The Forbes article below was published in June 2006. It paints a very revealing picture of Shell’s new controlling “partner” in the Sakhalin II project in Siberia. Not Gazprom, but in reality Vladimir Putin, the ruthless “Energy Tsar†who planned and created Gazprom in its current predatory form. Gazprom is described in the article as “scandal-prone†and a “clumsy beast, wounded by its own history of cronyism and corruptionâ€: characteristics it shares with Shell. Gazprom has strong links the Russian security services – Putin is a former KGB Colonel. Shell was closely linked with the British Secret Service for many years (and probably still is). So there is a good deal of common ground. Nonetheless, Jeroen van der Veer and his colleagues could be forgiven for feeling slightly apprehensive when having tea and biscuits with their new Russian boss.  Â
Published by Forbes Magazine
Energy Tsar
By Michael Freedman and Heidi Brown 07.24.06
Vladimir Putin is using publicly traded Gazprom, and its monster reserves, to remake Russia. Should you own a piece of it?
On a recent morning Alexei Miller, head of Russia’s OAO Gazprom, the world’s largest public energy company by reserves, strode toward a lectern in a standing-room-only convention hall in Amsterdam. There to deliver a keynote address to leaders of the world’s foremost oil and gas companies and investors, Miller locked eyes with the crowd and said icily, in English, “The speech will be in Russian.” At that, scores of executives rushed to the exits, tripping over one another to get headphones for a translation. Miller stood alone at the lectern, scowling into the spotlight.
The crowd returned moments later for the speech, a 30-minute overview of the company’s plans. But the incident underscored the contradictory faces of the sixth-most-valuable company on the planet as it lurches toward Western-style capitalism. There’s the slick salesman who needs billions of dollars in capital and technical know-how from the outside in order to exploit a quadrillion cubic feet of proven natural gas reserves (50 years’ U.S. consumption) and 300,000 miles of pipeline crisscrossing Russia from the Baltic border east to Tomsk in Siberia and from Uzbekistan north toward the Arctic Circle. And there’s the clumsy beast, wounded by its own history of cronyism and corruption but proud enough to insist on its own rules. These twin incarnations constantly vie with each other.
Whatever Gazprom turns out to be, it is today a formidable force. Though still inefficient and scandal-prone, the company provides most of the gas to former Soviet states and to central Europe, as well as 25% of the needs of western Europe. Since Miller took over in 2001, the company has increased earnings from $440 million to $7.5 billion, on $42 billion in sales. It has announced one deal after another and is discussing a pipeline to Japan and a joint venture in Iran. By 2010 it expects to send gas in liquefied state from reserves near the Barents Sea to ports in the U.S. And the company is looking eastward, too, with plans to build pipelines to China. In a decade, executives insist, Gazprom’s market cap will exceed $1 trillion.
Despite his title Miller is the second-most-important figure involved with Gazprom. Number one is the 53-year-old president of the Russian Federation, Vladimir V. Putin, who takes center stage at the Group of 8 summit beginning July 15 on his home turf in St. Petersburg. He has made energy security, a subject he has long pondered, the theme of the gathering. Nine years ago, in a late-life Ph.D. dissertation, he laid out his plans for management of the country’s natural resources. And when he assumed the presidency from Boris Yeltsin in 2000, he started consolidating the Kremlin’s power over the nation’s most valuable asset–its rich store of oil, gas and other resources. Putin has seized control of large sectors of the economy, including stakes in autos, aviation, metals and mining. As chief executive of Russia Inc., he is creating a post-Soviet, post-Yeltsin superpower whose strength comes not from warheads but from commodities.
Putin has put his stamp in particular on the nation’s largest company and crown jewel, Gazprom, where he packed the board with friends from his hometown St. Petersburg, including Dmitry Medvedev, simultaneously chairman of the Gazprom board and Putin’s first deputy prime minister, and installed Miller, then an unknown technocrat with little direct experience in the gas industry. Last year the government paid $7.1 billion to Gazprom subsidiaries for an additional 10.7% stake in Gazprom, giving the Kremlin a majority stake in the company. Putin’s interest in energy is perhaps not just geopolitical; there are rumors he will take over Gazprom himself in 2008 when his second term is over and he is supposed to step down.
He has denied any interest in the job. Yet, more than any previous Russian politician, Putin recognizes the importance of an industry that provides not just heat to the nation’s 143 million people but as much as 20% of its $77 billion in annual tax revenue. Energy is the foundation of Putin’s ultimate source of strength: the widespread support of the Russian people. Largely because of the national energy supply, and Putin’s ability to exploit it, per capita personal income has increased 29% annually since 2001. Renationalizing Russia’s resources is tantamount, in a post-Cold-War age, to resurrecting the old empire.
Putin’s role model isn’t Stalin but Peter the Great (1672–1725), whose portrait hangs in his office. Peter dragged a backward Russia into the modern age by exploiting Western technology–shipbuilding in particular–and creating a formidable navy, as he reformed the economy and enlarged national boundaries. By the time he died, Russia was a mighty European power.
To the outside world today a Russia resurgent comes across as threatening and potentially dangerous. Coincident with the Kremlin’s chauvinistic grab for greater ownership of energy companies comes its curtailment of civil liberties, the crushing of dissident media groups and jailing or expelling powerful political rivals (like Mikhail Khodorkovsky, now doing time in Siberia for financial misdeeds at his oil company). Gazprom’s brief shutdown of natural gas to Ukraine last winter sent a shudder through Europe and later provoked Vice President Dick Cheney to say, “No legitimate interest is served when oil and gas become tools of intimidation or blackmail.” A recent call for more government control of multibillion-dollar projects with ExxonMobil and Royal Dutch Shell has Westerners rethinking whether they want to send capital into this nation and wondering whether Russia has really molted a past pocked by scandalous inefficiency–and worse. Is Gazprom the latest weapon with which to wage foreign policy or a powerful partner ready to do business?
Gazprom executives insist the company’s role in Russia is merely to be a fast-growing enterprise. “Why are we attacked so brutally and unfairly?” asks Alexander Medvedev, deputy chairman of Gazprom’s management committee and architect of its ambitious plans for global expansion, in accented English. “Seven years ago we have a $20 billion capitalization; today it is ten times more. We don’t have any problems raising money for our projects. We are introducing modern marketing techniques, project management, and not everybody likes it because it’s a competition.” Adds Victor Khristenko, Russian Minister of Industry & Energy, “Our goal is to make Gazprom a strong international player that honors contract commitments and is respected worldwide.”
Sinister or stumblebum, Gazprom has long been intertwined with the government. Its roots date back to the Stalin era, when the government built a 525-mile pipeline to bring gas from Saratov in the south to Moscow. Though hugely wasteful and disorganized under the centralized Communist economy, in the 1970s it still supplied all the Soviet states and, by way of pipelines in Ukraine, even parts of western Europe, says Arild Moe, deputy director at Fridtjof Nansen Institute in Lysaker, Norway. By the 1980s the state gas sector that ran the operation was controlled by a classic Soviet functionary, Victor Chernomyrdin, and he held on tight to his post until 1992, a year after Boris Yeltsin became the first popularly elected leader of Russia.
Under Yeltsin the economy began to stagger toward free-market capitalism. Like many who became rich and powerful during those years, Chernomyrdin turned his government appointment into an opportunity for personal gain. In 1992 he created Gazprom. Nearly free from government regulation, it later provided financial support and advice to 130 political candidates, including his own “Our Home is Russia” party. In 1992 he became Russia’s prime minister, and control of Gazprom was assumed by his deputy, Rem Vyakhirev, a chain-smoking Soviet-style bureaucrat, whose first name stood for Revolution, Engels, Marx.
Despite his background, many outsiders believed Vyakhirev was absorbing lessons of Western business. In the three decades Gazprom had sold gas to western Europe, it never missed a delivery, and in 1997 he told FORBES of his ambitions to expand the company overseas. Yet the Yeltsin era was scarred by widespread corruption and asset looting; Gazprom was not immune. When the government sold a slug of the company in 1994, one-third of its shares were bought at closed auctions. According to the hedge fund and investor Hermitage Capital Management, between 1997 and 2001 the company lost 10% of its gas reserves via share dilution to partners in various joint ventures, totaling an amount equal to Exxon’s entire reserves at the time.
One outfit, called Itera, bought gas from Gazprom and the central Asian nation of Turkmenistan, resold it on the market to Ukraine and other former Soviet states and acted as a sort of guarantor that Gazprom would be paid by indebted former Soviet states. But Hermitage estimates that over a seven-year period, beginning in 1996, Gazprom gave away half the revenue from gas markets in those former states to Itera, at a loss of $7 billion. Itera also wound up owning Gazprom gasfields and other assets. In a recent U.S. federal court lawsuit Texas oilman Richard Moncrief alleged that Itera had fraudulently stripped Gazprom of assets. The suit has been thrown out on jurisdictional grounds; Moncrief has appealed.
Who benefited from Itera? The company is run by champion cyclist Igor Makarov from Turkmenistan, who operates out of a four-story building in Jacksonville, Fla. But the Russian press and many others have suggested that Rem Vyakhirev and Chernomyrdin or their families were enriched by the dealings with Itera, though both men have denied it. Still, FORBES estimated in 2001 that the two men each had fortunes upward of $1.1 billion, the direct result of their work with a onetime Soviet ministry.
Investors who complained were blackballed or worse. Boris Federov, an investor and a former minister of finance, criticized the company’s leadership, which reacted so fiercely he began to fear for his life, according to an account by Marshall Goldman, an economist and Russia scholar at Harvard. Federov was threatened with jail. The Russian mafia paid him a visit. His dog was poisoned. He remains on Gazprom’s board and is active in national politics.
But life at Gazprom, and the world of Russian business, started to change in June 2000, with the ascension of Vladimir Putin. He cracked down on the wealthy rogues who enriched themselves during the Yeltsin era. Sibneft Oil’s Boris Berezovsky fled to England; Russia’s richest man, Yukos Oil boss Khodorkovsky, was marched off to prison on a conviction for tax evasion and fraud. The Kremlin broke apart Yukos and seized control of its oil assets. Particularly dismaying to Westerners was the heavy-handed treatment of Khodorkovsky and the show-trial nature of the court proceedings. The Russian stock market plunged 10% on the news of his arrest.
Yet Putin’s tactics paid off. Last October Gazprom paid $13 billion, financed by banks, for 73% of Sibneft. Authorities dismantled Yukos in a closed auction, and its key assets were ultimately acquired by state-controlled Rosneft, which is slated to go public on the London Stock Exchange this summer in one of the largest initial offerings ever. With the oligarchs reined in, companies began paying taxes, living standards improved and, in the words of one of Russia’s most bullish investors, the nation went from “horrible to bad.”
By seizing control of energy resources, Putin could also begin to clean them up. At Gazprom he sent Vyakhirev packing and anointed the now 44-year-old Miller, who had worked with Putin in the St. Petersburg mayor’s office, served as a port director, run a small pipeline company and served as deputy energy minister. In 2001 the Gazprom board, made up of six government insiders and five others, unanimously approved a Kremlin proposal to appoint the young official as head of the company. With the arrival of Miller, notes Jonathan Stern of the Oxford Institute for Energy Studies, Gazprom became a part of the state of Russia, with direct links to Putin, and “accepted its role as an instrument of government policy.”
Miller’s first task was, according to the Russian press, “to restore constitutional order.” He dispensed with many of the old-guard characters who struck it rich at Gazprom, began paying dividends and set about repurchasing or reclaiming subsidiaries Gazprom had sold or lost control of. It won victories in the Russian courts, for instance, and supported an effort by the state prosecutor’s office to recover $85 million in an illegal sale of Gazprom assets. By such means, which some asset holders have contested, Miller has been largely successful, recovering billions of dollars’ worth of assets and regaining control of subsidiaries in former Soviet states and elsewhere. John Connor, who manages the Third Millennium Fund in New York City, which has 7% devoted to Gazprom, says the company has come a long way since Miller took over. “At shareholder meetings, it used to be you didn’t know who you were voting for,” he says. “Now they have an investor relations department that supplies information like that. It’s much more businesslike.”
But Miller–and Putin–still have a long way to go to remake Gazprom’s image in the West. Investors complain about its inordinately high payments to obscure intermediaries for basic supplies. Between 2003 and 2004 Ukrainian pipe prices inched up 1%, but Gazprom reported price increases of 35%. Following a 2002 project in Turkey, known as Blue Stream, the chairman of the Turkish pipeline company was tried and later fined over alleged corruption involving the cost of materials; Gazprom shelled out roughly twice as much. (The company says the Russian part of the project was more difficult because of terrain differences.) Then there are the billions of dollars worth of ancillary businesses, many of which are losing money. Over the years Gazprom has owned stakes in such things as a poultry farm and a resort on the Black Sea. In 2004, Hermitage Capital says, Gazprom paid $1.5 billion to employees in offshoot businesses, resulting in losses of $350 million. Gazprom executives say they are in the process of restructuring noncore assets.
Adding to outsiders’ suspicions about the company is a lack of transparency in its relationships with states like Ukraine and Turkmenistan. (Turkmen dictator, President Saparmurat Niyazov, is known for human rights violations and has renamed the months of the year after himself and members of his family.) In 2001 Gazprom cut out the middleman’s role for Itera, which bought gas from Gazprom and Turkmenistan, then sold it at a far higher price in Gazprom’s own markets, according to U.K. corporate watchdog Global Witness. But two new companies simply took its place. First came Eural Transgas, a Hungarian company granted rights by Gazprom to sell gas to Ukraine. Its true shareholders are unknown, and Carlos Pascual, then U.S. ambassador to Ukraine, remarked at a conference in Kiev that he feared it was connected to organized crime. The company’s long-term contract effectively ended in July 2004, when Putin himself met in Yalta with Ukraine’s then president, Leonid Kuchma, and a group of oil and gas executives, including Gazprom’s Miller, and drafted terms for a new outfit to deliver gas to Ukraine called Rosukrenergo.
Like its predecessors this new company makes enormous profits on each trade, buying Gazprom gas for $2.27 per million cubic feet and selling it for $5.55, according to Mikhail Korchemkin, a Malvern, Pa. energy consultant. But Gazprom owns just 50% of this company, giving up half the profits–and, seemingly, transparency. Ownership of the remaining half of Rosukrenergo was a closely guarded secret until April, when, amid news of a possible U.S. Justice Department investigation, two mysterious businessmen, Dmitry Firtash and Ivan Fursin, came forward to claim their stakes (respectively, 40% and 10%). Who are these guys? Firtash owns part of Eural Transgas and has media interests in Ukraine, while Fursin reportedly owns a movie theater and other small businesses. (Gazprom says the Ukrainians insisted on this arrangement.)
Gazprom has also raised hackles by the way it has thrown its weight around on oil and gas projects. It has, for instance, tied a much sought-after deal to extract gas at Shtokman in the Barents Sea and deliver it to North America–Chevron and ConocoPhillips are among the contenders–with Russia’s accession to the World Trade Organization, according to Andrew Somers, head of the American Chamber of Commerce in Russia. (Gazprom denies there is any quid pro quo.) More ominously, it is delaying TNK-BP, half-owned by the British energy giant, from developing the gas-rich field of Kovykta in eastern Siberia. Gazprom claims that TNK-BP is not addressing the gas needs of the region’s population. But the location makes the field ideal for eventual supply to China, and observers are convinced Gazprom is conniving to keep it for itself. Anton Rubtsov, an oil and gas analyst at Rye, Man & Gor Securities in Moscow, says if Gazprom denies TNK-BP access to the pipeline, the Russo-English company will lose its license for the field. “Gazprom could acquire full control,” he says. The company denies this, saying that Russian law makes it impossible for TNK-BP to fully exploit the fields on its own.
But nothing has inspired greater paranoia than Gazprom’s ham-fisted dealings with Ukraine. Last winter it raised prices on gas, as it had said it would. Yet rather than work through back channels or phase in the price increases, it briefly cut off Ukraine’s energy supply and began reducing pressure in transmission lines that carry supplies to western Europe. Gazprom blamed Ukraine, saying it needed to pay market prices, and insisted that the reduced pressure to Europe was the result of illegal siphoning of gas in Ukraine. Whatever its motives, western Europeans suddenly believed they had reason to fear for their own energy security.
The backlash erupted in the U.K., amid speculation that Gazprom was interested in purchasing Centrica, a British gas company. Tony Blair’s government promised “robust scrutiny” of the deal but backed down while Gazprom threatened to sell its gas in other markets, suggesting to many that it planned to tear up or renegotiate existing long-term gas delivery contracts. Gazprom now denies it was ever interested in Centrica and the implication that contracts were in jeopardy. Still, these incidents only ratcheted up nervousness about the reliability of Russian energy. “They don’t seem to get it when it comes to reputation,” says Clifford Gaddy, an economist and Russia expert at the Brookings Institution. “Nobody trusts them anymore. No one. They have no idea how much they’ve been hurt, and it’s impossible to say how long it will take them to recover the trust.”
Gazprom seems to be trying. This winter the Russian parliament relaxed rules on foreign ownership of shares, which trade as American Depositary Receipts. For all its ursine huffing and puffing, Gazprom vitally needs outsiders. Europe is likely to be the company’s biggest market for years to come. Fulfilling its other ambitions will require partners and the ability to make large acquisitions. And Gazprom executives will need foreign expertise to tap reserves in some of the world’s most inhospitable places–Sakhalin in the Far East and Shtokman, toward the Arctic Ocean, among them. If it hopes to crack the world’s biggest market, the U.S., it needs help every step of the way–from tapping the reserves and liquefying the gas to acquiring capacity at the handful of regasification terminals in North America.
Last September a group of Gazprom and other executives stood at the Cove Point Lighthouse in Maryland, cheering as the Castillo de Vellalba tanker cruised into the terminal. The arrival of the ship, filled with 4.4 million cubic feet of LNG, marked the company’s first delivery to America. Yet it was just a dress rehearsal, a favor from Western energy companies, to help traders at Gazprom’s new London trading desk learn how to put in place agreements between buyer and seller, work out kinks in the system and go through the process of finding and negotiating for cargo and locating a home for it. “This is not a business where you can get away with bullying a counter-party,” says John Hattenberger, Gazprom’s point man in the U.S., from his one-man office in downtown Houston, set up in preparation for building more permanent Gazprom digs there.
It will be at least four years before Gazprom is fully prepared to enter the North American market. Expansion into China is a long way off, too. But as Gazprom gropes its way to fulfilling its global ambitions, it will be under the spotlight as never before. Putin has turned Gazprom into the nation’s public persona–creating in the process the specter of a frightening and newly powerful Russia. This weekend at the G8 conference, the president, not Miller, is onstage for all the world to see. Will Russia–with its difficult and confounding history, its boom-and-bust cycles, its questionable commitment to rule of law and open markets–once again send investors stampeding for the exits?
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