№4 April 2010Table of contents Issue Archive
№ 4 (April 2010)
Russian Prime Minister Vladimir Putin’s proposal to merger Gazprom with Ukraine’s Naftogaz certainly came out of left field to investors and, it seems, to the Ukraine government. Gazprom’s CEO, Alexei Miller, has confirmed that the two companies will meet after the May holidays to discuss the proposal.
By C Weafer
An outright merger of both companies seems very unlikely, if not impossible. What we are looking at is more likely the creation of a JV to control the gas transmission system in Ukraine or, some other asset swap between the two companies that would allow Gazprom gain an equity interest in the pipeline. Gazprom could, for example, offer Naftogaz an equity interest in upstream production in Russia. For both financial and political reasons, a merger is the least likely course of action.
From a strategic perspective, a full merger of the two companies would be negative for Gazprom’s share price while an asset swap that allows Gazprom gain an interest in the pipeline would be a net positive. That latter direction is the more likely and would be positive for Gazprom (OCZD.LI Buy) longer term.
Why no merger?
Several reasons, financial and political;
There is a significant size differential between the two companies. Naftogaz would end up with only a small equity interest in the combined entity. That would seem like a complete takeover of Naftogaz by Russia and would be completely unpalatable in Kyiv. President Yanukovych would risk a considerable political backlash if he supported that move.
It would be difficult to value Naftogaz so as to keep the process transparent. Gazprom is a listed company with a market value, Naftogaz is not listed and any valuation used in a merger would have to be calculated rather than derived from the stock market. A valuation that was perceived as too low would raise the political pressure on Yanukovych while too high a valuation would prompt accusations of discrimination against Gazprom minorities.
The government is much more proactive in trying to improve the country’s image with investors and is trying to avoid any action that maybe viewed negatively by markets. For example, even though the government used Gazprom as the mechanism to give the Ukraine economy a $30 billion subsidy (i.e. cheap gas) it immediately balanced that with a cut in the export duty so that Gazprom does not suffer any financial loss.
Russia would not allow its holding in Gazprom to drop below a 50%+1 controlling stake (where it is now) so any merger would also mean that there would have to be an equity issue to the state to keep its controlling stake intact. The Finance Ministry would likely oppose that at a time when the strategy is to cut the state’s involvement in the economy and to sell state assets.
Asset swap makes more sense
Russia has made no secret of the fact that it would like to have an equity interest in the pipeline system that takes Russian gas to its European customers. It partly blamed the crisis in 2006 and in 2009 because of the fact that it had no equity in the pipeline. The gas deal with Belarus involved Gazprom acquiring a 50% interest in the pipeline that transits Belarus. The objective with Ukraine is clearly similar. If such a deal is broadly replicated, both Gazprom and Naftogaz would remain independent with both having, for example, a 50 percent stake in a company that operated and controlled the pipeline.
What’s in it for Ukraine?
An asset swap would almost certainly involve Naftogaz getting equity in upstream gas production in Russia. For example, in one of the Yamal projects. That would allow Naftogaz to become more diversified and to move away from being just a gas utility. Valuation would be an issue but involving Naftogaz in a very long-term production project would allow for greater “valuation flexibility”.
The transit pipeline is old and needs substantial investment to upgrade it. The cost would be shared with Gazprom if there were a JV.
If Gazprom was an equal equity partner in the Ukraine gas pipeline, Moscow could then reverse its objections to the proposal to upgrade the Ukraine transit system to take Caspian/Central Asian gas to Europe. This was a plan proposed by the previous Ukraine government to take gas from Azerbaijan and, eventually, Turkmenistan, across the Black Sea and into an upgraded Ukraine pipeline. A variation of the so-called "White Stream” project. At the time, the EU expressed interest in the project but stopped short of full support because of objections from Moscow. Taking additional gas into the pipe from the Caspian would boost transit revenues for Ukraine.
What’s in it for Russia?
Moscow would realize its long held ambition to regain some control over the delivery system that brings gas to its customers in Europe.
It would allow for further integration of Russia into the commanding heights of the Ukraine economy and better secure a more stable long-term relationship between the two countries. One that could also better withstand any political changes in the future. Greater integration and co-investment would move the relationship beyond just political relationships to a more structured co-investment base.
If Russia supported the proposal to upgrade the Ukraine pipeline and the Caspian/Central Asia producers agreed to supply gas across the Black Sea (transiting across Georgia) then Nabucco would be a dead project. It would have no access to a gas supply.
What’s in it for the EU?
A JV deal to control the transit pipeline would almost certainly eliminate any risk of a repeat of the gas disputes that left parts of Europe shivering in early 2006 and early 2009. It would create much greater reliability in the gas supply.
It would also remove a potential headache for the EU. As Russia invests more and more into the Ukraine economy, the need for the EU to do so will be less. While Yushchenko was president, he tried to force the EU into accepting some financial responsibility for Ukraine as he tried to steer the country Westwards. It became clear that neither Brussels nor Washington have an appetite for that and increasingly acknowledge Moscow’s sphere of privileged interests in the CIS. Let Moscow take care of the CIS states appears to be the attitude in both the EU and Washington. There are enough political complications and financial demands elsewhere.
New reality…More Pragmatism
To a great extent the political relationship between Washington, Brussels and Moscow has fundamentally changed in the last few years. It used be based on willingness towards confrontation and encroachment. Today, it seems as if there is an acceptance of each other’s so-called areas of privileged interests. Partly that came about because of the global financial crisis, partly because of the Georgian war and the realisation of how close Europe/NATO came to being dragged into a conflict not of its choosing, and partly because of the need to co-operate on more urgent issues such as Iran, the war in Afghanistan, etc.
Either way, the acceptance of each other’s regions of privilege is a big part of geo-political relations between the three today. Russia’s increasing investment into the Ukraine economy and in assets that are also strategic for Europe and, indirectly, assuming a financial supporting role for the country suits both Brussels and Washington just fine.