VZCZCXRO1716
PP RUEHAG RUEHAST RUEHDA RUEHDBU RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA
RUEHLN RUEHLZ RUEHNP RUEHPOD RUEHROV RUEHSK RUEHSR RUEHVK RUEHYG
DE RUEHMO #0367/01 0441453
ZNR UUUUU ZZH
P 131453Z FEB 09
FM AMEMBASSY MOSCOW
TO RUEHC/SECSTATE WASHDC PRIORITY 1953
INFO RUCNCIS/CIS COLLECTIVE PRIORITY
RUEHZL/EUROPEAN POLITICAL COLLECTIVE PRIORITY
RUEHXD/MOSCOW POLITICAL COLLECTIVE PRIORITY
RHEHNSC/NSC WASHDC PRIORITY
RHMFIUU/DEPT OF ENERGY WASHINGTON DC PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY

UNCLAS SECTION 01 OF 04 MOSCOW 000367 
 
SENSITIVE 
SIPDIS 
 
DEPT FOR EUR/RUS, FOR EEB/ESC/IEC GALLOGLY AND WRIGHT 
EUR/CARC, SCA (GALLAGHER, SUMAR) 
DOE FOR HEGBURG, EKIMOFF 
DOC FOR JBROUGHER 
 
E.O. 12958: N/A 
TAGS: EPET ENRG ECON PREL RS
SUBJECT: GAZPROM FACING TOUGH FINANCIAL TIMES AHEAD 
 
REF: MOSCOW 153 
 
SENSITIVE BUT UNCLASSIFIED.  PLEASE PROTECT ACCORDINGLY.  NOT 
FOR INTERNET DISTRIBUTION. 
 
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SUMMARY 
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¶1. (SBU) Gazprom's financial outlook for 2009 is increasingly 
bleak.  The company's revenues from exports to Europe are set 
to decline dramatically as gas prices to Europe, which lag 
oil prices by about six months, head to one-third their peak 
price.  Unfortunately for Gazprom -- and the GOR, which 
depends heavily on Gazprom for its budget -- this trend will 
be amplified and prolonged by reduced European demand due to 
recession and pricing pressure from massive new volumes of 
LNG.  Domestically, hopes for higher revenues from 
liberalized prices are fading as the GOR will find it 
politically difficult to raise gas prices during an economic 
downturn.  Furthermore, Gazprom is facing substantial debt 
repayments in 2009, yet continues to talk of new 
multi-billion dollar investments.  The markets have rightly 
punished the company, driving down its stock price by over 
70% from its peak, giving the company little hope of 
achieving its long-sought goal of becoming the "most valuable 
company in the world."  End summary. 
 
----------------------------------------- 
LOW PRICES TO HIT GAZPROM HARD IN 2009... 
----------------------------------------- 
 
¶2. (SBU) Gazprom's revenues from European gas sales are 
dropping fast.  In a February 6 presentation to investors, 
Gazprom predicted an average gas price to Europe of $280 per 
thousand cubic meters (mcm) in 2009, down from an average 
price of $409 per mcm in 208.  Considering the European 
market alone, Gazprom's price estimate combined with its 
expected decline in the volume of sales, from 179 billion 
cubic meters (bcm) to 170 bcm, would result in decreased 
revenues of approximately $26 billion for Gazprom in 2009, 
compared to 2008. 
 
¶3. (SBU) The financial hit of reduced gas sales to Europe is 
amplified by Gazprom's relative dependence on those sales. 
Gazprom's figures indicate that revenues from Europe were $73 
billion in 2008, while revenues from the former Soviet Union 
(FSU) states and from the domestic market combined were 
approximately $31 billion -- meaning European sales account 
for over 70% of Gazprom's revenues from gas sales. 
 
¶4. (SBU) Ron Smith, chief strategist at Alfa Bank, told us on 
February 9 that he expected Gazprom's quarterly revenues from 
Europe to drop steadily from a peak of $26 billion in the 
fourth quarter of 2008, to just $7 billion in the third 
quarter of 2009.  The price of Russian gas sold to European 
customers is based on formula tied to oil and lags the oil 
price trend by 6 to 9 months.  The precipitous drop in oil 
prices from the summer 2008 peak will thus cause gas prices 
to Europe to drop similarly from the first quarter of 2009 to 
the third quarter.  Smith estimated the average price to 
Europe would drop from $512 per mcm in the fourth quarter of 
2008 to just $170 per mcm in the third quarter of 2009. 
 
------------- 
...AND BEYOND 
------------- 
 
¶5. (SBU) Unfortunately for Gazprom, there does not seem to be 
much hope for a rebound in the prices it can charge European 
customers.  Wood Mackenzie, a global energy consulting firm, 
predicts continued downward pressure on European gas prices 
for the next few years.  Tim Lambert, Vice-President at Wood 
Mackenzie, told the AmCham Energy Committee on February 5 
that his company has significantly lowered its forecast for 
European gas demand in the coming years as the effects of the 
recession take hold. 
 
¶6. (SBU) Lambert noted that reduced European demand will 
coincide with large increases in global volumes of LNG, 
largely from Qatar, coming online in 2009 and 2010.  Lambert 
 
MOSCOW 00000367  002 OF 004 
 
 
explained that most of this LNG would find itself in Europe, 
over-supplying the market and driving spot-market gas prices 
lower for the foreseeable future.  Lambert went on to explain 
that Gazprom would not be able to completely isolate itself 
from the lower spot market prices, even though its contracts 
with European customers are long-term and indexed to oil. 
According to Lambert, the contracts have enough flexibility 
in them that Gazprom would have a difficult time maintaining 
a strict link to oil prices.  Thus, even an unlikely rebound 
in oil prices may not relieve the price pressure on Gazprom 
in the near-term. 
 
------------------------------------ 
NO RELIEF FROM DOMESTIC, FSU MARKETS 
------------------------------------ 
 
¶7. (SBU) By volume, Gazprom sells more than twice as much gas 
to domestic consumers and the former Soviet Union (FSU) than 
it does to Europe.  The company expects some of its lost 
revenues from Europe to be offset by price increases for FSU 
and domestic consumers.  However, this expectation seems 
overly optimistic.  Price increases to the FSU will be 
partially offset by lower volumes and higher prices paid by 
Gazprom to Central Asian suppliers.  Domestic price increases 
are only planned, and will be politically very difficult to 
implement during a recession. 
 
¶8. (SBU) In its presentation, Gazprom publicly predicted the 
gas price to FSU customers would rise from $159 per mcm in 
2008 to $198 per mcm in 2009.  However, Gazprom also expects 
sales to the FSU to drop in volume from 88 bcm in 2008 to 75 
bcm in 2009.  Using those figures, Gazprom would only realize 
a net increase of less than $1 billion in revenue from the 
FSU.  The true figure is likely to be even be lower as the 
majority of gas volumes sold the to FSU originate in 
Turkmenistan, to which Gazprom reportedly will pay a fixed 
$150 per mcm, leaving little room for a substantial mark-up. 
Furthermore, by the company's own admission, the gas shutoff 
to Europe and Ukraine in early January (reftel) cost Gazprom 
$2 billion in sales -- sales lost during a period of record 
high prices. 
 
¶9. (SBU) Accepting the GOR's planned increases in domestic 
gas tariffs as a given, Gazprom's message to investors and 
analysts has been that its domestic revenues should see 
robust growth in coming years.  Under the existing GOR plan, 
domestic prices, currently averaging approximately $62 per 
mcm, are set to rise to "netback parity" (export price minus 
transportation and taxes) by 2011.  For that to happen, 
according to Gazprom's presentation, domestic prices would 
have to rise 210% by 2011. 
 
¶10. (SBU) Most investment analysts are generally cautious, 
however, about planned future domestic gas price increases. 
Raising prices at that rate during a recession would likely 
be nearly impossible from a political standpoint. 
Slower-than-expected domestic price rises, coupled with an 
expected drop in domestic demand -- as Gazprom's Chief 
Financial Officer Andrey Kruglov reportedly advised was 
likely in a February 11 conference call with investors -- 
would result in a relatively minor increase in overall 
domestic revenues. 
 
-------------------------------- 
RUBLE DEPRECIATION A BRIGHT SPOT 
-------------------------------- 
 
¶11. (SBU) The one bright spot for Gazprom's finances is the 
weakening ruble.  With most of its revenues in dollars or 
euros and most of its operating expenses in rubles, the 
company stands to benefit substantially from a weak ruble. 
In its presentation, Gazprom estimated that each 1% decline 
in the value of the ruble would result in about $500 million 
of benefit to the company. 
 
------------------------------------------ 
YET GAZPROM EQUIVOCATES ON COST-CUTTING... 
------------------------------------------ 
 
¶12. (SBU) Gazprom, as currently structured, will have a tough 
time turning its finances around.  It is not just a company, 
 
MOSCOW 00000367  003 OF 004 
 
 
but a political enterprise.  With its most senior executives 
and the most senior leaders of the GOR pledging to push ahead 
on expensive and politically motivated projects such as the 
South Stream pipeline, the company will have a tough time 
finding major savings in project cancellations and delays. 
Furthermore, second only to its mission of providing gas to 
Russian consumers is its non-commercial mission of providing 
a variety of social welfare programs. 
 
¶13. (SBU) However, Gazprom will face tremendous political 
pressure to avoid cost-cutting measures that would result in 
massive job losses or big reductions in procurement or social 
expenditures.  That is likely why the company has been 
unclear about how it will meet its expenses and what proposed 
investments it plans to delay or cut.  In its investor day 
presentation, Gazprom maintained that it was moving ahead 
with its 2009 investment budget of $29 billion, including 
"priority" production and transportation projects, most of 
which would be financed in dollar or euro terms.  These 
priorities include development of the Shtokman field in the 
Barents Sea and the Nord Stream pipeline across the Baltic to 
Europe.  (N.B. In a February 13 meeting with the Ambassador, 
Gazprom CEO Alexey Miller affirmed that his company has not 
changed its investment plans.  Septel.) 
 
¶14. (SBU) The company said in its February 6 presentation to 
investors that it planned for Nord Stream phase 1 to be 
complete by 2011 and for the South Stream pipeline under the 
Black Sea to southern Europe to be complete by 2015.  It 
estimated the total cost of Nord Stream (both phases) at 7.4 
billion euros and of South Stream at "24 " billion euros. 
The company also announced that it planned to complete its $5 
billion purchase of a 20% stake in Gazpromneft (Gazprom's oil 
subsidiary) that is owned by Italian company ENI. 
 
¶15. (SBU) In Kruglov's February 11 conference call, however, 
he was more equivocal, saying the company planned to review 
its 2009 investment program for possible delays or cuts. 
Doug Busvine, Russia analyst for Medley Global Advisors, a 
strategic advisory firm, told us February 9 he couldn't see 
how Gazprom would find the money to move ahead with its 
investment plans.  Various analysts have expressed the same 
doubts in investment newsletters over the last several weeks 
-- in a period of substantially lower revenues and with 
external credit markets virtually closed to Russian 
companies, it would be very difficult for Gazprom to stay on 
its intended course. 
 
¶16. (SBU) Even if it cut back on planned investments, 
however, Gazprom would still need to take tough and specific 
actions to reduce operating expenses to effectively weather 
the tough financial times ahead.  To that end, the company 
has said it planned to cut overhead expenses by 29% at the 
parent company and by 24% at its subsidiaries.  However, the 
company did not provide any details on those cuts except to 
note that about 40% of those cost reductions would be due to 
the weak ruble.  It has not announced any cuts in its 436,000 
staff, other than a reduction of about 600 employees at 
headquarters announced months ago.  There have been press 
reports that the GOR may allow state-owned companies like 
Gazprom to withhold dividends to save cash, but Gazprom has 
not confirmed that it would do so.  A February 11 press 
report indicated Gazprom would hold back on payments to 
suppliers as a way of "managing" its working capital.  (N.B. 
This supports anecdotal evidence we have been hearing for 
months that Gazprom's debts to suppliers are increasing). 
 
---------------------------------- 
... WHILE LOOKING TO ROLLOVER DEBT 
---------------------------------- 
 
¶17. (SBU) While Gazprom's operating expenses are in rubles, 
its very substantial debts, much of which is short-term, are 
almost entirely in dollars and euros, complicating its 
efforts to reschedule or rollover debt.  According to 
Gazprom's figures, as of June 30, 2008 (the latest available 
figures), the company's total outstanding debt stood at $47.6 
billion, of which 90% was in dollars and euros and only 4% of 
which was in rubles.  As of June 30, 2008, almost 39% of 
Gazprom's debt had a maturity of less than 2 years, and 
another 22% had a maturity of 2-5 years.  That would mean the 
 
MOSCOW 00000367  004 OF 004 
 
 
company would need to retire or refinance over $18 billion 
between July, 2008 and the first half of 2010.  In its 
investor day presentation, the company said it planned to 
repay $9.2 billion of debt in 2009, but did not provide 
details. 
 
--------------------- 
HARSH MARKET REACTION 
--------------------- 
 
¶18. (SBU) As with Russian companies as a whole, the markets 
have been tough on Gazprom in the face of its looming 
financial problems and its inability or unwillingness to deal 
with them.  On February 4, Fitch ratings lowered its outlook 
for the company to negative from stable.  According to 
Bloomberg news, the yields on Gazprom debt have skyrocketed, 
with the yield on the company's 10-year notes due in 2018 
reaching 1053 basis points above U.S. Treasuries at the end 
of January, up from 383 basis points in April, when the notes 
first traded.  The company's stock price is down more than 
70% from its peak in May 2008 and its market capitalization 
is down from about $365 billion to about $85 billion on 
February 11. 
 
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COMMENT 
------- 
 
¶19. (SBU) As of mid-year 2008, Gazprom was still confidently 
predicting that it would become the "most valuable company in 
the world" and the first company to reach a market 
capitalization of $1 trillion.  The failure of Gazprom's 
out-sized ambitions is bad news for the GOR.  Not long ago, a 
company representative told us Gazprom alone is responsible 
for contributing 40% of the GOR budget.  That could partly 
explain recent upward revisions by the GOR of its expected 
2009 and 2010 budget deficits.  Like the Russian economy as a 
whole, the company's problems are deeper than the immediate 
financial difficulties it faces.  Gazprom is perhaps the most 
prominent example of the flawed economic model in Russia -- 
giant, inefficient, politically directed companies that 
destroy wealth and stifle dynamism. 
BEYRLE