Gazprom: The Fall of a State Owned Company

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 37^th 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

Comments

[adamnb:]

Gazprom is down because oil is down, having fallen with the global downturn, not because of but despite government ownership. When oil was up, everyone made gobs of money on Gazprom, state owned or not. If state-owned Saudi oil company stock was for sale, the world would leap at it. My hope: more critics like Gamble to knock the price down further, so I can buy more, particularly with the major fall in the rouble. By the way, same goes for Hunang Power.

Apr 07 04:36 PM

[adamnb:]

Smart move Tonda. Even with the downturn, I'm up over 3,000% on Gazprom. My advise, keeping buying at the lows. Long term, you'll be very happy.


On Apr 07 11:41 AM Tonda wrote:

> Well, I'm putting my money where my mouth is and have already bought
> 300 shares (not a lot) and have no doubt this is a smart investment
> for the future. Thanks Ferndinand for the kind words. I'm afraid
> in my homeland Russia is again become the great bogeyman. Is Gazprom
> perfect? Absolutely not. By the have negotiated pipeline deals
> throughout most of Europe, including Germany, including Austria,
> including Slovakia, including Hungary, including the Czech Republic.
> They are building a pipeline through the Baltic to sidestep the pesky
> Poles and Ukrainians. They have a lot of junk in assets they can
> jetison, and I hope they do. They own a nice stake in Rosneft, which
> gives me a stake in an oil company. So, if you think it's a bad
> buy, all the more for the intrepid.

Apr 07 04:41 PM

[Paul Harper:]

you seem to be a little too focussed on Gazprom as a pure energy play. This article by Ryan Freund gives a much more realistic view of the company, in my opinion :

seekingalpha.com/artic...

Apr 08 01:36 AM

[19 years ol...:]

"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"

And miller stated several years ago that gazprom would hit a value of 1 trillion dollar...Ironic is'nt it ?

On Apr 07 03:59 PM William Gamble wrote:

> Of course there is no difference between gas. There is a difference
> between gas suppliers. If you want to be successful in any business
> whether it is running a restaurant or supplying energy you have to
> prove that the customer and profits are the more important than political
> agendas.
>
> As to Chinese companies, in China the price of gasoline is controlled.
> Last summer, Petro China was forced to take huge losses because they
> were buying at market prices and selling at fixed prices. The same
> happened with the electric utilities. They had to buy coal at world
> market prices and sell at fixed prices. The banks were told to make
> loans to help stimulate the economy and most of those loans were
> used to speculate on the Shanghai A. For short term, it is possible
> that some of these companies might make profits, but not if they
> exist to serve the political needs of a country's leadership.
>
> I can understand making investments for patriotic reasons, but not
> if you want to make money.
>

Apr 08 04:28 PM

[William Gamble:]

Gazprom, Russia’s natural gas monopoly, signed a $4.2bn deal to acquire Italian oil group Eni’s 20 per cent stake in Gazprom Neft. This is despite the fact that Gazprom is Russia's most indebted company with $48 billion in debts owed mostly to state owned banks.

Those banks are in such bad shape because of questionable loans to companies like Gazprom that they needed a $129 billion bailout. But that is not the problem.

The problem is that Gazprom Neft was part of Yukos stolen assets. The former share holders of Yukos have brought a case in the European Court of Human Rights in Strasbourg which has been accepted. Five days later, prosecutors brought up new charges against Mikhail Khodorkovsky in a second absurd trial on charges that conflict with the charges of the first trial.

What is obvious is that the siloviki in Russia are trying to strengthen their claim on stolen goods.

But they can't. All corporations, even in Russia, are simply pieces of paper: bunches of property rights. The value that any shareholder can hope to gain depends upon the legal infrastructure that surrounds those pieces of paper. If that legal infrastructure does not support property rights, then those pieces of paper may be just that, paper.

It may be possible that the Kremlin will not give up its ill gotten gains because of a court ruling from Europe. It also may be possible that Gazprom share prices could spike on another energy crunch. Still without a good legal infrastructure that gives certainty to the words on the paper, companies like Gazprom will not be safe investments. There are other safer ways to play energy.


The problem is that Gazprom Neft was part of Yukos stolen assets. The former share holders of Yukos have brought a case in the European Court of Human Rights in Strasbourg which has been accepted. Five days later, prosecutors brought up new charges against Mikhail Khodorkovsky

Apr 09 09:33 AM

[adamnb:]

To the world's astonishment, Gazprom kept arms length distance and never participated in the rigged auction to sell Yukos assets. Correct me if I'm wrong, but I recall that Gazprom bought its 60% stake of Gazprom Neft directly from Yukos, a willing seller at that time, that needed the money. Only 4 years later, did it recently buy the 20% stake of GN from Eni. If these are stolen goods, I think it would be awfully difficult to prove Gazprom's culpability in the theft.

Apr 09 05:17 PM

[adamnb:]

" All corporations, even in Russia, are simply pieces of paper: bunches of property rights. The value that any shareholder can hope to gain depends upon the legal infrastructure that surrounds those pieces of paper. If that legal infrastructure does not support property rights, then those pieces of paper may be just that, paper."

My comment: I'm not trying to make fun or belittle you. I understand that you're a good and decent man. But that's an awfully ironic statement in the midst of the financial ponzi game that's being played out in the U.S. and has brought the global economy to its knees.

I think you believe that business should be as ethical as you are. Would it were so. We differ there. You know as well as I do how the Rockefellers and Morgans made their fortunes.

I'm not saying there's no risk in Russia. Certainly there is. But the game of oil/gas is about proven reserves, and there, Gazprom has a great deal of real tangible goods to back up its paper. I'm not sure the same can be said for the U.S.

My read is Gazprom fell with the global downturn and will rise again with the recovery. The proof is in the pudding. The recent rise in stocks has G up 65% from its low in November. Correct me if I'm wrong.

Apr 09 11:39 PM

[William Gamble:]

No need to worry about my feelings, although that is very kind. I am a lawyer, and at least in the US we do not have a very good reputation for being either good or decent.

However my point has nothing to do with being either good or decent. My point has to do with the law. Some would say that the law in the US failed. In so far as it did not force more transparency regarding derivatives, it did fail. In so far as it did not avoid the concentration of risk within the financial system, it failed. In that it did not catch Madoff, that was not a failure. In fact it never caught Madoff. He turned himself in because he was afraid of the law, so that was actually a success.

Regarding the US, there is a general view that the economic crisis was created in the US and just happened to affect the world. Not so. Like all other crisis this one was about too much money, too much speculation and too much risk. This happened in every country. There were real estate bubbles from California to Kazakhstan. 2Russian banks' bad loans will quadruple to $70 billion this year, according to a Bloomberg survey. Nonperforming loans will increase to 12.8 percent of the 18.4 trillion rubles ($549 billion) that is owed by Russian companies and individuals by the end of this year, from 3.2 percent in March. These bad loans were created in Russia, not on Wall Street. Every country has them. We simply do not know about them because the laws in many countries do not protect information, so asymmetries develop.

Businesses are not ethical. They are not supposed to be. They are however predictable. They are in it for the money. They are trying to be profitable. So investors know what the company will try to do. Politicians on the other hand are not predictable. They are in it for power. When politicians run state owned companies, investors have no idea what or why. (Actually J. P. Morgan was a far seeing financier with fairly high morals. His biography is both excellent and timely)

I applaud you on any investment that increases 65%, but that is what investing in emerging markets is often about. Since many state owned companies go up or down depending on government actions or pronouncements, their stock can be very volatile. If you invest in these stocks, or in China where the entire market may be made up of state owned companies, keep your time horizons, very short. Unless you can predict government policy tomorrow, you might get nailed. So just invest when you see a trend, make a few bucks and bail. Be like Warren Buffet when he invested in the Chinese market for four months, not like Goldman Sachs who has invested for years.

As to Gazprom’s claim to assets, many of those were stolen from Yukos. The case has now been accepted by the European Court of Human rights. Russia as part of the Council of Europe has some obligation to enforce the court’s judgments. So Gazprom may not have title to some of those assets.

It’s not about morals. It’s about risk. Sustainable economic growth can only occur if the risk and government intervention is limited by the law.

Apr 10 04:48 PM

[Living4Divi...:]

William - I liked your article. I also like the fact that you have responded to the comments made.

When I first heard of Gazprom - I was salivating - I could get huge energy reserves at bargain prices.

You are correct - it seems from reports that Gazprom is Putins piggybank. As well, Gazprom is subject to significant extraction taxes and export taxes. Gazprom is not alone, CNOOC the state owned oil co of china for example, is subject to a tiered tax that costs the companies 20% on revenues if crude is over $40 a barrel, 40% when crude is over $60 a barrel.

Basically these reserves are treated as state property. Some of the capital-starved state oil companies have offered equity to investors with the promise of untold riches. Basically it seems the energy-rich govts are saying "Yes, dear investor you can buy reserves of crude and gas at low prices. However, don't try to take your profits." They milk the cash cow ... no rather... they BLEED the cash cow with political agenda, bloated payrolls and taxes.

Russian oil & gas majors have been notoriously stingy with dividends. Gazprom's dividend is south of 3% and about to be cut. Lukoil is south of 1%. Oil and gas is an extraction business - not a growth business, and should be dividend rich.

When I look at the picture in totality it seems that it is impossible to buy stocks in companies with substantial oil and gas reserves who are willing to share the profits with their investors. Most reserves are completely nationalized and off limits to investors.

Question: William - do you see any oil/gas companies with substantial reserves who are willing to share the profits with their investors?

Apr 10 06:36 PM

[William Gamble:]

I would pick a company that is at the very minimum privately owned. For reasons based on game theory and law and economics, I do not believe that any state owned company can be managed efficiently.

Also after 30 years of investing I have severe doubts about information in any company. Information is valuable. It is either disclosed for consideration or because required by law. Since no law enforcement, as we have seen, is totally efficient in forcing disclosure, there will always be asymmetries of information.

So to protect yourself I would always diversify across a sector with ETFs.

As to oil generally, I feel that commodities are driven by demand from China. Specifically I reason to believe that the gas spike of last summer was driven by China buying on the open market to shore up reserves for the Olympics. For reasons stated in other articles, I question continued rapid Chinese growth, and as a result, the growth of oil.

Right now I would play it safe and stick with an S&P 500 ETF (SPY). I know only one thing about markets. They go up and down. The US market will recover and you will make money over the next 12 months. After that it might be time to look around. Right now the information available everywhere could be questionable. This is especially true in emerging markets. If you don't know what is going on, don't invest.

Apr 13 01:38 PM

[William Gamble:]

Gazprom Neft Posts $543M Q4 Net Loss

Apr 16 09:39 AM

[adamnb:]

Hi Tonda:

I wasn't aware that Gazprom owns a stake in Rosneft. Are you sure? Any reference for that? I think you may be referring to Gazprom's ownership of Gazprom Neft, the old Siberian Oil Co. that it bought directly from Yukos (77%) and later bought most of the rest recently from Eni (20%).


On Apr 07 11:41 AM Tonda wrote:

> Well, I'm putting my money where my mouth is and have already bought
> 300 shares (not a lot) and have no doubt this is a smart investment
> for the future. Thanks Ferndinand for the kind words. I'm afraid
> in my homeland Russia is again become the great bogeyman. Is Gazprom
> perfect? Absolutely not. By the have negotiated pipeline deals
> throughout most of Europe, including Germany, including Austria,
> including Slovakia, including Hungary, including the Czech Republic.
> They are building a pipeline through the Baltic to sidestep the pesky
> Poles and Ukrainians. They have a lot of junk in assets they can
> jetison, and I hope they do. They own a nice stake in Rosneft, which
> gives me a stake in an oil company. So, if you think it's a bad
> buy, all the more for the intrepid.

Apr 16 05:25 PM

[Tonda:]

Hey Adam - Let me check that for you. I would've sworn it was them. By the way, excellent points. Kinda ironic to hear an American lecture about ethics in business after the financial mess it caused with its funny 'investments' they sold 'round the world. By the way, I'm American.

Apr 17 06:14 PM

[Tonda:]

You're right Adam, I confused Sibneft with Rosneft. You're on top of this.

Apr 17 06:30 PM

[19 years ol...:]

Yes and sibneft became latter gazprom neft.

Also,BP own a small stake in Rosneft


On Apr 17 06:30 PM Tonda wrote:

> You're right Adam, I confused Sibneft with Rosneft. You're on top
> of this.

Apr 21 04:15 PM

[adamnb:]

Hi William:

I think you're mistaken about Gazprom's assets being stolen from Yukos. Gazprom never participated in the Kremlin's rigged auction of Yukos assets. Yukos assets were awarded to an unknown company that later proved to be a stand-in for Rosneft. Any reference for your claim?


On Apr 10 04:48 PM William Gamble wrote:

> No need to worry about my feelings, although that is very kind. I
> am a lawyer, and at least in the US we do not have a very good reputation
> for being either good or decent.
>
> However my point has nothing to do with being either good or decent.
> My point has to do with the law. Some would say that the law in the
> US failed. In so far as it did not force more transparency regarding
> derivatives, it did fail. In so far as it did not avoid the concentration
> of risk within the financial system, it failed. In that it did not
> catch Madoff, that was not a failure. In fact it never caught Madoff.
> He turned himself in because he was afraid of the law, so that was
> actually a success.
>
> Regarding the US, there is a general view that the economic crisis
> was created in the US and just happened to affect the world. Not
> so. Like all other crisis this one was about too much money, too
> much speculation and too much risk. This happened in every country.
> There were real estate bubbles from California to Kazakhstan. 2Russian
> banks' bad loans will quadruple to $70 billion this year, according
> to a Bloomberg survey. Nonperforming loans will increase to 12.8
> percent of the 18.4 trillion rubles ($549 billion) that is owed by
> Russian companies and individuals by the end of this year, from 3.2
> percent in March. These bad loans were created in Russia, not on
> Wall Street. Every country has them. We simply do not know about
> them because the laws in many countries do not protect information,
> so asymmetries develop.
>
> Businesses are not ethical. They are not supposed to be. They are
> however predictable. They are in it for the money. They are trying
> to be profitable. So investors know what the company will try to
> do. Politicians on the other hand are not predictable. They are in
> it for power. When politicians run state owned companies, investors
> have no idea what or why. (Actually J. P. Morgan was a far seeing
> financier with fairly high morals. His biography is both excellent
> and timely)
>
> I applaud you on any investment that increases 65%, but that is what
> investing in emerging markets is often about. Since many state owned
> companies go up or down depending on government actions or pronouncements,
> their stock can be very volatile. If you invest in these stocks,
> or in China where the entire market may be made up of state owned
> companies, keep your time horizons, very short. Unless you can predict
> government policy tomorrow, you might get nailed. So just invest
> when you see a trend, make a few bucks and bail. Be like Warren Buffet
> when he invested in the Chinese market for four months, not like
> Goldman Sachs who has invested for years.
>
> As to Gazprom’s claim to assets, many of those were stolen from Yukos.
> The case has now been accepted by the European Court of Human rights.
> Russia as part of the Council of Europe has some obligation to enforce
> the court’s judgments. So Gazprom may not have title to some of those
> assets.
>
> It’s not about morals. It’s about risk. Sustainable economic growth
> can only occur if the risk and government intervention is limited
> by the law.

Apr 22 06:46 PM

[adamnb:]

Anytime. I'm American too.


On Apr 17 06:30 PM Tonda wrote:

> You're right Adam, I confused Sibneft with Rosneft. You're on top
> of this.

Apr 23 01:57 AM

[Living4Divi...:]

> 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.

I tend to agree with your opinion that state owned enterprises like Gazprom and Huaneng are bad investments.

One day, energy demand will pick up and coal prices will increase. This will put further downward pressure on Huaneng's profits.

Question For You: how long does the Chinese govt think that it's SOE's and utilities can continue to run at a loss?

It would be interesting to see a long-term study of the performance of SOE's.

Apr 23 08:09 AM

[adamnb:]

I doubt that free market philosophy has anything to do with today's highly manipulated markets. Let's take a factual look at Gazprom for the last six months, up from its October lows for a gain today in April of 62%. My question: are you in the markets for the money or to impress you philosophy professor?


On Apr 23 08:09 AM living4dividends wrote:

> > 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.
>
> I tend to agree with your opinion that state owned enterprises like
> Gazprom and Huaneng are bad investments.
>
> One day, energy demand will pick up and coal prices will increase.
> This will put further downward pressure on Huaneng's profits. <br/>
>
> Question For You: how long does the Chinese govt think that it's
> SOE's and utilities can continue to run at a loss?
>
> It would be interesting to see a long-term study of the performance
> of SOE's.

Apr 23 03:11 PM

[adamnb:]

This for the moralists in our crowd: Is America the new Russia?
America may be more like an emerging market than we realize.

That is the analysis by an increasingly vocal and influential professor at MIT, Simon Johnson. In an interview with the Huffington Post, Simon Johnson, the former chief economist at the International Monetary Fund, just like the emerging markets he has spent his life studying, the U.S. has created a system whereby Wall Street "oligarchs" have monopolized and cannibalized the economy. At the same time, Washington regulators have been rendered ineffective, seduced by their aura of wealth and power.
(Huffington, 4/23)

Apr 24 02:13 AM