Updating the management at Gazprom - the dream of any investor who put money into Russia -- is a symbol of change not only in the monopoly itself, but in the country as a whole. Rumors of Alexei Miller’s resignation resurfaced this spring and have already led to a 10% rise in Gazprom’s share price in the past two weeks. The potential successor is said to be a manager in the industry, and candidates include Gazprom Oil president Alexander Dyukova, Leonid Michelson, chairman of the board at Novatek, and famed reformer and Sberbank head German Gref, who has Minister of Economic Development once proposed breaking up Gazprom.

Is there a chance for rapid reform in the company? On one hand, reform at the gas giant is inevitable, and there are two reasons why:

1. In recent years the gas market has undergone radical changes, primarily due to the rapid growth of shale gas production in the United States. Gazprom simply ignored these changes for some time, calling the shale revolution in the US a PR campaign. As a consequence, the monopoly was totally unprepared for the growth of competition in the European market after significant volumes of liquefied gas previously destined for the United States were redirected to Europe due to growth in domestic US production. Coupled with falling demand amid the economic crisis in Europe, this led to a need to revise contracts with European customers. In my opinion, the situation will only get worse. The US may begin to export gas and production technology as well, particularly to China. Gazprom’s position on the world market will weaken and revenues will decline. In fact, just one of the stories is enough to dismiss the entire management team headed by Alexei Miller.

2. Growth in infrastructure and social spending in Russia will sooner or later lead to the need to increase tax revenues. The gas industry will be the principal potential victim of the tax increase. First, this is the only sector that can offer the government significant inflows, and second, the tax burden on Gazprom is much lower than on oil companies (30% of revenue versus 50%), which is bound to cause problems. The truth is that a substantial tax increase on Gazprom will be extremely difficult, as almost all free cash flow goes to capex, M & A and debt service. According to estimates by Sberbank CIB, the trend observed over the past 14 years suggests that Gazprom has paid dividends by borrowing (over the years, the company paid out USD 22 billion while debt increased by USD 26 billion). It’s impossible to increase the tax burden on Gazprom until the company becomes more transparent and optimizes its cost structure. One way is to install new management and, ideally, break the company up into mining, transport and export divisions.

The problem, however, is that change in Russia is almost never due to the country’s overall strategic interests or those of a company (or industry). As a rule, structural changes are due to two reasons. First, existing problems have become so serious that it is no longer possible to ignore them (one example, the 1998 default). From this point of view, Gazprom has a few more years before the changes in the gas market and the budget problems become sufficiently critical and obvious to trigger major change in the monopoly. The second reason is lobbying for reform by a particular political or economic group.

Ironically, there may be no one to lobby for change in Gazprom. Although Gazprom is a public company, minority shareholders make few decisions in our country, and the conflict between shareholder activist Bill Browder and the Russian authorities is there for all to see. Oil holdings also producing natural gas were desperate for reform at Gazprom to gain free access to the company’s pipelines. Novatek most of all is interested in a special relationship with Gazprom and the absence of competition from other players.

Remaining is Igor Sechin, head of Rosneft, known for ambitious development plans and the significant administrative resources of a state-owned company. Rosneft is lobbying the government for the right to export liquefied natural gas, a monopoly still enjoyed by Gazprom. In addition, according to media reports, Sechin is offering to buy a 0.23% stake in Gazrpom through Rosneftegas and thus increase the share under state control. Perhaps this news provoked a hearing on Miller's resignation, because we all know the relationship between the two state managers is more than strained.

However, in my opinion it’s still too early to talk about a full-fledged attack on Gazprom by Sechin, as Rosneft is in the process of completing an important deal - buying TNK-BP for USD 60 billion. Does Igor Sechin need a major new war right now? And does the Kremlin need one manager controlling virtually the entire Russian fuel and energy complex, a state of affairs that would completely destroy the system of checks and balances? I think not. In addition, Putin's recent personnel decisions, such as the appointment of Elvira Nabiullina to head the Central Bank shows that loyalty is now the quality most prized by the President. Investors shouldn’t expect any quick changes at Gazprom.

18 March 2013, Forbes

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