The Wall Street Journal: E.On Taps Gazprom Ties for Russia Energy

Talks Are Resumed
To Finalize an Accord
On Siberia Gas Field
By JAN HROMADKO and ANDREAS HEITKER
August 2, 2007

FRANKFURT — E.On AG aims to build on friendly ties with OAO Gazprom to tap Russia’s energy wealth, even as Russian-U.K. relations sour and foreign oil companies relinquish control of Russian resources.

Düsseldorf, Germany-based E.On, the world’s largest nongovernment owned, publicly traded utility by market value, has resumed negotiations with Russian gas monopoly Gazprom over final details of a swap agreement to give E.On a stake of 25% minus one share in the massive Yuzhno-Russkoye gas field in Western Siberia, E.On Chief Executive Wulf Bernotat said.

“All in all, we hope that we can reach an understanding with our partners at the German concern before the start of production at Yuzhno-Russkoye, which is planned for the beginning of autumn,” Gazprom representatives said in a written reply to questions.

E.On and Gazprom struck a basic agreement a year ago on the asset swap, originally intending to seal the deal by the end of 2006. However, Gazprom delayed talks partly to focus on restructuring production-sharing agreements with international oil and gas companies operating in Russia, Mr. Bernotat said.

Gazprom acknowledged the delay in talks with E.On and confirmed those talks have resumed. “The key issue for Gazprom is that the assets proposed by E.On correspond to our strategic goals,” Gazprom said.

E.On isn’t the only participant in Gazprom’s Yuzhno-Russkoye gas field. BASF AG’s fully-owned unit Wintershall AG already runs a joint venture with Gazprom, called Wingas; Wintershall also will take a 25%-less-one-share stake in Yuzhno-Russkoye.

Eni SpA and Enel SpA earlier this year indicated how keen Western energy companies are to gain a foothold into the Russian upstream market. Italy’s biggest energy companies in April paid a combined $5.83 billion for some of the assets belonging to bankrupt Russian oil producer OAO Yukos in an auction that appeared to have the backing of state-controlled Gazprom. These assets include gas-producing companies ArcticGaz and Urengoil, as well as 20% of major Russian oil producer OAO Gazprom Neft. Gazprom holds an option that expires in 2009 to buy the majority of the auctioned assets.

Enel, which has set aside as much as €4 billion ($5.5 billion) to expand in Russia, was keen to secure gas supplies to the power-generating assets it seeks in the vast Eastern European country. Meanwhile, Eni appears to have found a way to channel its Russian gas assets to the lucrative Western European markets with the expected pipeline project, “South Stream,” that will run under the Black Sea announced one month ago in a venture with Gazprom.

As for E.On, talks with Gazprom over the deal have been delayed in recent months “because Gazprom didn’t have enough management resources to manage a number of projects at the same time,” Mr. Bernotat said. Gazprom “had to concentrate on the Shell case for Sakhalin, then on the BP case for the Kovykta gas field, and now they have returned to the negotiating table with us,” he said.

Under pressure from Russian regulators for alleged environmental degradation, Anglo-Dutch oil-and-gas company Royal Dutch Shell PLC last year announced it would hand control of its Sakhalin-2 oil-and-gas joint-venture project in Russia’s Far East to Gazprom. BP PLC joint venture TNK-BP Holding has followed suit and sold its 62.9% stake in its Kovykta project to Gazprom.

While Gazprom secured control of those oil-and-gas projects, E.On backed away from its lengthy takeover battle for Spanish electricity utility Endesa SA earlier this year. E.On then revised its growth strategy in May and highlighted its plans to grow in Russia’s gas and electricity sectors and put its cash to use. E.On has earmarked €3 billion for investment in Russia and Turkey to 2010. This is only a fraction of its €60 billion overall investment strategy, but E.On CEO Mr. Bernotat said the company will invest more in those markets “if necessary and the right opportunities arise.”

Since the E.On strategy shift, Russia’s relations with the U.S. and the U.K. have deteriorated amid rows over the proposed American missile-defense shield and Russia’s refusal to extradite a suspect in the murder of former Russian spy Alexander Litvinenko in London last November.

Seeking to stay above the fray, E.On — a Gazprom shareholder — is pressing ahead with plans in Russia and Western Europe.

E.On’s ties with Russia date to 2002, when it took over Ruhrgas, which had been importing Russian gas since 1973, and stood by Gazprom at a time when other foreigners were heading for the exit after its financial crisis, building a 6.4% stake in the company. Consequently, E.On Ruhrgas CEO Burkhard Bergmann, who also sits on the group’s management board, has been the only foreign member of Gazprom’s board for the last seven years.

“We don’t regard the political side in Russia as a reason not to invest in the country,” Mr. Bernotat said.

Thomas Deser, fund manager at E.On shareholder Union Investment Privatfonds GmbH, added, “We see some political risk for investing in the Russian energy market, particularly in the oil sector where we’ve seen political influence in the past few years.” However, he added, investments in the energy market are for the long term, and as a result, short-term political events shouldn’t be exaggerated.

Today, E.On targets about 10 billion cubic meters per year in gas production, of which the Yuzhno-Russkoye deal will contribute around six billion cubic meters per year, the company has said.

The Yuzhno-Russkoye gas field has proven reserves of around 700 billion cubic meters, making it about one-third as large as Kovykta.

–Geoffrey T. Smith in Moscow, Liam Moloney in Rome and Leia Parker and Benoit Faucon in London contributed to this article.

Write to Jan Hromadko at [email protected]

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