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Tuesday, July 03, 2007

"A Monster Has Appeared! What Else Could the Man on the Street Think?"

Miller// Alexei Miller on the Russian Monopoly's Expansion in the Gas, Oil, and Electrical Energy Markets
07-01-2007 Kommersant -
Gazprom CEO Alexei Miller did not attend the company's annual shareholders' meeting on June 29, 2007, although he voted with his shares on all of the issues on the agenda. Mr. Miller spoke last week with Kommersant about the company's recent performance and its future plans for the gas, oil, and electrical energy sectors.
What were the main results of 2006 for Gazprom?
Primarily the signing of a whole series of agreements concerning the extension of long-term export contracts, the sale of new volumes of gas in Europe, and the entry into the market of new end consumers. I'm referring to Italy, France, Austria, and [our] first deal with Denmark. So despite unceasing attacks on Gazprom from certain politicians and the press, European business is rationally choosing to seek to develop and strengthen cooperation with us. And that's understandable. The public at large found out about Gazprom's existence only a few years ago, in connection with the auction of Yuganskneftegaz, the conflict with Ukraine, and the shocking growth of capitalization. A monster has appeared! What else could the man on the street think? Meanwhile, our partners had 100% confidence in Gazprom. New contracts for the delivery of gas, new joint projects, and new routes for the transport of gas are the best answer to all of the skeptics in Europe and especially outside of it.
But the most serious changes apparently took place in the CIS, isn't that right?
In a sense, 2006 was for us an intermediate year in that region. As it happened, last year involved very tense negotiations with Ukraine and Belarus. For the last few years, the price of gas in Europe has grown several-fold, but almost nothing has changed in the CIS. Eventually, Gazprom was basically subsidizing the economies of the former Soviet republics at the expense of its own profits. The main difficulties in the negotiations arose because the transit countries linked the fulfillment of our export obligations to Russian gas being supplied [to them] at a discount. In the end, we were able to reach some fundamental agreements concerning the separation of the issues of the transit and supply of gas, as well as holding to the principle of equal yield on supplying gas for consumers in Europe and the CIS. The third important outcome of 2006 was the decision concerning the liberalization of the Russian gas market. It was already impossible to put the resolution of this problem off any longer. Cheap gas resulted in uncontrolled growth in demand. During the entire period of economic reform in our country, Gazprom's gas was the only fuel whose price was directly regulated in terms of historical importance rather than being defined by real supply and demand. The share of natural gas in the energy balance rose to more than 50%, and to 80% in some regions, and the use of coal, fuel oil, and other kinds of alternative fuel dropped significantly.
In other words, there isn't enough gas?
Gazprom has already surpassed the parameters of the government's energy strategy, a fundamental program document that was adopted only three years ago. Gas extraction in 2006 was 25 billion cubic meters higher than the plan for 2010. And the extraction volume for 2010, according to which the investment program was worked out, corresponds to the maximum level of extraction in 2020 according to the energy strategy. Keeping the price of gas artificially low has led to a growing imbalance between the expected growth in demand for that resource and the ability of gas companies, including independent companies, to supply the stated demand. With the levels of pricing that had taken hold in the domestic market, our investments in the extraction and transport of gas would never have broken even.
Has the trading of gas on the stock market helped balance out the situation?
The expansion of trading on the stock market, the use of mid-range contracts with a pricing formula for the basic supply volume for commercial consumers, and the gradual evening-out of yield from all of Gazprom's markets has allowed full-fledged market relations to be created in the Russian energy sector. That will stimulate the development of competition and expand business [opportunities] for independent gas producers. The objective inclusion in gas prices of the quality characteristics of gas in comparison with alternative types of fuel will ensure its sustainable use. In addition, without a transition to market prices for gas for industrial consumers, the temptation for our economy to remain in the role of an exporter of energy resources and energy-rich prepared raw materials will be too great; there will be no stimulus to invest in the manufacturing of high-tech products. So the government's decisions concerning the liberalization of the gas market are important not only for the fuel and energy sectors but also for the economy as a whole.
You mentioned the auctions of assets belonging to Yukos. Why did Gazprom not participate in them? In particular, the company's top managers earlier confirmed that [Gazprom] was interested in Tomskneft. You couldn't come to an agreement with Rosneft concerning the purchase of some Yukos assets?
We decided that the potential risks of participating in these auctions were too high for Gazprom. And with regard to any agreements, Gazprom is an open company, and if we really had reached any concrete agreements, we would have immediately and directly announced them. This is also true concerning the implementation of any points in a partnership agreement with Rosneft.
Nevertheless, Gazprom received its share of Yukos assets via an option with the Italian [oil companies] Eni and Enel concerning Arktikgaz, Urengoil, and Gazprom Neft. When and under what conditions will the company act on these agreements?
Like always – on time and under market conditions. This deal attracted extra attention, but it shouldn't be forgotten that the implementation [of these agreements] is only part of a large bundle of agreements with Eni. We are taking our cooperation with the Italian company to a qualitatively higher level. In the same way that Gazprom is already working with German partners, with Eni we are building up a joint business along the whole pricing chain – from the wells to work with consumers, including projects for the transport of gas. The agreement concerning the Yuzhny Potok gas pipeline shows that European countries share our concern about the risks involved in transit. As you may remember, it was their leaders who first suggested evaluating the advantages of the construction of a new southern corridor. Europe needs new volumes of gas and a more reliable supply. The Yuzhny Potok [project] answers these demands. And Eni has been searching for a long time for new joint projects to work on with Gazprom – they're trying to repeat the success of the Goluboi Potok [project].
Do you consider that project a success, even though so far it is still underutilized?
First of all, its load is increasing according to a plan that was previously agreed upon. Secondly, we're not the only ones who think so. Ask the Turks what they would do without the Goluboi Potok after the explosions and interruptions in the supply of gas to pipelines that go to Turkey from third-party countries. This isn't the first year or the first time that we have supported the gas balance in Turkey for several months by increasing the gas delivered via the Goluboi Potok pipeline by almost one and a half times. That is particularly felt in Turkey in the winter.
Gas from the region around the Caspian Sea is being considered as one of the sources of resources for the alternative Nabucco project. Isn't the Yuzhny Potok [project] a political solution that puts an end to that project (Nabucco) that would be launched without Gazprom's participation?
Why do you consider these projects to be alternatives? If the Nabucco project is economically grounded and has reliable demand for gas and the corresponding resource base, nothing can interfere with it. And in the future, Gazprom might join the participants in Nabucco, especially since we are in constant contact with its initiators.
After Gazprom bought Kovykta, which is conveniently located with regard to China, it would be logical to export gas to China from there, and keep gas from Sakhalin in the domestic market. But then a conflict of interest arises with Rosneft and the Sakhalin-3 project. Where will gas from Sakhalin and Kovykta end up going? The direction of the flow of deliveries and the resource base is defined by a program for eastern Siberia and the Far East that was approved by the Russian government. Kovykta is not among the primary export projects. Extraction from that field began significantly later than on Sakhalin.
How are the partnership negotiations going for the Shtokman project? In August, when the Norwegian companies Statoil and Hydro join up, there will still be three foreign candidates for the project to develop the Shtokman gas condensate field. That accords with the number of partners that Gazprom originally wanted to attract to the project. Is it possible that you will accept all three of them and begin the project?
As you know, in October 2006 Gazprom decided that it will be the single owner of the license for Shtokman. Nevertheless, potential foreign partners have continued to speak with us regarding other means of cooperation. The negotiations concerning the first phase of the development of the field are close to completion, and I think that soon we will be able to announce that concrete agreements have been arrived at. We consider Shtokman to be a resource base for the export of Russian gas to Europe via the Severny Potok pipeline (the Northern European gas pipeline, Nord Stream), as well as for the construction of a plant to produce liquefied natural gas (LNG).
What in general is going on at the Shtokman field: how is work going, what is the volume of financing from Gazprom, what are the updated timeframes for the completion of the project?
A schedule has been worked out to synchronize the beginning of extraction, the supply of gas to the pipeline, and the production of LNG with Gazprom's long-term gas balance. The first gas will be extracted from Shtokman in 2013. In 2007, the volume of investment in the development of the field is 17.1 billion rubles. This project has a special significance not only for Russia but for the global gas market. The geographical location and the dimensions of this field are such that over the long term Shtokman will become one of the links in a system of global energy security. We are ready to cooperate with our foreign partners in all spheres of this project.
But the Nord Stream pipeline has met with active opposition from several European countries. The EU antimonopoly commission has warned that Gazprom will have to sell its share in the project if amendments to the Gas Directive within the framework of the liberalization of Europe's gas market are approved. Might Gazprom wait a little before beginning construction? And wouldn't it be better to build a second branch of the Yamal-Europe pipeline, which could be done for a third of the cost of a similar pipeline in the Baltic region?
[The plan for the pipeline] is neither legally or geographically unsound. The Severny Potok pipeline will go from the Russian coast along the bottom of the Baltic Sea, in neutral waters. I would also like to note that the gas that will be delivered via the Severny Potok pipeline has already been sold – consumers will be waiting for it in 2010, and we would advise the European Commission to carefully analyze the possible effects that a delay in the completion of the project will have on the future pricing situation in Europe. With regard to Poland, there is no demand in that country for additional supplies of gas from Russia, and that means that there is no need to build up new gas transport capacities in the direction of Poland. If the situation changes in the future, gas can be provided from the western direction, and such proposals have already been made.
What should Gazprom Neft eventually become – a company that has its own market capitalization and that possesses its own oil reserves, or a production division of the [Gazprom] monopoly that holds all of Gazprom's oil licenses? Will you take Gazprom Neft off the quota lists? How are you planning to increase Gapzrom Neft's extraction [volume] to 40-45 million tons?
The strategy for Gazprom Neft envisions a much more ambitious increase in extraction – up to 80 million tons by 2020. The same document describes the basic steps for achieving this goal. The combination of Gazprom's resource base of liquid hydrocarbons and Gazprom Neft's production capabilities will yield very good results. In order to combine the two, we will of course exercise [our] option with Eni and buy up the 20% stake in Gazprom Neft. Then we will decide the way that the shareholder equity and the resource base will be consolidated. Our future course will be guided by the increased interest that the packet of shares in Gazprom Neft attracted during the preparations for the auction. Most likely, the company will remain public and quoted on the stock market. In the distant future, we could consider the possibility of using a packet of shares that is not quite a blocking share as a basis for the creation of a new international alliance.
What plans does Gazprom have in the electrical energy sector? How will you structure the energy assets that you've acquired? What place will the partnership with SIBENCO have in that structure? What will it be called, who will lead it, and what assets and how much [financing] will Gazprom contribute? Will it be a public company? Are you entering into this partnership to finance the revival of electricity generation using only gas, or coal as well?
In the last few years, Gazprom has actively expanded its presence in electrical energy. Our strategic goal is to create an effective group of electricity-generating enterprises that will be one of the core divisions of Gazprom's activities. The amount of gas that is used for electrical energy is very large, and that allows us to ensure a good level of synergy with the gas business. Among our goals is increasing the profitability of capital, diversifying the risks of tariff regulation, and optimizing the fuel balance. As a large shareholder in UES Russia and Mosenergo, Gazprom intends to become one of the largest – though not a monopoly – players in Russia's reformed electrical energy market. Gazprom's involvement in coal-based electricity generation projects will allow the realization of plans for balancing the consumption of coal and gas and will also increase the effectiveness of the marketing of gas. For that, we intend to create a joint venture with the country's largest coal company, SIBENCO. The partnership will include electrical energy assets belonging to Gazprom and coal and electrical energy assets belonging to SIBENCO. Right now we are continuing to work on the deal, and we primarily need to figure out which electricity-generating assets we will get for our packet of shares in UES Russia.
How will you manage your non-core assets? In particular, as far as we understand, you are planning to sell a controlling stake in Gazprombank this year. If that is the case, what will happen with SIBUR Holding? Will it be completely transferred to Gazfond, for example? What plans exist with regard to SIBUR – the sale of the stake to a strategic investor, an IPO, a reorganization that puts chemical companies in a narrower division?
It is commonly believed that we're buying up everything in sight. But in reality, our core divisions are gas, oil, and electrical energy. We are selling [our] non-core assets. The budget for this year alone stipulates the sale of more than a billion dollars worth of non-core assets. Gazprombank and SIBUR are non-core assets for Gazprom. Plans for SIBUR might include any or all of those different approaches: strategic investors, an IPO, reorganization.
Recently the Russian and international press, pundits, and even the US Congress have repeatedly talked about the possible creation of a so-called gas OPEC. Are you ready to get onboard that project? I wouldn't limit that question to just the gas sector. Modern business is rapidly globalizing and breaking out of the strictures of sectors and national markets. That is exactly why, two years ago, Gazprom decided to launch the creation of a global energy company. And it is no exaggeration to say that by now the process of transforming Gazprom from a "national champion" company into a leader in the global energy business is complete. In six years, the company's capitalization has increased 25-fold, and by the end of last year it was more than $270 billion. We're not only developing a unique resource base, enhancing production potential, and investing significant funds in modernizing the pipeline system – we're also opening new market outlets, diversifying energy transport routes, and developing new business models by actively getting involved in electrical energy and the oil business and developing an entire production chain for hydrocarbons. In addition, Gazprom is becoming a huge player in the LNG market. This implies an active expansion of business models and regions of activity, as well as an additional lowering of risk. The results of Gazprom's activities over the last several years clearly demonstrate its effectiveness as a global competitor – it is sufficient just to point out that we are already number two among the world's energy companies. And we're not resting on our laurels. It may be precisely because of Gazprom's rapid growth over the last few years that we feel the discrepancy between the "rules of the game" that exist in the energy sector and the current challenges of the international economy more sharply than our colleagues and partners in the market.
What exactly do you mean?
The global energy market is characterized, first of all, by increasingly stiff competition for resources, appreciation of resources, and the closed-off nature of several markets, and, second of all, by a noticeable increase in the risks facing different participants in the market. In particular, energy consumers constantly express fears regarding the reliability and volume of supplies and their projected cost. Transit countries, which play a large role in the system of global energy exchange, make no secret of their anxiety over retaining existing volumes and transit tariffs, which, in turn, is inextricably linked to the necessity of maintaining and modernizing energy transport systems. For their part, suppliers still cannot be certain that the market's growth tempo, the balance of supply and demand, and acceptable standards of profit can be maintained, which threatens the rate of return on investment and undermines the basis of how the electrical energy business is run. Gazprom, like all market leaders, constantly runs up against such problems. Though it is following a consistent course of liberalization of the Russian domestic market, in European markets Gazprom encounters various manifestations of discrimination. Instead of unfounded fears of Gazprom's inability to guarantee supplies according to long-term contracts, we expect acknowledgement from our international partners of the obvious fact that the company's proven reserves are sufficient both to unconditionally and in the long-term fulfill all [of our] signed and planned agreements and to back up a fully-fledged entrance into new markets. From our European colleagues, we expect support when it comes to the necessary modernization of the gas-transportation system in transit countries, and that support should take into account Gazprom's investment in the capital of the corresponding companies. In connection with this, I want to express hope that the joint venture between Gazprom and Beltransgaz will allow us to avoid situations like those that arose in the Ukrainian gas transit system last spring.
What possible measures to deal with the situation might be considered? Something like a gas OPEC after all, or something different?
The risks that arise systematically in the global energy market require the creation of a system of worldwide energy security, the construction of which is possible only once the transition from competition between national champions to cooperation between global leaders in the market is complete. The basis for the creation of such a system should be that each participant in the market takes simple and coherent measures to lower the fundamental risks [involved in the market], and the system should coincide with the interests of both global leaders and participants in national markets. The founding principles could be the development of a system of long-term commercial contracts, including contracts for transit; obligatory international audits of reserves; the adoption of regional and global strategies for increasing reserves; and coordination between energy balances from a middle- and long-term perspective and issues of the integrity of the system, including taking into account the evolution of the LNG market. And finally, the creation of a system of international cooperation on technological and ecological maintenance for global energy projects. Clearly, a possibility might be the creation of an international energy organization – along the lines of the UN Security Council, but in the energy sphere. Unlike the gas OPEC you mentioned above, such an organization should not regulate extraction quotas – although those, of course, are also very important – rather, it should deal with the coordination of strategic principles of cooperation in global energy markets. We've done enough competing – it's time to cooperate.

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