Russ Oil-Gas

 January 2006 RYE, MAN & GOR Securities - Gazprom shares got off to a great start in 2006 thanks to share market liberalization, and the effect was magnified by perception that the company’s New Year agreement with Ukraine will mean increased revenues from gas supplies to that country in 2006. But this is a tricky agreement. It is warped by the role of RosUkrEnergo (RUE), which has succeeded Itera and Eural Trans Gas as the middleman in supplies of gas from Central Asia to Ukraine via Gazprom’s Russian pipelines. The agreement also has dangerous political ramifications Itera was chased from the lucrative Central Asia-Ukraine transit business after its protector, Rem Vyakhirev, quit Gazprom. Its successor Eural Trans Gas was closed down after embarrassing, detailed revelations about huge unjustified mark-ups. However, Austrian-registered RUE has key officials in common with its predecessors and its ownership structure is equally hazy: 50% is held by the Gazprom institution, Gazprombank, and 50% is held by Raiffeisenbank Investment (a subsidiary of Austria’s Raiffeisenbank), which says that it is acting in the interests of unnamed individuals. According to the New Year agreement, RUE will buy about 55bcm of Central Asian gas at about $65 per 1000cm and 17bcm of Russian gas at $230 per 1000cm and will sell to Ukraine for about $95 per 1000cm. These figures immediately looked odd, because Ukraine needs only 75bcm per year and produces about 20bcm of its own gas. Indeed, the Ukrainian national gas company soon explained that it will buy no Russian gas in 2006. Apparently, all of Gazprom’s 17bcm will be sold on by RUE to European customers. The initial impression that Russia will start selling its gas to Ukraine at a much higher price than $50 per 1000cm (the 2005 level) is therefore false – Russia should sell zero gas to Ukraine in 2006. But there should still be a significant gain for Gazprom: in 2005 it sold about 25bcm to Ukraine for about $50 per 1000cm, instead of which it will now be able to sell at least 17bcm of gas to Europe for about five times more. It is not clear, though, why RUE deservers to get a cut of the takings. Also the figure of $50 per 1000cm in 2005 is very hazy because the Ukrainians were mainly paid in kind (in gas) for providing a transit service (carrying Russian gas to Europe) and the settlement sums are unverifiable. It is also important to note that the Ukrainians have secured an increase of $0.5 per 1000cm per 100km for transit from January 1, 2006. Calculating roughly, Gazprom gets an extra $200 per 1000cm on 17bcm in 2006 – i.e. total $3.4b. And, assuming that transit across Ukraine is about 1000km and 2006 exports to Europe will be about 100bcm, the extra transit cost paid by Gazprom will be $500m. The potential net gain for Gazprom and loss for Ukraine in 2006 is, therefore, nearly $3b. RUE also does well out of the deal. However, it is more than likely that Central Asian suppliers will be angry: volumes, which they previously sold to Gazprom far below world prices will now be sold at the same inadequate prices to a middleman (RUE), who will add insult to injury by selling the gas onto Ukraine with a 50% mark-up. It is clear that Russia chose its moment to play the gas card against the semi-hostile Ukrainian administration of President Yushchenko. Ukrainian parliamentary elections are due in March, and Yushchenko has decided to accept a bad deal with Russia quickly instead of risking gas starvation in mid-winter and a resultant debacle at those elections. Yushchenko’s opponents in Ukraine’s parliament, mainly ethnic Russian forces led by the man whom Putin backed against Yushchenko in the fraught presidentials of late 2004, seem upset that Putin and Gazprom have let Yushchenko off the hook so lightly. So last week the Russian faction in the Kiev parliament voted no-confidence in the Ukrainian government for accepting a deal imposed by… the Russians. Where this will end is anybody’s guess. But we think that a $3b bird in the bush does not justify a Central Asian gas price revolt, hardening of anti-Kremlin sentiment in Ukraine, and (most worryingly for Gazprom) a crisis of confidence in Europe over reliability of Russian gas supplies.