A couple of weeks ago, a scandal broke out. An analyst at Sberbank’s investment subsidiary published a critical report on Gazprom and was immediately fired. Then his boss was fired too. And then Sberbank chief German Gref had to call one of Gazprom’s offended contractors and apologize. The contractor was not Kadyrov, as one might assume, but Gennady Timchenko — a longtime friend and close associate of Vladimir Putin.
An astonishing story, isn’t it? What could possibly have been written in this dry, fairly formal document for it to end so badly? We got hold of the report, studied it carefully, and are ready to tell you all about it in detail.
A clarification is in order. Reports like this are a completely standard part of how investment divisions at major banks operate. They are issued regularly and provide overviews of the stock and securities markets. They contain expert opinions based on company news, financial statements, mathematical models, and forecasts. These reports are sent to the bank’s clients — investors — who can then use them to make decisions about what securities to buy, what to sell, and so on.
But this particular May report led to a major scandal. People lost their jobs, and the issue was widely discussed in the media. So let’s take a look at what exactly it said.
To begin with, here is the document itself. It is 43 pages of English-language text about Russia’s oil and gas sector. From the table of contents, we can see that the report has two major sections — one on Gazprom and one on Lukoil.
We are interested in the section on Gazprom. The report’s main point is summarized right away on the first page.
But before we get to that, we need a bit of context.
Gazprom has been doing “not so well” for quite a long time. In 2008, the company was valued at $367 billion, and as we now understand, that was the best period in Gazprom’s entire history. But at the time, people thought it was only the beginning. Putin said that only victories lay ahead, talked about dreams coming true, and called Gazprom our national treasure. Gazprom CEO Alexei Miller claimed that by 2016 the company would be worth ONE TRILLION dollars.
Want to guess how much it is worth now? A trillion? Maybe half a trillion? Maybe at least as much as in 2008 — $300 billion? No. Gazprom is worth $54 billion.
You have to admit, for an investor who believed Miller and Putin in 2008, this is, to put it mildly, a disappointment. The company is worth twenty times less than was forecast. The investor has less profit, smaller dividends, cheaper shares, and those dreams stubbornly refuse to come true.
So what went wrong? This question has been hanging in the air for 10 years now, ever since things started going wrong. Who is to blame? Why did this happen? What is the reason? Why is it that a giant, supposedly promising company under the close watch of the president and the government is worth one and a half times less than the Starbucks coffee chain?
A couple more examples for context. Netflix, with its TV shows, is worth almost $160 billion. Disney is right there too — $150 billion. Not a single well, yet both are worth three times more than Gazprom. The world’s most valuable company, Apple, is worth $945 billion.
That is the context. Now let’s return to Sberbank’s report, because these are exactly the questions it tries to answer.
And their conclusion is simple. Unlike normal companies, Gazprom simply does not have the goal of being profitable. Gazprom has a different agenda. It exists not to generate returns for shareholders — that is, the state and other private investors — but to enrich the contractors who service it. We are talking about Putin’s well-known friends: the already mentioned Timchenko and another childhood friend, the sportsman Arkady Rotenberg.
Sberbank’s analysts make one more observation. Instead of pursuing economically sound projects, Gazprom is busy serving the country’s so-called geopolitical interests — in other words, the ambitions of that same Putin.
That is why Gazprom’s value is not rising but falling. All the free cash that could have gone into profitable investments or dividends for the state and shareholders is being spent on dubious, loss-making projects.
To support this argument, Sberbank analyzes three Gazprom megaprojects, which we will now discuss.
1. POWER OF SIBERIA
Power of Siberia is a pipeline between Russia and China. The entire project costs $60 billion, or 3.7 trillion rubles — in other words, more than Gazprom itself is worth. The project was launched in 2014 as part of Russia’s “pivot to the East.” At the time, our state decided that we would now be friends with the Chinese and signed a 30-year gas supply contract.
The Power of Siberia project effectively replaced the cheaper “Altai Route,” which would have cost $10 billion. Contractors, of course, find it much more profitable to build something for $60 billion rather than $10 billion. Contracts for the construction of the pipeline’s main section were split roughly equally between Stroytransgaz and Stroygazmontazh. One belongs to Gennady Timchenko, the other to Arkady Rotenberg. Both received multibillion-dollar contracts without any tender.
There are two major problems with the project. First, it benefits China exclusively. China will be able to dictate the terms because it has alternative suppliers. But for Power of Siberia, China is the only possible buyer. And if China refuses to take the gas at the proposed price, there will be nowhere else to send it, so Gazprom will have to lower the price and persuade the Chinese to buy it after all.
Second, Sberbank’s analysts built a mathematical model and calculated that the project can pay for itself only if oil prices are above $110. First, prices have not been that high since 2014. Second, at that price level, it would be more выгодно for China to reduce volumes from Power of Siberia and buy gas from Central Asia or liquefied natural gas delivered by specialized tankers.
Sberbank writes that the net present value of the Power of Siberia project is negative, at minus $11 billion. Many of you already know perfectly well what net present value means, but just in case, let us rephrase it. Even if you take into account all the potential future payments Gazprom will receive for supplies through Power of Siberia, it still would have been more profitable simply not to build this pipeline at all. To do nothing whatsoever. That would have been better by $11 billion.
2. NORD STREAM 2
The next megaproject analyzed by Sberbank is Nord Stream 2. It is a project to expand the existing gas pipeline to Germany. One of the key reasons for building it is geopolitics — the pipeline would allow more gas to be pumped while bypassing Ukraine.
The project is valued at $17 billion, with one-third of that spending going to construction on Russian territory. And a month ago, Stroytransneftegaz was selected as one of the contractors without any tender. The company is at least half-owned by Gennady Timchenko. Notably, Gazprom tried to hide the contractor’s identity and blacked out the details in electronic documents. They did it so clumsily, however, that journalists highlighted the redacted text, copied it into another document, and immediately uncovered everything.
Don’t worry, Rotenberg was not left out either. His company Stroygazmontazh is building the starting compressor station for Nord Stream.
Once operational, Nord Stream 2 may recoup its costs in 20 years, but its net present value is again negative: minus $6 billion.
3. TURKSTREAM
The third project is TurkStream. It is a new gas pipeline running along the bottom of the Black Sea to, accordingly, Turkey.
Here too, the desire to bypass Ukraine is clearly an important, if not the main, reason for construction. Yes, having its own pipeline directly to Turkey and potentially to Bulgaria would save money on transit payments to Ukraine. But it still will not be possible to abandon transit entirely. And neither of these projects opens up any new export markets for Russia.
The cost of TurkStream is estimated at $21 billion, with more than half of that going to the Russian section. That means the same unaccountable contractor-friends will be involved there too.
The report does not provide details about the sums involved or the contractors for the Russian section of TurkStream. Apparently, in this case Gazprom did a better job blacking things out in the documents. But we do know for certain that, for example, the compressor stations were built by Rotenberg’s Stroygazmontazh.
The losses from TurkStream will be even greater than those from the more expensive Power of Siberia. It will recoup its investment only after 50 years, and its net present value is, attention, minus $13 billion. Even if it operates for half a century, it would still be better not to build it at all.
So that you do not get lost in all these numbers, below is a simple table with all the data brought together:
A NEW MEGAPROJECT
But that is not all the report says. According to Sberbank, Gazprom’s next megaproject will be replacing old pipes on existing pipelines. Gazprom has no clear rules for pipe replacement: some are changed after 20 years, while others remain in service for 50. Management decides when the pipes should be replaced.
Right now, Gazprom spends about $4.5 billion a year on this. But after Power of Siberia, TurkStream, and Nord Stream 2 are completed, Gazprom will be able to spend $15–20 billion a year on it over the next 15 years. That will be very pleasing to those who will supply the pipes and lay them.
But why does Sberbank think such a megaproject is coming? Existing pipe manufacturers in Russia are currently operating at only about 50% of capacity. The situation is not great, but suddenly a new pipe-rolling plant is being built near Zagorsk (the former Soviet name of Sergiyev Posad), and it very quickly receives approval to supply pipes and a contract worth 11 billion rubles from Gazprom. At the same time, Gazprom is terminating old contracts with other pipe manufacturers. And once again, surprise: one of the known owners of the new plant turns out to be Nikolai Yegorov, Putin’s former classmate from Leningrad State University.
After the report was published, news emerged that indirectly confirms Sberbank’s analysts’ assumptions about the coming megaproject: Gazprom and the Zagorsk Pipe Plant signed a scientific and technical cooperation program for 2018–2023. The plant will supply more and more types of pipes, and Gazprom, with the help of its old contractors, will lay them. Obviously, this megaproject will bring Gazprom no revenue at all. In this case, the only ones set to profit are the suppliers and contractors.
CONCLUSIONS
What Sberbank’s analysts wrote is not some shocking revelation; all of this has long been understood and said before. The scandal lies in the fact that, for the first time, such an opinion was published in a report by Russia’s state-owned Sberbank.
For two decades, Putin has been building a system that allows any scheme to be carried out easily and quietly. Over that time, Gazprom — a state company that makes money from natural resources — has effectively turned into his personal pocket enterprise. An enterprise that serves not you and me, and not even its shareholders, but simply whoever Putin wants it to serve.
Do not think this is a management mistake or a miscalculation. No. Gazprom was DELIBERATELY designed and organized to work this way. Today we have been talking about people: Putin, Miller, and, incidentally, the apologizing Gref too. Thirty years ago, in the 1990s, these people sat in the same offices at St. Petersburg City Hall. Back then, Timchenko and the Rotenbergs — still unknown to the public — came to see them there. Nikolai Yegorov, with his new pipe plant, comes from the same circle. They studied together with Putin, Medvedev was in graduate school under him, and he had joint business ventures with the billionaire cellist Roldugin.
There are no accidental people here at all, you understand? And there cannot be. Because any sane person who ended up at Gazprom by chance would immediately sound the alarm. This whole scheme is glaringly obvious and could be the plot of some mafia TV series, but unfortunately, it is our everyday reality.
But even here, allow me a little optimism — optimism shared, incidentally, by the fired authors of the scandalous report. If Gazprom’s management changes... bluntly speaking, if all this Putin-era crookery is thrown out of there... if the whole concept changes and the company stops pouring money into loss-making projects nobody needs, then things will quickly fall into place. It will not be worth a trillion, of course, but Gazprom could be worth four times more.
Let’s do our best to make that happen as soon as possible.