I write from St. Petersburg, Russia, where as part of the McCombs School of Business curriculum, my fellow MBA students and I have the opportunity to talk with domestic and international companies about doing business in Russia. Today, I would like to share some insights I have gained about the natural gas industry here in Russia through my experience as a tourist and through conversations with several major oil global companies working here.
Public Perception, Public Policy
Russia is no different from any other place in that the public’s attitudes and expectations about energy and government regulation profoundly shape the policy landscape and economics of the energy industry. Here in Russia, there is still an expectation that the government will provide a high level of social welfare services and subsidize energy prices. Gazprom, the largest natural gas company in Russia, which produces, refines, transmits, and sells natural gas here in Russia and abroad sells its gas in Russia at 15-20% of the market price that it charges Germany. It is estimated that Gazprom lost nearly half a million dollars on its domestic gas sales in 2006.
Move Over Texas: Everything is Bigger in Russia
It is surprising that a company of Gazprom’s size and power would have these problems in a western free market economy. It began its life as the Ministry of Gas Industry under the Soviet Union, which was privatized in 1989. Gazprom has a near monopoly on natural gas in Russia. If Gazprom’s assets were valued at the market rate, or a western company like ExxonMobil had Gazprom’s assets, it would be valued at $17 Trillion dollars. Gazprom is the largest company in Russia. It is the largest earner of hard currency in Russia, and its taxes make up 25% of total federal tax revenue.
Legacy Costs of Communism
One reason it is so difficult for Gazprom to raise its prices in the domestic market is that in a country as cold as Russia, making heating unaffordable is politically very unpopular. Nevertheless, the way heating works here is grossly inefficient, and unlikely to improve. Since Soviet times, heating has been centrally controlled. In the dead of winter, it is common to see open windows because the heat can only be adjusted upwards; it cannot be turned town by individual consumers, so they must open their windows to let in cold air. This is true here today in my hotel in St. Petersburg!
Technology and Innovation Outlook
Gazprom aims to increase production through 2030 but most of that increase will come from smaller private companies. Last week we spoke to a Russian banker who complained somewhat tongue-in-cheek, that energy prices (oil and gas) were not low enough to be good for Russian energy companies, or the Russian economy because they were low enough to hurt, but not enough to force the kinds of difficult reforms necessary to make those companies efficient and effective in the future.
Gazprom can rely on smaller companies for production growth, and Russia can count on western oil and gas companies for technological innovations to address their most challenging energy problems.
For example, Shell is participating in a project in Siberia that has set records for the efficiency and speed with which they drilled wells, yet they had to reduce their ownership stake (by selling off the majority to a Russia company) in order to stop additional regulatory hurdles that were being created and to guarantee government support. The Russian government is free to operate in this way, but it threatens the innovative potential of local Russian companies like Gazprom and its sister oil companies, Rosneft and Lukoil.
Interviews with Reiffesbank & Citigroup Tuesday, March 9, 2010
Interviews with Shell & ExxonMobil Wednesday, March 10, 2010