Zee Beam News

March 16, 2006 Russia Profile by Matthew Wrigley
Having Conquered the Domestic Market, Russian Companies Look Abroad
Rumors in early February that Gazprom was close to making a bid for the British gas distributor Centrica were enough to send Britain's leaders on a frantic search for alternative energy sources, dusting off long-shelved plans for a return to nuclear power. The frightening prospect of the Russian giant's takeover of the UK's national gas network even drew a rare comment from the Department of Trade and Industry, which called the Russian bid a threat to national security. The government's reaction seems rather extreme when most analysts agree that the deal makes sense in principle. British households pay the highest prices in all of Europe for gas, and falling domestic production in the North Sea threatens to push prices up by another 25 percent next year. In contrast, Russian gas giant Gazprom has no such problems – it produces a quarter of the world's gas and, according to the influential Energy Business Review, would probably be able to offer British consumers a lower price – one equivalent to that paid by consumers on the continent. The problem is that Russia's energy giants come with some image issues. "Gazprom is a very controversial energy company," said Peter Luff, Chairman of the British Parliamentary Trade and Industry Select Committee. "It appears to behave not simply in a commercial way, but also in a political way." The New Year's gas dispute with Ukraine, which interrupted Russian supplies to Europe for the first time in decades, has created – or, alternatively, reinforced – the belief that Gazprom is a tool of the Kremlin's foreign policy. The Washington Post characterized President Vladimir Putin as "brandishing Russia's natural gas and oil reserves as his Soviet predecessors once flaunted nuclear rockets." Britain's politicians fear seeing Russian control of the gas supply used as a political weapon in the event of a future dispute with Moscow. Gazprom's interest in Centrica is only the latest in a series of bids across Europe – and the rest of the world – by Russian energy firms focused on building up their overseas infrastructure. From oil fields in Kazakhstan to filling stations in the United States, Russian companies are playing an ever-larger role in the world energy market. The main question for many observers is why. Much of Russia's energy expansion has been focused on Europe, and Britain isn't alone in its skepticism. When oil giant LUKoil made a $1 billion bid for Poland's failing Refinery Gdansk in 2003, a move that would have secured 17 percent of Poland's domestic gasoline retail market, public opinion put an end to the deal. "We are worried about the leverage the Russians could get," said former Polish Defense Minister Janusz Onyszkiewicz, expressing the mistrust many Poles feel toward their eastern neighbor. Similarly, Hungary's government fended off Gazprom's proposed takeover of Borsodchem, a major chemical manufacturer, in 2000, fearing the deal would give Gazprom control over the nation's gas transit network. Alexander Rahr, Director of the Koerber-Center for Russia/CIS Studies, says this kind of suspicion is misplaced. "People may be afraid of economic dominance by Russian energy giants, but should learn not to look at Russia the same way as in the 1990s," said Rahr. "Russian energy companies have begun to integrate as responsible global players." In other words, Russian companies are willing to play by the rules of the market. "It's completely logical and legitimate for Russian energy companies to buy assets in Europe," argues Rahr. Russia's energy sector is cash-rich and looking for opportunities to diversify. Its needs seemingly go hand in hand with the development going on in central Europe, where the new EU member states are desperate for foreign investment. Over 60 percent of Russia's oil and gas exports are sold to the EU. At the same time, the EU's newest members are reliant on Russia for up to 80 percent of their oil and gas needs. Seen in the light of such enormous and economically vital commercial interests in the area, Russian purchases of energy infrastructure in these countries are a means of safeguarding uninterrupted deliveries to their most valuable markets – as well as a continued flow of income to the state budget. Price caps on energy for the Russian market mean that Gazprom and others barely break even on domestic sales. Put together with increasing yields, this gives energy firms reason to set their sights firmly on exports. "Production is growing and European markets are definitely more attractive than the domestic market," says Madina Butaeva, a senior equity analyst for Raiffeisen Bank in Moscow. "The planned export routes to the United States, Japan and China are still a few years away, so European exports are the most attractive option for Russian oil companies for the time being." At the end of January, Russian Finance Minister Alexei Kudrin announced Gazprom's participation in talks aimed at securing direct access to the Italian gas market. The company is also interested in the privatization of Italy's gas pipeline operator, Snam Rete Gas, scheduled for 2008. A look at the figures involved in Russian gas sales to Italy shows that Gazprom and others have good reason to increase their role further down the distribution chain. The price of Russian gas when it reaches the Italian border is around ?200 per 1000 cubic meters ($238/35,300 cubic feet). According to the Italian Authority for Energy, the price reaches ?640 ($761) by the time the gas gets to Italian households. Clearly, the closer Gazprom gets to the end consumer, the more profit it stands to make. Anisa Redman, an oil and gas researcher at Alfa-Bank, says an increase of both production and profits explains LUKoil's acquisition of refineries in Europe. LUKoil can make more money by refining its own hydrocarbons than simply selling crude oil for others to process. It's cheaper from a tax and transportation point of view to refine the oil as close to the market as possible, Redman says. This also explains LUKoil's focus on building a network of filling stations overseas. By controlling its own retail outlets, LUKoil becomes its own most reliable and dependable customer, while strengthening its brand. In short, Russian energy firms are buying stability. This does not mean, however, that Russian expansion poses no risk to Europe's energy security. Asked if Russia was turning to its growing economic might as a means to achieve its foreign policy aims, Russian President Vladimir Putin emphatically denied the charge. "I think it's absolutely unfounded to talk of a Russian energy weapon," he told the 900 journalists gathered in January for his annual press conference. But, in the words of Gazprom Deputy CEO Alexander Medvedev, "it is too naive to say that the energy business can be completely separated from foreign policy." Russia's energy sector carries enormous political weight by its very nature as the country's most significant generator of wealth. Because of their political influence, decisions made by energy heavyweights must balance both political and economic concerns. Putin has made it a stated priority to improve domestic living standards, and the fortunes of the country's energy exporters will determine the extent to which his promises are fulfilled. This alone offers some assurance that Gazprom and others will be left free of interference from the Kremlin to develop their business according to market forces, as long as their business remains profitable overseas. While Europe might be ever more dependent on Russia, Russia simply cannot afford to frighten its European consumers into looking elsewhere for its energy needs. As Redman says, "It's a partnership – both sides need each other. It's not like Gazprom is a monopolist and can do whatever it likes in Europe, because there are other suppliers as well." The Kremlin's sudden spirit of compromise with Ukraine in its gas dispute following an outcry from its customers further to the West can be seen as good news for Europe. It was a sign of the importance that Russia places on maintaining its reputation as a reliable supplier of gas – and gives reason to believe it will not use its control of European energy infrastructure as political leverage against its most important customers. Russia is unlikely to forget the experience of OPEC, which hurt itself politically and economically by using its grip on the oil supply to pressure the West in 1973. The situation with Russia's immediate neighbors is less clear-cut. Russia has turned off the gas taps before as part of a political dispute, most recently to Ukraine and, in 2002, Belarus. The completion of Gazprom's next major overseas venture – the North European Gas Pipeline carrying Russian gas directly to Germany and beyond, avoiding transit through Ukraine and the Baltic states – offers the prospect of serious change in the balance of power between Moscow and its ex-Soviet neighbors, since Russia's dependence on them for the transit of its gas exports will be reduced. Russian plans for the rest of Europe look more certain. As long as high energy prices remain, it is possible that Russian companies' shopping spree in the European energy sector has only just begun. Click here to see Russian Ownership in Select Foreign Energy Enterprises