The rise and fall of Russia’s Gazprom
The Russian Federation’s stability largely depends on the performance of its energy industry. But its giant gas company is in trouble.
In a nutshell
- Gazprom recorded a net loss in 2023
- The predicament stems largely from its European market losses
- The gas giant’s problems are not quick or easy to solve
It has been said that in Russia, everything is about oil. This is true in the sense that oil accounts for the lion’s share of Russian export revenues. As such, it constitutes the main driver of economic growth, the critical factor determining the balance of payments and the size of the federal budget, as well as the leading source of increases in real incomes. In short, oil keeps the Russian economy and society afloat. During its war against Ukraine, it has been of supreme importance to the Kremlin that its crude oil exports are maintained despite Western sanctions.
What is less known outside Russia is that on the domestic scene, everything is about natural gas. While the production of oil and gas has long been roughly equal when measured in thermal units produced, the role of gas has been more pronounced on the home front. Gas is fed into communal heating systems, propels electrical power generation and supports energy-intensive industries that thrive on this heavily subsidized fuel. Above all, the national gas giant PJSC Gazprom has long been an essential tool in the service of the Kremlin’s ruling elite, allies, supporters and cronies.
Gazprom’s financial woes
In stark contrast to the oil sector, where the Soviet-era state monopoly was broken up into competing private ventures, the gas sector was preserved intact and privatized into the hands of well-connected insiders. Public joint-stock company Gazprom is a state-owned enterprise: The Russian government controls roughly half of its outstanding shares. Since 1993, when its trade arm Gazexport was transformed into a Russian joint-stock company (RAO), Gazprom’s foreign trade subsidiary has performed two critical roles.
The magnitude of the surprise should be measured against the Kremlin’s bluster in previous years about how Europe would freeze and even starve if it did not come to terms with Russia.
First, it serves as a cash cow for corrupt insider enrichment, and second, it provides vital levers for geopolitical power plays. Given how important these twin roles have been, it came as a shock when, in May 2024, the company announced its results for 2023.
Analysts had expected net income of 447 billion rubles ($4.9 billion), down from 1.2 trillion rubles ($13.1 billion) in 2022. However, the numbers instead showed a massive net loss of 629 billion rubles ($6.9 billion). That was the first time since the late 1990s that the the behemoth’s results had been in the red, and the apparent reason was a collapse in its exports to Europe.
Since early 2023, Gazprom has stopped publishing its own export statistics, but according to calculations by Reuters, its natural gas supplies to Europe fell by 55.6 percent in 2023 to 28.3 billion cubic meters.
Facts & figures
Gazprom’s annual net financial results and gas extraction volumes, 2019-2023
The magnitude of the surprise should be measured against the Kremlin’s bluster in previous years about how Europe would freeze and even starve if it did not come to terms with Russia. The hard data suddenly made clear that Europe was adapting successfully to living without Russian gas and that it would now be up to Gazprom to absorb the costs for its past management and strategy failures.
Missed gas market warnings and management mistakes
There had been warnings. An outside consultancy report presented to Gazprom management in November 2023 proclaimed that gas sales lost due to Europe’s reaction to Russia’s aggression against Ukraine would not be recovered for more than a decade. The authors estimated that by 2035, exports to Europe would average 50-75 billion cubic meters per year – about a third of the level prior to the full-scale invasion of February 2022.
In a comment on that report, Elina Ribakova of the Washington-based Peterson Institute for International Economics noted: “It is very grim. Gazprom is at a dead end, and they’re very much aware of it.” Being aware is, however, not the same as being able to act. The ongoing implosion of the national gas giant will have far-reaching consequences.
Read more on Russian gas
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2007 was a fantastically prosperous year for Gazprom, with energy prices high and rising (oil prices, for example, reached their all-time high in July 2008). Buoyed by its booming business in Europe, Gazprom agreed that it would pay its suppliers in Central Asia, such as Turkmenistan, more. Gazprom management was convinced that it could pass the high costs on to its European customers. However, as the markets subsequently tanked amid the financial crises, that promise came back to haunt the gas giant.
Moscow’s emphasis on Gazprom achieving political objectives was accompanied by substandard corporate governance.
But in 2007, it was all blue skies. With a stock market valuation of $360 billion at the time, Gazprom was the world’s third-largest company by earnings, after ExxonMobil and Apple. Chief executive officer Alexey Miller expressed confidence that he would be able to boost its value to $1 trillion. Until quite recently, it looked like things were heading in that direction.
Blowback in Europe
The Russian aggression of Ukraine in 2014 did not result in biting sanctions for Russian companies. Not even the 2022 full-scale military onslaught could shake the Western powers enough to sanction Gazprom. Germany fought tooth and nail to ensure that the Russian gas sector would remain exempt from punitive measures and that this exemption would be extended to Gazprombank, which was needed for processing payments for the commodity. It is against this background that the shock over the Gazprom 2023 loss hit the energy industry.
The Russian government responded by recommending that the company not pay dividends for 2023. Its board of directors promptly passed that recommendation on to the shareholders’ meeting. Already burdened with heavy debt, Gazprom also embarked on a fire sale of properties in Moscow.
Markets reacted to the bad news by selling, and the Gazprom share price dropped from 165 rubles on May 2, 2024, to 114 rubles on June 13 – a decline of 30 percent in six weeks. On June 19, the company had a market capitalization of $32.2 billion, making it the 609th most valuable company in the world – a far cry from where it wanted to be, on the cusp of number one.
Gas giant weakened by cronies
Another factor behind this collapse is that Moscow’s emphasis on Gazprom achieving political objectives was accompanied by substandard corporate governance. Given that Russia has the largest proven reserves of natural gas in the world, well ahead of both Iran and Qatar, its national champion producer should have been in pole position to do good business. Yet, where the first two terms of Vladimir Putin’s presidency (2000-2008) saw a spike in production by private companies in the oil sector, increasing output by 50 percent, Gazprom’s production remained flat.
Mr. Miller claimed that ‘shale gas is a well-planned propaganda campaign, similar to those for global warming or biofuels.’
A key feature of the company’s track record is its tendency to conduct business through politically well-connected intermediaries such as ITERA, EuralTransGas, and RosUkrEnergo. Almost all Gazprom exports of gas to Ukraine and onward were farmed out to such entities, allowing substantial margins to be siphoned off into private pockets.
Two strategic blunders
Beyond allowing a steady erosion of business fundamentals, Gazprom management also made two highly consequential errors of judgment. The first was ignoring the competition. When hydraulic fracking technology showed promise to alter the global energy landscape and transform the United States from an importer to a major energy exporter, it was international news, but not in Gazprom’s headquarters in St. Petersburg. Mr. Miller had nothing but scorn for the shale energy innovation.
In a June 2010 speech to a business forum in Cannes, he tried to debunk “the shale myth.” A year later, in another speech, Mr. Miller claimed that “shale gas is a well-planned propaganda campaign, similar to those for global warming or biofuels.” His long-standing deputy, Alexander Medvedev, chimed in by branding the growth in U.S. shale gas production as a “bubble,” like the “dot com bubble” that burst in 2000, dealing a powerful blow to the Western-dominated information technology industry.
An immediate casualty of Russia underestimating the shale revolution was the Shtokman field in the Barents Sea, one of the largest natural gas reservoirs in the world. Gazprom had plowed money into developing it into a core asset for the export of liquefied natural gas (LNG) to the American market. That plan did not age well.
Gazprom’s second fundamental mistake was that when other gas-rich countries began investing in sophisticated facilities to produce LNG, Gazprom remained focused on building out its legacy pipeline business. There were obvious geopolitical ambitions behind this fateful choice. The two-pronged approach of constructing the Nord Stream and South Stream pipelines would make it possible to cut the gas flow through Ukraine without halting supplies to Europe.
With strong support from Germany, the Nord Stream consortium succeeded in laying two lines of pipes on the Baltic seabed. When Nord Stream 2 was launched, plans were floated for a third and even a fourth line. The South Stream project – to transport natural gas from Russia to Europe through the Black Sea – was a different story. Faced with stiff opposition from the European Union (which aimed to build its own Nabucco pipeline), the South Stream project eventually had to be scrapped. Gazprom took much flak for having invested heavily in the preparatory phase before the necessary permits could be secured.
Gazprom has little agency of its own, as it is heavily dependent on the policies of outside actors.
The last manifestation of Kremlin hubris was when the EU responded to Russian energy-bullying against Ukraine by designing its Third Energy Package. The Kremlin was especially angered by the “Gazprom clause,” which called for a ban on energy companies being both producers and distributors. The Russians’ arrogant response was to assert that if Europe did not want Russian gas, then it would divert the gas and sell it to Asia instead.
Waning gas market influence
All these chickens are presently coming home to roost. Europe is well on its way toward becoming fully independent of Russian gas, while China is showing little interest in picking up the slack in the commodity’s trade, at least at any price higher than the highly subsidized price Russians pay domestically. Although Gazprom did finally manage to launch the Power of Siberia pipeline that links its gas fields in Eastern Siberia with markets in China, it is not operating at full capacity and the contracted price is believed to be a fraction of what European customers used to pay. Beijing is also dragging its feet on Mr. Putin’s Power of Siberia 2 idea.
At present, Gazprom has little agency of its own, as it is heavily dependent on the policies of outside actors. The issue is fundamentally one of geography. The bulk of Gazprom pipelines were built to deliver gas to Europe. Nord Stream has now been blown up, and if the agreement with Ukraine on gas transit expires at the end of 2024, as appears likely, Gazprom lines in Ukraine will also be closed. That leaves two pipelines to Turkey, the Blue Stream and the Turk Stream, both of which are dependent on the goodwill of Turkish President Recep Tayyip Erdogan, and one line to China, which is hostage to the sentiments of President Xi Jinping.
Scenarios
Possible: Moscow finds support to boost sales to Europe
The Kremlin has two European hopes: one, that its EU ally Hungary lobbies successfully to persuade the Ukrainians to renew the gas transit agreement, allowing Russian gas to continue to flow to Hungary and Austria; and two, that Turkey allows Russian gas to be blended with gas from Azerbaijan which flows to Europe via the Trans-Anatolia Pipeline. Both could bring some short-term relief to Gazprom (and Russia).
Possible: Pivot from Europe to Asia
If Russia could boost exports to Asia, the picture would change radically for Gazprom. One option is that President Xi eventually agrees to proceed with the Power of Siberia 2. However, Beijing has let it be known that it would only accept paying the domestic Russian price (which is heavily subsidized), and the project would, in any case, take years to materialize.
Another option Russia has is diversifying by building LNG export plants on the Pacific coast. However, since Gazprom lacks the technology, this would be a boon for private Russian companies like Novatek.
Likely long-term: Gazprom cannot take its reserves to market
Adding to its woes, Gazprom is also feeling the impact of Western sanctions on crucial technology, such as the turbines to pressurize pipelines and spare parts for repairs and maintenance of vital energy infrastructure. Although Russian companies are expected to be able to repair their U.S.-made turbines soon, they will still struggle to reproduce crucial parts that are sourced in the West.
The implications for the Kremlin in this scenario – if Gazprom is not able to swiftly restore exports to Europe nor significantly boost flows to Asia – are severe. It stands to lose crucial levers for geopolitical power plays and an important source of personal enrichment for regime members. Also, the Russian government will have to watch an accelerating erosion of communal heating systems, national power generation and support for energy-intensive industries, possibly leading to price hikes for domestic customers. Likely, Ukrainian drone strikes will exacerbate these problems, causing prices paid by consumers to spike further.
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