Cablegate: Gazprom's Reversal of Fortune, Part One

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INFO RUCNCIS/CIS COLLECTIVE PRIORITY
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DEPT FOR EUR/RUS, EEB/ESC/IEC GALLOGLY AND WRIGHT, S/EEE
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E.O. 12958: DECL: 10/05/2019
TAGS: EPET ENRG ECON PREL RS

SUBJECT: GAZPROM'S REVERSAL OF FORTUNE, PART ONE

REF: A. MOSCOW 971
B. MOSCOW 403
C. MOSCOW 367

Classified By: Econ MC Matthias J. Mitman for Reasons 1.4 (b/d)

1. (U) This is the first of a two-part report on the new
economic realities facing Gazprom, Russia's state-owned gas
sector giant.

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summary
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2. (SBU) Far from reaching its ambitions of becoming "the
most valuable company in the world," Gazprom's fortunes have
reversed dramatically in the past year. The company's market
value, production, and sales have all plummeted since the
onset of the economic crisis. With dramatically reduced
cash-flow, the company has been forced to cut back on capital
expenditures and its ambitions, despite political rhetoric to
the contrary. However, as we will examine in part two of
this report, Gazprom's problems are likely longer term. End
summary.

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massive reversal in major indicators
------------------------------------

3. (U) Major indicators of Gazprom's performance have all
reversed course dramatically in the past year. (Note:
Figures in this report are taken from Gazprom reports,
statements, and presentations, unless otherwise indicated.
End note.)

Market capitalization --

4. (U) At its peak in May 2008, Gazprom's market valuation,
based on the small percentage of its shares that trade
publicly, was over $350 billion, and company president Alexey
Miller declared Gazprom would become "the most valuable
company in the world." Miller suggested Gazprom's market
capitalization would reach $1 trillion in the near future.
By May 2009, in the midst of the global economic and
financial crisis, the company's market capitalization had
dropped to its recent low of approximately $75 billion, but
has since rebounded to approximately $120 billion.

Production --

5. (U) Gazprom's gas production peaked in 2006, at 556
billion cubic meters (bcm). In 2008, it was 550 bcm. In the
first seven months of 2009, however, Gazprom's production was
down almost 25% over the same period in 2008. As of
September 2009, Gazprom expects 2009 production to reach just
474 bcm, and many analysts believe that figure to be overly
optimistic. In a September note on Gazprom, investment bank
Troika Dialog predicted Gazprom would have difficulty even
reaching 460 bcm. On the low end, some analysts estimate
Gazprom could produce just 450 bcm or less in 2009 -- a 100
bcm or more decline from its peak production. Even this
massive drop in production is masked to some degree by the
halt in gas imports from Turkmenistan since April (ref A).
In 2008, Gazprom imported 42 bcm from Turkmenistan, nearly
all of which was re-exported to Ukraine. Having halted these
imports, Gazprom itself is supplying the Ukrainian market out
of Russian production.

Revenues --

6. (U) The Russian Customs Service reports that Russian gas
export revenues were down 50% in the first 7 months of 2009,
compared to the same period in 2008, a decline of almost $20
billion. While Gazprom's official results for 2009 will not
be published until well into 2010, a back-of-the-envelope
calculation using Gazprom's own projections for average price
and volumes of exports to Europe in 2009 (ref C) indicates
the company might receive about $30 billion less from exports
to Europe in 2009 than in 2008. This represents a loss of
about 2% of Russian GDP and is in line with estimates from
various analysts. (Note: Given the relative significance of
export sales to Europe (excluding FSU), the relative
reliability of the figures, and to avoid exchange rate
complications, we focus only on export revenues here.
According to its recent bond prospectus, Gazprom's exports
are divided into sales to the FSU, and to Europe. Sales to
the FSU and Europe represent 16% and 63%, respectively, of
its sales by revenue -- meaning exports represent 79% of
Gazprom's revenues. End note.)

Domestic sales --

7. (U) Gazprom's domestic sales are not down as dramatically
as one would expect given the economic crisis, due primarily
to artificially low domestic prices, which prop up demand.
While Gazprom has not yet reported official results for the
first half of 2009 (1H09), various analysts predict a drop of
about 10% in gas volumes to the domestic market.

Export volumes --

8. (U) Gazprom's overall exports peaked in 2008 at 281 bcm.
Gazprom's sales to the FSU peaked in 2007, at 101 bcm,
dropping slightly to 97 bcm in 2008. Sales to the rest of
Europe peaked in 2008, at 184 bcm. (Note: Interim
statements regarding 2009 sales often do not coincide in
definition with audited annual reports. Thus 1H09 sales
estimates only give an indication of the trend and are not an
exact comparison with 2008 figures. Gazprom has not yet
released official results for 1H09 and only released first
quarter (1Q09) results on August 26. End note.) Through
1H09, Gazprom has said it shipped about 33% less gas to
European customers than in 1H08. In a recent statement, the
company said its exports to the FSU in 1H09 dropped 54%
compared to 1H08. A weighted average of those estimates
indicates overall exports shrunk by about 40% 1H09.

9. (U) As Gazprom and many analysts point out, however, 2H09
should be much better for Gazprom exports as many European
customers restrained purchases in 1H09, knowing that prices
-- which are tied to oil prices with a six to nine month lag
-- would drop dramatically in 3Q09. Furthermore, export
volumes in 2H08 were already dropping rapidly due to the
economic crisis and high gas prices that were reaching their
peak in 4Q08. Results for 1H09 were also significantly
affected by the 21 day gas cutoff to Ukraine and 10 day
cutoff to Europe in January. That said, 2009 will still be a
dismal year for Gazprom export volumes.

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forced cutbacks
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10. (C) Facing financial realities, Gazprom recently cut its
capital expenditure budget by $7.5 billion, or about 25%,
including cuts to Shtokman and Yamal development. However,
Gazprom and GOR leadership continue to take the tack that
"everything is fine" (ref B). One attendee at the recent
gathering of the "Valdai" group of international Russia
experts told us that Gazprom CEO Alexey Miller told the group
that the company's plans for the Nord Stream and South Stream
gas pipelines, and for the development of the Shtokman and
Yamal gas fields are "all on track."

11. (C)xxxxxxxxxxxx told us recently that
Miller's and other GOR leaders' public statements on Gazprom
should be ignored. xxxxxxxxxxxx said these leaders understand well
that Gazprom is in trouble but they just don't know what to
do about it.

12. (C) According to xxxxxxxxxxxx, Gazprom simply doesn't have the
money to move forward on all its so-called "priorities," and
it will need to choose which are most important, while facing
insatiable political demands on its revenue streams. xxxxxxxxxxxx, told us
recently that he believes Gazprom has "a heck of a lot of
cost-cutting capacity" still available, but that the company
has too many political constraints preventing it from taking
the most necessary and painful measures. Furthermore, he
figures the company needs to spend about $5 to $8 billion a
year just to maintain its aging system and that these costs
will rise in the future. xxxxxxxxxxxx is thus also very
skeptical of Gazprom's other major commitments such as South
Stream and Shtokman.

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comment
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13. (C) Gazprom's capital expenditure cuts reflect an
understanding that, public rhetoric aside, the company can't
spend money it doesn't have. However, Gazprom's longer-run
problems are largely beyond its control and require
fundamental reforms that will be difficult to achieve. In
part two of this report, we examine the constraints to
Gazprom's return to dominance.
Beyrle

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