Russia cannot exactly be described as full of brotherly love. Many among Russia's nationalist factions feel that this creates dependence, and would prefer to have the country's energy exports bypass as many transit states as possible. The primary rationale for the line in their mind -- indeed, the only rationale at all -- is that it would ship Russian natural gas directly to Germany, cutting out all interim players.
Such players see Germany as the most likely Western power to pursue friendly relations with Moscow, and therefore, a country that Russia needs to establish direct ties with. There is considerable evidence to support the idea that Germany is rather pro-Russian. During the"Orange Revolution" in Ukraine in late 2004, a broad array of Western interests participated diplomatically and otherwise in helping now-President Viktor Yushchenko seize the reins of power. Notable by its absence was Germany. Under Schroeder, Berlin has been quite aggressive in seeking out Russian opinions on topics ranging from Iraq to Iran to the European Union.
The Baltic line is not about money; it is about strategic alignment -- and with some help from the government, Gazprom is going to find itself with the cash to build it.
Ultimately, the Russian government sees Gazprom as not just a cash cow, but a tool of foreign policy. Though Gazprom CEO Alexei Miller is not exactly happy with that arrangement, he realizes that since he is running what is in essence a state firm, he has little leverage to resist initiatives that have the support of broad swathes of the governing elite, not to mention President Vladimir Putin himself. Russia's nationalists are most certainly on the rise, and the Baltic line is something they direly want.
The only question then, is how to make sure that Gazprom can pay for the Baltic line? Several Western firms are happy to help Gazprom acquire Sibneft in an above-the-table transaction, but none is willing to underwrite a project of such questionable profitability as the Baltic pipeline. If Gazprom is going to build this project, it will have to do so from its own meager cash reserves.
Luckily for Russia's nationalists, there is a neat way to square the circle.
Although Gazprom is majority state-owned, not all of those government shares are in the hands of the actual government. A fair chunk of the shares Gazprom holds itself. In order to solidify state ownership over Gazprom (and not incidentally, control over Gazprom's strategic agenda) the state needs to acquire those shares. Gazprom's problem is primarily cash. As luck would have it, the 10.74 percent of Gazprom's shares that Russia's nationalists want to file safely away are worth about $7.15 billion, and the government is in the process of filing paperwork with itself in order to finalize the funds/shares transfer.
And there is one final player in this mix: Rosneft. Rosneft is the Russian state firm that snatched Gazprom's first oil acquisition target, Yukos, away from Gazprom at the last second. As part of that effort, Rosneft is also hoping to get the 20 percent of Sibneft shares that Yukos holds as part of a two-year-old (and now defunct) merger deal. If Rosneft were to secure those shares, and then purchase another 5 percent of Sibneft in open market trading, it would have a blocking stake in the oil firm -- effectively paralyzing Gazprom's corporate plans.
Consequently, Gazprom is buying up as many as it can of the 8 percent of freely traded shares of Sibneft that are available on the open market, in order to prevent Rosneft from being able to get that blocking stake. The Moscow rumor mill indicates that Gazprom may have already acquired 3 percent. Add in the 72 percent that Gazprom plans to purchase from Sibneft's owners directly, and Gazprom should achieve its goal of becoming an energy supermajor.
But that does not mean that Rosneft is finished. Though it might not be able to sabotage Gazprom's plans for Sibneft, it certainly does not want Gazprom to be flush with cash and looking for more acquisition targets. Rosneft's solution? Help saddle Gazprom with an expensive white elephant. Most likely one of the loudest voices arguing within the Kremlin for Gazprom to construct the Baltic pipeline regardless of cost has nothing to do with nationalist goals -- and everything to do with Rosneft wanting to tie Gazprom's spare cash to a bum project.
© Copyright 2005 Strategic Forecasting Inc. All rights reserved.
<b>STRATFOR - Russia: The Politics of Gazprom's Baltic Sea Plans</b>
August 23, 2005 20 46 GMT
Summary
Russian natural gas monopoly Gazprom has begun construction on a multi-billion dollar pipeline to ship natural gas to Germany. There is far more at stake here than a mere pipeline. Gazprom is being used as arm of Russian foreign and domestic policy, and a sometimes unwilling one at that.
Analysis
Russian natural gas firm Gazprom announced Aug. 19 that it had broken ground on a new pipeline project that would ship natural gas under the Baltic Sea directly to Germany. The economics of the project are questionable at best, but that does not mean that the Russians will not proceed with it. Note we said the Russians -- not Gazprom. The project is inherently political and geopolitical and reveals much about what the Russian government is thinking -- and how it is using Gazprom.
By any financial measure, the Baltic Sea project is a white elephant. Since nearly the entirety of the line would lie under the Baltic Sea, there would be almost no pumping stations along the length of the project. The result is an extremely high-cost, and relatively low-capacity, chunk of infrastructure. Gazprom is being deliberately vague about the project's cost and capacity, with estimates -- Gazprom's and independents' -- of costs ranging from $2 billion to $12 billion and up, and capacity from 10 billion to 55 billion cubic meters. One thing is sure: The cost-benefit ratio will be extremely high. On average, undersea lines cost three to five times as much as their conventional land-bound counterparts. Once completed, the line will be the longest sub-sea line on the planet, stretching 1,200 kilometers from Vyborg, Russia to Greifswald, Germany.
Unsurprisingly, no one has expressed a whit of interest in participating in the line's construction. That includes the European Bank for Reconstruction and Development, which was formed to help transition the economies of the former Soviet empire to market status, the European Commission, which helps oversee European energy infrastructure and has an interest in maintaining smooth relations with Moscow, or even German energy firm E.On-Ruhrgas, which actually owns about 6.5 percent of Gazprom. What support has come out of Europe has come from German Chancellor Gerhard Schroeder, who for political reasons wants to appear close to the Kremlin. But even Schroeder has not promised a single euro to the project. We have long noted that if this project is to be realized, it will be because the Russians have chosen to pay for it themselves.
Gazprom is well aware of the project's dubious economic "merits," and has hardly been the loudest cheerleader for the pipeline. Financially, it certainly has reasons not to. Although Gazprom is the world's largest producer of natural gas, the company has severe problems breaking even. The Russian government regularly fleeces the firm -- Gazprom consistently supplies one-quarter of all government revenues -- and forces it to supply the Russian market with as much natural gas as it needs at well below market rates. The result is that 71 percent of all Gazprom production is sold roughly at cost, with all of the firm's profits stemming from the remainder, which is exported.
Gazprom even has the benefit of previous experience to tell them that the project will be a white elephant. In 2002, the company helped finance the construction of the Blue Stream pipeline under the Black Sea to Turkey. In order for the line to operate at a profit, Gazprom had to hike up the costs of the natural gas used to fill it. After carrying out an investigation that revealed that the line was only built because of some hefty kickbacks, Ankara balked at the cost and walked away, leaving Gazprom with an unused undersea pipeline suspiciously similar to the one they have just broken ground on.
Gazprom's announcement that it had broken ground on the pipeline reflects its lack of enthusiasm for the project. The construction that has begun is only the portion of the project that will stretch from the existing Gazprom infrastructure to the Baltic coast. Gazprom plans to take a leisurely six months to construct this short 100-kilometer portion, and then blitzkrieg through the 1,200 kilometers of undersea construction in two to three years. The reason for the odd schedule is simple: Gazprom is hoping that a Western entity will be convinced that the Russians are serious about building the line with or without assistance, and therefore sign on to the project to avoid being left out.
So what are the bigwigs at Gazprom thinking? Surely they realize they are just pouring money into the Baltic. After all, Gazprom's real interest is in transitioning from a "mere" natural gas firm to a global energy supermajor. Specifically, Gazprom wants to expand its portfolio to include large amounts of oil production. In that effort, Gazprom is essentially starting from scratch; while its natural gas production is the largest in the world, it only produces about 220,000 barrels of crude per day.
Getting from rookie to supermajor requires one of two paths. First, it can embark on a decades-long effort to expand its assets and expertise. Second, it can acquire a pre-existing oil firm. Gazprom is in the process of negotiating a loan with a consortium of Western banks to pursue this second option.
But enough about Gazprom's savvy business plans. If Gazprom is not all that thrilled about its undersea pipeline, who is so thrilled that they are able to force Gazprom to build it -- and why?
This project is not about money, and it certainly is not about profitability. It is about geopolitical strategy. Currently Russia's natural gas export lines flow through Ukraine, Poland, Romania and a handful of other states whose histories with Russia cannot exactly be described as full of brotherly love. Many among Russia's nationalist factions feel that this creates dependence, and would prefer to have the country's energy exports bypass as many transit states as possible. The primary rationale for the line in their mind -- indeed, the only rationale at all -- is that it would ship Russian natural gas directly to Germany, cutting out all interim players.
Such players see Germany as the most likely Western power to pursue friendly relations with Moscow, and therefore, a country that Russia needs to establish direct ties with. There is considerable evidence to support the idea that Germany is rather pro-Russian. During the"Orange Revolution" in Ukraine in late 2004, a broad array of Western interests participated diplomatically and otherwise in helping now-President Viktor Yushchenko seize the reins of power. Notable by its absence was Germany. Under Schroeder, Berlin has been quite aggressive in seeking out Russian opinions on topics ranging from Iraq to Iran to the European Union.
The Baltic line is not about money; it is about strategic alignment -- and with some help from the government, Gazprom is going to find itself with the cash to build it.
Ultimately, the Russian government sees Gazprom as not just a cash cow, but a tool of foreign policy. Though Gazprom CEO Alexei Miller is not exactly happy with that arrangement, he realizes that since he is running what is in essence a state firm, he has little leverage to resist initiatives that have the support of broad swathes of the governing elite, not to mention President Vladimir Putin himself. Russia's nationalists are most certainly on the rise, and the Baltic line is something they direly want.
The only question then, is how to make sure that Gazprom can pay for the Baltic line? Several Western firms are happy to help Gazprom acquire Sibneft in an above-the-table transaction, but none is willing to underwrite a project of such questionable profitability as the Baltic pipeline. If Gazprom is going to build this project, it will have to do so from its own meager cash reserves.
Luckily for Russia's nationalists, there is a neat way to square the circle.
Although Gazprom is majority state-owned, not all of those government shares are in the hands of the actual government. A fair chunk of the shares Gazprom holds itself. In order to solidify state ownership over Gazprom (and not incidentally, control over Gazprom's strategic agenda) the state needs to acquire those shares. Gazprom's problem is primarily cash. As luck would have it, the 10.74 percent of Gazprom's shares that Russia's nationalists want to file safely away are worth about $7.15 billion, and the government is in the process of filing paperwork with itself in order to finalize the funds/shares transfer.
And there is one final player in this mix: Rosneft. Rosneft is the Russian state firm that snatched Gazprom's first oil acquisition target, Yukos, away from Gazprom at the last second. As part of that effort, Rosneft is also hoping to get the 20 percent of Sibneft shares that Yukos holds as part of a two-year-old (and now defunct) merger deal. If Rosneft were to secure those shares, and then purchase another 5 percent of Sibneft in open market trading, it would have a blocking stake in the oil firm -- effectively paralyzing Gazprom's corporate plans.
Consequently, Gazprom is buying up as many as it can of the 8 percent of freely traded shares of Sibneft that are available on the open market, in order to prevent Rosneft from being able to get that blocking stake. The Moscow rumor mill indicates that Gazprom may have already acquired 3 percent. Add in the 72 percent that Gazprom plans to purchase from Sibneft's owners directly, and Gazprom should achieve its goal of becoming an energy supermajor.
But that does not mean that Rosneft is finished. Though it might not be able to sabotage Gazprom's plans for Sibneft, it certainly does not want Gazprom to be flush with cash and looking for more acquisition targets. Rosneft's solution? Help saddle Gazprom with an expensive white elephant. Most likely one of the loudest voices arguing within the Kremlin for Gazprom to construct the Baltic pipeline regardless of cost has nothing to do with nationalist goals -- and everything to do with Rosneft wanting to tie Gazprom's spare cash to a bum project.
© Copyright 2005 Strategic Forecasting Inc. All rights reserved.
