Don’t stand in our way

By Richard Orange

April 30, 2006

You could be forgiven for thinking that those hundreds of fashionably-dressed couples caught on TV disembarking from chauffeur-driven Mercedes and Rolls-Royces into Claridges and the Dorchester hotel last week were heads of blue-chip companies. If so, you would have been wrong.

Those sturdily-built, prosperous, cigar-smoking men accompanied by bottle blondes were Russian – and there were some 2,000 of them in London last week attending the Russian Economic Forum.

Many flew in on eight specially chartered Transaero jets. The glitzy entertainment kicked off with a concert by Liberty X. On Saturday night, some of Moscow’s most beautiful, most famous, and most rich glugged Moet and Chandon in an Alice-in-Wonderland-themed fantasyland built under the Victorian arches of London’s Old Billingsgate market. And the fashion show put on that night by DJ Zorkin and Russian designer Denis Simachev illustrated that the Russia of grim-faced oligarchs in loud, ill-fitting pinstripe suits has passed. “Moscow style” is starting to match anything London, New York, Tokyo or Milan can offer.

But the cameras were there for other reasons. The Russian bear was growling and Moscow was demonstrating its growing economic influence on the West. Alexander Medvedev, gas giant Gazprom’s deputy chief executive, even made it on to the BBC’s main evening news signifying just how far Russian companies have come in establishing their global profile.

President Vladimir Putin’s seizure of control over Russia’s oil and gas sector is now complete. Russia is flexing its muscles to recover its former superpower’s swagger on the world stage.

The forum’s week came after a threat from Alexei Miller, chief executive of Gazprom: if Europe didn’t allow it the access it wants to European gas pipeline and supply companies, Gazprom might divert its European energy supplies to the US and the Far East. On the BBC, Medvedev put it even more clearly: “There are two concepts available – a weak Russia or a strong Russia. There are still people who believe that weak Russia is good for the world. We completely disagree with this. A strong Gazprom is good for the world.”

Cliff Kupchan at Eurasia Group, a consultancy that studies the politics of energy told The Business: “In the 20 years I’ve been doing this, I’ve never seen Gazprom exert this extent of bullying or political pressure. I could describe the Moscow mindset right now as ‘Petro-steroid’. They think this is their ticket back to the world stage … and they may be right.”

A look at past Russian Economic Forums shows how times have changed. The 2003 event was about western investment in Russia. Talk was about how western oil companies could repeat BP’s landmark deal with Russian oil company TNK. Yukos’s founder Mikhail Khodorkovsky was even seeking to bring Exxon Mobil into a merged Sibneft and Yukos. A year later a disenfranchised Khodorkovsky was in a Moscow jail, but BP’s Lord John Browne was still the toast of the 2004 forum. Last year, Medvedev vied with TNK-BP chief executive Bob Dudley. This year, Medvedev and Sergei Bogdanchikov, chief executive of Rosneft, Russia’s emerging state oil giant were unchallenged, with western bankers and business executives little more bowing courtiers.

Gazprom’s Miller made his threat after meeting 12 European ambassadors in Moscow. What other company can call in that kind of audience at short notice? When was the last time a listed company tried to dictate energy policy to a union of 15 of the world’s most powerful countries?

Mattias Westman, chief executive of Prosperity Capital, a leading Moscow-based investment fund told The Business: “There’s never been a company with Gazprom’s type of power. Not since the days of Standard Oil anyway and that was a long time ago.”

The United Kingdom has taken Gazprom’s bullying as a warning not to block any bid it might make for UK energy retailer Centrica. Gazprom has made clear it will not respond well if its efforts to control the European gas market right down to supplying directly to consumers are frustrated. UK Prime Minister Tony Blair quickly capitulated saying his government would not stand in the way should Gazprom bid for Centrica.

Gazprom’s executives are flexing their muscles because they are angry with the European Union’s policy of energy liberalisation, which the European Commission has this year belatedly begun to force on to some of Gazpom’s key customers, such as Germany’s Eon, France’s GdF, and Italy’s Eni.

When Medvedev says Gazprom aims to take a share of Europe’s downstream gas pipelines in the same breath as he writes off the Energy Charter Russia signed with Europe, as a “stillborn document”, it is intended as a deliberate snub to Commission president José Manuel Barroso. The commission’s boss travelled to Moscow in February to try to broker an exchange whereby Gazprom would allow European companies access to its gas fields and pipelines, a key part of the Energy Charter, and Europe would offer its downstream. Gazprom wants its side of the deal without offering anything in return.

Last September The Business reported that Gazprom aimed to triple its market value within three to five years to the point where it would rival Exxon Mobil’s $380bn value. That already seems ridiculously timid. Morgan Stanley, in a note this month, said Gazprom’s true value was already between $350bn to $450bn. Its share price has already more than quadrupled in the last year. Just as the forum ended last week, Gazprom’s market cap overtook Britain’s largest company, BP, hitting a value of $264bn. By the end of the week, it had overtaken Microsoft.

During the forum, Medvedev said Gazprom’s value could rise to $1 trillion in the next 10 years, making Gazprom the largest company on the world’s stock markets. Even at that market value, Gazprom’s mammoth gas reserves, between a quarter and a third of the world’s total, would still be valued at less than half those of Royal Dutch Shell’s.

Putin’s achievement with Gazprom was to wrest control back over the vast monopoly and put his own men, Miller and Gazprom chairman and Kremlin chief of staff Dmitri Medvedev, at the helm.

Rosneft, another Russian state oil giant, chaired by Kremlin chief of staff Igor Sechin, is even more of a Kremlin creation. Once little more than a collection of oil fields the oligarchs hadn’t bothered to strip from the state, Rosneft has been transformed by the government’s expropriation of Yuganskneftegaz from Yukos.

Once it has completed what could be the biggest flotation on the London Stock Exchange this year, expected around July, Rosneft, too, aims rapidly to surpass the West’s listed oil producers.

Bogdanchikov told the forum in a rare public appearance that he aimed for Rosneft to produce more oil than any other listed company by 2015, with a target production of 3m barrels per day (bpd), surpassing Exxon Mobil’s 2.7m bpd.

Even Lukoil, now free from direct Russian state control, has ambitions to surpass BP and Exxon Mobil, targeting 4m barrels worth of oil and gas per day by 2015.

Lukoil’s recent results showed it increasing production at 10.5% in 2005, a growth rate conventional oil industry wisdom dictates should only be possible for a far smaller company. Vice president Andrei Gaidamaka said: “We’re like an elephant with wings.” He says Exxon will not be able to find the oil it needs to keep its lead. He said: “Where do they find big reserves? I don’t think there’s a place where they can find more reserves.”

Rosneft and Gazprom are Putin’s legacy. His legendary 1997 university dissertation returned to the public eye in March after researchers at Washington’s Brookings institute unearthed it. Putin’s themes – the doctrine of “strategic planning”, whereby the state guides an otherwise free economy – have defined his presidency.

Now the project is complete, and the deference shown last week by German Chancellor Angela Merkel and Blair demonstrate how effective the prescription has been.

In the short term, Europe need not worry about its gas supplies being diverted to North America or the Far East. Gazprom’s vast Shtokman development in the Arctic Sea will start to deliver gas to the US from 2015 at the earliest, and plans for two pipelines that could eventually supply China with 60bn to 80bn cubic metres a year are at an early stage. Until these come to fruition, Gazprom is as reliant on Europe as Europe is on Gazprom. Russia supplies 26% of Europe’s gas, but just 2% of the UK’s gas requirement and relies on its western European exports to make its books add up. It gains around $40 for each barrel’s worth of gas it sells in Europe, and just $7 in its heavily subsidised home market. So it shouldn’t surprise that it aims to increase supplies to the EU by 33%, and to the UK to 20%.

Alexander Medvedev described the reaction of the UK press to rumours of a Centrica takeover as hysterical. But Gazprom only has ambitions to control the gas market closer to consumers because it fears Europe might look elsewhere for supplies, and that there might be a crash in gas prices. Gazprom’s heavy-handed threats risk being counter-productive. Every time it spooks Western governments it brings a revival of the nuclear industry, clean coal and renewable energy one step closer. Gazprom’s opposition to European market liberalisation also comes from its weaknesses. EU energy liberalisation threatens Gazprom’s ability to make investments in its Siberian heartland which it desperately needs to keep its supplies coming.

A London banker told The Business: “They want big, monopolistic companies with lots of assets that can be their counterparty, because they’ve got a weak credit rating and the only way they can raise money is against gas offtake agreements with counterparties, if they want to fund this massive investment programme.”

The people benefiting most from the emergence of Russia’s oil and gas giants are international investors who were this year allowed to invest freely in Gazprom for the first time, and will soon be able to invest in Rosneft. Bill Browder, chief executive of Hermitage Capital, a long time investor in Gazprom, said: “As shareholders we are delighted for it to have such ambitious targets. Five years ago it was difficult to find anyone in Gazprom who even knew what the market cap was.”

The sense on Moscow’s financial street is that Gazprom and Rosneft have are not yet finished absorbing Russia’s remaining private oil and gas companies. Kupchan at Eurasia said: “I think it’s better than 50:50 that Rosneft buys Surgutneftegaz before the 2008 election. I think it’s likely that Gazprom will take TNK’s role as BP’s partner in TNK-BP, once they are allowed to sell in 2008.

Neither of these are likely to be as clumsy as the seizure of Yukos’s key oil production company at the end of 2004. But they could easily involve trampling on western investors. Who knows what delights the Forum organisers are lining up for next year’s party. But you can be certain Rosneft and Gazprom have secured their places at the world’s top table.