If there was ever a poster child for the failures of a state owned company, Gazprom (OGZPY.PK) would probably take first prize. The collapse of Gazprom from the third largest company in the world by capitalization to the 37th certainly has a great deal to do with the collapse of energy prices. But it is also has an enormous amount to do with the owners of Gazprom, the Russian Federation.
Gazprom should be one of the most successful companies in the world. It is sitting on the world’s largest reserves of gas. It has what amounts almost to a captive wealthy market in Europe. All it has to do is to find, pump the gas and sell it to the Europeans. It cannot do that because like all state owned companies it is run for political reasons, not for profit.
A year ago, Gazprom’s position looked unassailable. It appeared that Russia had a strangle hold on Europe’s energy needs. A strangle hold that Premier Putin could use to flex atrophied Russian muscles into getting anything he wanted. Times have changed.
Gas exports to Europe are expected to plunge 22% this year with the selling price falling from $400 to $260 per 1,000 cu. Since gas exports to Europe make up over 60% of Gazprom’s income, this will put a very large dent in its profitability. In fact often Europe is Gazprom’s only paying customer. Gazprom also sells gas within Russia and to countries that once made up the Soviet Union, the so called near abroad. Like Chavez in Venezuela, Russia sells energy to these countries at a discount to maintain loyalty. Most of this loss falls on Gazprom.
Chinese utility companies experienced the same problem last year. Huaneng Power International Inc., China’s biggest electricity generator, lost money last year. Huaneng had to buy coal Indonesia, Australia and Russia at market prices. Last year the price of energy sky rocketed. To dampen inflation and potential social unrest, the Chinese government refused to allow Huang and other utilities to raise rates to take into account the price of energy. So, like Gazprom, Huang and other utilities started losing money. Even worse, they ran down their supplies of coal waiting for a price decline reducing the amount of electricity available during a particularly cold winter. Huaneng is experiencing the flip side this year. To comply with the government stimulus decrees it is increasing expenditures on plants and equipment by 18% to 33.1 billion yuan ($4.8 billion) despite the fact that electricity usage has plummeted. Apparently acceding to government demands is the priority task not profit as the annual report claims.
The reduction in export income will exacerbate Gazprom’s exploration plans. There planned $27bn investment program, is no doubt being drastically reduced. Gazprom could have solved that problem, but again the heavy hand of the government intervened.
Shell is supposed to deliver its first cargo of liquefied natural gas from the Russian Sakhalin-2 gas project to Tokyo today. Originally Shell owned 55% of this development project in Russia’s far east, but as a result of “a breach of environmental” regulations it was forced to cut its 55 per cent shareholding down to 27.5 per cent and allow Gazprom to increase its interest to 50 per cent. Of course using the local legal system to force investors to give up prospective profits to benefit state owned companies is not exactly the way to encourage new and often badly needed foreign capital.
If loss of its supplies were not enough, now Gazprom is facing the loss of customers. The Russian government’s spat with Ukraine resulted in a gas shut off for thirteen days in many parts of Europe this winter. Cold customers do not make for loyal customers. Last year, Gazprom could have ignored this with impunity, but not now.
The world is now awash in gas. The combination of falling demand, production increases from shale coal gas and a big expansion of capacity for producing liquefied natural gas in Qatar together with new terminals in the US and UK for receiving LNG will increase pressure on already depressed prices. Gazprom is now not the only game in town. As an unreliable seller, it will be last on the list when the economy and market recovers. Europeans have extreme reasons to buy from anyone else and will design their infrastructures accordingly.
The story of Gazprom should be a warning to investors and economists alike. Analysts and economist projections of profitability usually reflect the assumption that consumers in given market conditions will have a certain level of demand. These projections also assume that for any given level of demand that sellers trying to increase their profits will naturally try to run their businesses to meet that demand. The flaw in the projections is that political will of single party states often has nothing to do with economics. As a result projections for profitability of these companies and for their economies can be as dysfunctional as the governments that control them. It may be possible to make money betting on these companies, but only in short term speculative markets. Although the ‘story’ may seem exceptionally attractive, the reality may be something very different. Without legal limits, the assumptions cannot be accurate. Predicting the outcome of the game is impossible if when the rules change.
Disclosure: no positions
