THE WALL STREET JOURNAL: Latest Move Seals Gazprom's Role As Energy Giant: "But Growing Clout, TiesTo Kremlin Stir Concern": “Other global companies have gotten the message. Royal Dutch/Shell Group, which operates the only big project on the Far East island of Sakhalin without a Russian state company involved, is in active talks to bring Gazprom in as a shareholder. As part of the deal, Shell could work with Gazprom on its Siberian fields.” (ShellNews.net) 24 Dec 04

But Growing Clout, Ties

To Kremlin Stir Concern;

Trying to Shed Soviet Past

By GREGORY L. WHITE

Staff Reporter of THE WALL STREET JOURNAL

December 24, 2004; Page A1

MOSCOW -- OAO Gazprom yesterday confirmed that it will control the main oil-production unit of OAO Yukos -- a huge milestone in the transformation of Gazprom into a global oil-and-gas behemoth tightly controlled by the Kremlin.

Confusion had reigned about the Yukos unit since it was auctioned Sunday to an unknown company, but in a flurry of deal-making, it ended up in the hands of a state company soon to be taken over by Gazprom.

The latest expansion of Gazprom comes amid concerns about how President Vladimir Putin views the Kremlin's role in Russian business and Russia's role in the global energy marketplace -- even as Gazprom itself tries to shed years of Soviet traditions.

Led by a close protégé of Mr. Putin's, Gazprom is the flagship of the Russian leader's initiative to place the nation's most valuable resources firmly under the Kremlin's grip. Already the world's largest producer of gas, Gazprom will become one of the world's biggest oil companies as well by acquiring the state oil company Rosneft and the main production asset of Yukos, a privately owned oil giant being dismantled under Kremlin pressure. Following those acquisitions, Gazprom's combined reserves will be more than six times those of Exxon Mobil Corp., and the new entity will produce 1.45 million barrels of crude a day, or nearly as much crude as Libya. Gazprom had about 330,000 employees at the end of 2003. Russia as a whole is No. 2 in world oil production after Saudi Arabia.

Mr. Putin yesterday defended his drive to ramp up the Kremlin's role in Russia's energy industry -- after the Rosneft acquisition, the Russian government will own just over 50% of Gazprom's shares. "Today, the state -- using absolutely legal, market mechanisms -- is ensuring its interests. I consider this perfectly normal," Mr. Putin said at his annual news conference in the Kremlin.

Gazprom, which owns more than a fifth of the world's gas reserves, controls 27% of the European market and is looking for more, and some Western officials warn that Europe is at risk of becoming too dependent on the Russian giant. Company officials say a stronger Gazprom should be reassuring to consumers around the world as natural-gas demand surges. Gazprom could help counterbalance dependence on Middle Eastern oil.

But like the Organization of Petroleum Exporting Countries in oil, Russia's energy clout could make itself felt in the world market. Mr. Putin could slow Gazprom's output to keep prices up or divert supplies to energy-hungry Asian countries.

Mr. Putin's willingness to put the preservation of his own power before the promotion of friendly business relations with the West was evident in Russia's dismantling of Yukos, which accounts for about 2% of the world's daily oil output. Yukos's founder is in jail and the company, once a favorite among Western investors, is now nearly worthless.

Although Gazprom will be majority-owned by the Kremlin, the rest of the company's shares will be available on Western stock exchanges, making it the largest publicly traded energy company in the world in terms of reserves and production.

Driving to modernize a company steeped in Soviet tradition, Chief Executive Alexei Miller wants to use Gazprom's enormous size to make it a global player, unlike national oil companies in the Middle East that let Western and Japanese companies distribute, refine and sell their oil around the world.

"Gazprom will be not just a significant player on the global energy market but it will set the rules of the game," Mr. Miller told shareholders in June.

For most of the 1990s, the company was run as a personal fiefdom by Rem Viakhirev, an industry veteran from the company's communist days when it was the Ministry of Gas Industry. By the end of the 1990s, Gazprom's production was falling amid allegations of extensive graft. Nearly a tenth of its gas reserves had been transferred for a tiny fraction of their value to private companies with links to management. Its global strategy was focused on delivering gas to Europe as it had since the Soviet era.

Mr. Miller was widely viewed as in over his head when Mr. Putin in 2001 picked him, at the age of 39, to lead Gazprom. Mr. Miller had spent most of his career as a government bureaucrat, first working as Mr. Putin's deputy when the future president was an official in the mayor's office in St. Petersburg and later becoming deputy energy minister. Upon joining Gazprom, Mr. Miller says he worked 18-hour days for months to get himself up to speed.

Mr. Miller reversed many of the deals that had ceded key company assets to entities controlled by Gazprom's previous managers. Some of those who resisted found themselves facing criminal charges or other official pressure. He pushed production executives to reverse the drop in output, while replacing many top executives in finance and sales.

Fund manager William Browder, a longtime Gazprom shareholder and outspoken critic of management, recalls delivering a broadside about Gazprom's problems at a conference in London shortly after Mr. Miller took over. Afterward a Gazprom executive approached, and Mr. Browder braced for a dressing-down. Instead, the executive complimented Mr. Browder's presentation and asked him to deliver a more-detailed version back at headquarters. Mr. Browder says many of the issues he pointed to have since been resolved.

"It's been getting more and more honest over the last three years," says Mr. Browder. "But that doesn't mean it's anywhere near honest yet."

Gazprom faces many hurdles in its modernization drive. The biggest is replacing the huge quantities of gas it pumps every year. Its reserves are mostly in remote places where extracting gas requires technology with which Gazprom has little experience. Production costs for the next generation of fields could be triple current costs, according to government estimates.

The company still retains much of its Soviet feel, with its own airline and company towns. Gazprom flies top Russian pop singers to its Arctic outposts to provide entertainment during the long winter nights. They sing songs like "Planet Gazprom."

Gazprom's profitability is already suffering as Mr. Miller pumps money into fixing the company's aging pipeline network and into higher salaries for workers. In the first half of this year, net income fell 13% to the equivalent of $3 billion even as revenue rose 12% to $15.7 billion. In the same period, Exxon Mobil earned $11 billion on revenue of $138 billion. If world oil and gas prices fall, the squeeze on Gazprom would worsen.

At a meeting in late 2003 to approve the company's capital budget for the coming year, managers expected Mr. Miller to rubber-stamp the expenditures. Instead, he started questioning line items and demanding justifications for project after project. The meeting ran late into the night. "People were in shock," says one attendee.

Like his Soviet predecessors, Mr. Miller has wielded his Kremlin contacts to great effect for Gazprom. The government approved annual rate increases of 15% to 20% for Russian gas consumers. Management "reports exclusively to the Kremlin," says Vladimir Milov, a former deputy energy minister.

Some government ministers with seats on Gazprom's board of directors who want to make the company more transparent say they have been given little information about the company, forcing them to turn to outside sources for basic corporate information.

Mr. Miller doesn't hide his agenda. Asked during a recent visit to the Arctic company town of Yamburg if Gazprom is a tool of Kremlin energy policy, he smiled and responded, "What do you think? Of course it is."

With strong Kremlin support and improving output, Gazprom under Mr. Miller has become much more confident this year in dealing with international energy companies, executives and diplomats say.

Britain's BP PLC has felt the change as it tries to exploit a Siberian gas field called Kovykta in which it has held an interest for nearly a decade. BP has been trying to bring Gazprom into the deal, believing it will have little hope of shipping the gas unless it has Gazprom's technical help and political clout behind it. But this year Mr. Miller said publicly his company had little interest in helping and noted offhandedly that there were questions about Kovykta's permits to produce gas. Shortly after that, the Ministry of Natural Resources confirmed that BP's joint venture in Russia might not be permitted to extract gas from Kovykta.

Gazprom now says Kovykta isn't a priority because the Asian countries that would be supplied by the field can instead get energy from oil projects on the Pacific coast. Gazprom inherited these projects in its takeover of the state oil company. BP's chief executive, John Browne, was in Moscow this month lobbying Mr. Miller to salvage BP's project.

Other global companies have gotten the message. Royal Dutch/Shell Group, which operates the only big project on the Far East island of Sakhalin without a Russian state company involved, is in active talks to bring Gazprom in as a shareholder. As part of the deal, Shell could work with Gazprom on its Siberian fields.

Gazprom is aggressively moving to expand its reach into new markets overseas. It wants a piece of the profits from its gas all the way from the wellhead in Siberia to the consumer in places like the U.S. Typically, the big Western energy companies, called majors, control most of that chain. The chance of getting to develop some of Gazprom's huge reserves has made the majors willing to considering letting Gazprom into their markets.

The biggest prize is a huge field called Shtokman under the Barents Sea, north of Russia. By the end of the decade, Gazprom wants to develop that gas and build a plant to convert it into liquid form so it can be carried on tankers to markets like the U.S. that are too far away to be reached with pipelines. Gazprom wants to own all or part of terminals in North America that will convert the fuel back into gas for sale to customers. So far, half a dozen big companies, including Exxon and ChevronTexaco Corp., have signed agreements to study the plans with Gazprom.

"No producer-country company has ever had the power to negotiate like that," says James Langdon, a veteran Washington energy lawyer involved in the discussions.

To get its foot into the U.S. market, where it doesn't yet have a presence, Gazprom plans to acquire rights to some liquefied gas sold in the U.S. next year in exchange for rights to some of the gas it pipes to Europe.

While Gazprom's global ambitions make sense in purely business terms, they also fit neatly into Mr. Putin's plans for boosting Russia's international clout. Mr. Putin has taken Mr. Miller along on many of his state visits to foreign countries, helping Gazprom line up deals to extend its reach.

Gary Litman, the vice president for Central Europe and Eurasia at the U.S. Chamber of Commerce, says Washington welcomes the emergence of a new supplier of energy, even with the Kremlin's strong hand at the wheel.

In addition, if Gazprom succeeds in expanding exports to the U.S. and Asia, it will help accelerate the creation of a global gas market -- like the one that now exists for oil -- and one in which Gazprom would be the single biggest player. American gas consumers might one day be dealing with Gazprom for fuel.

Gazprom executives "clearly see the U.S market as, if not the holy grail, a very important opportunity," says Mr. Litman, who met Mr. Miller in November. "As long as state control does not imply that the state is using the company for noneconomic purposes, nobody is going to have a problem with it."

Write to Gregory L. White at greg.white@wsj.com

RELATED WALL STREET JOURNAL ARTICLE: Putin Slams U.S. Court's Yukos Stance

By ALAN CULLISON in Moscow and RUSSELL GOLD in San Antonio

Staff Reporters of THE WALL STREET JOURNAL

December 24, 2004; Page A3

Russian President Vladimir Putin criticized a U.S. bankruptcy court for stepping into a dispute between the Kremlin and OAO Yukos, a move that gave the oil giant critical leverage to fight back in Western courts.

"I was surprised that a U.S. court tells us to halt an auction," said Mr. Putin, speaking at a news conference yesterday, in reference to a forced auction last weekend of Yukos's main asset. He lashed out at U.S. Bankruptcy Court Judge Letitia Clark for issuing a temporary restraining order that sent the auction process into turmoil. "I'm not sure she knows where Russia is located," Mr. Putin said. "And this causes me to worry about [her] level of professional preparation." Judge Clark couldn't be reached to comment.

It is unlikely a U.S. court order will have teeth within the Russian legal system. Still, the court's move last week, and the series of transactions that put Yukos's most valuable asset in government hands, could spur a slew of lawsuits that could further test relations between Russia and the West. The Bush administration already has been critical, though in measured terms, of Russian authorities' handling of Yukos. A U.S. State Department spokesman yesterday said the matter "sends the wrong signal to foreign investors."

State oil company OAO Rosneftsaid it purchased the mysterious Russian company that emerged from obscurity last weekend to buy Yuganskneftegaz, a Yukos unit that produces about 1% of the world's oil output. This means the asset, as had been widely expected, would end up in the hands of Russian natural-gas monopoly OAO Gazprom, which is in the midst of acquiring Rosneft as part of a Kremlin effort to create a government-controlled energy giant.

That outcome was thrown into doubt last week, after Yukos sought Chapter 11 bankruptcy protection from the court in a last-ditch attempt to keep Russian authorities from selling off Yugansk to pay off back-tax claims totaling $28 billion. Judge Clark issued a 10-day order forbidding a unit of Gazprom and its Western lenders from bidding on Yugansk. With its lenders hanging back, the Gazprom unit didn't bid in the auction, and a previously unknown company called Baikal Finance Group emerged to buy the unit for $9.37 billion.

Mr. Putin yesterday staunchly defended Rosneft's acquisition of Yuganskneftegaz as "absolutely legal."

Russian authorities contend that Yukos unlawfully used tax breaks. The Kremlin's campaign against Yukos has been widely interpreted as part of a Kremlin campaign to bring politically ambitious Yukos founder Mikhail Khodorkovsky to heel and regain state control over assets privatized in the 1990s.

Legal experts said the court isn't likely to look favorably on the elaborate approach Gazprom appears to have used to end up with the assets. "There is a basic principle in law: you cannot do indirectly that which you cannot do directly," says Rhett Campbell, a partner with Thompson & Knight LLP, which doesn't represent anyone in the case.

Yukos has been gearing up to ask U.S. and European courts to rule that the assets were acquired unlawfully and seek a judgment that would allow Yukos to seize assets of the buyers, such as tankers or bank accounts, outside Russia. An illegal-appropriation ruling by U.S. courts could result in a multibillion-dollar judgment, bankruptcy experts say. Gazprom also could face contempt-of-court fines.

A ruling likely would be enforceable only outside Russia. But, says University of Texas Law School professor Jay Westbrook, Yukos has managed to complicate the transfer of Yugansk considerably, and it can continue to be a "serious nuisance" by pressing for contempt-of-court orders and judgments. If this publicity continues to erode investor confidence in Russia, he says, Yukos will have strong leverage against the Kremlin.

It remains unclear whether Gazprom has assets in the U.S. that could be vulnerable to U.S. court action. But Chief Executive Alexei Miller's aspirations to expand Gazprom's operations include potential U.S. projects with U.S. partners.

In the U.S., Yukos lawyers say they will press for an injunction that goes beyond Judge Clark's 10-day restraining order.

People close to Gazprom say the big gas company is hoping that the court soon will agree with Gazprom that this is a case for Russian, not U.S. courts. That would open the way for Gazprom to complete the transaction without Western interference. Lawyers for Gazprom and its adviser, Deutsche Bank AG, didn't return calls.

The European Commission, the EU's executive body, also could enter the fray, because it has authority to examine mergers even if the companies involved aren't based in Europe. But Gazprom's gas is crucial to Central and Eastern Europe, and "were the Commission to try and block the deal, one possible outcome would be that Gazprom would simply terminate supplies," one lawyer said.

Thaddeus Herrick in Houston and Guy Chazan in Moscow contributed to this article.

Write to Alan Cullison at alan.cullison@wsj.com

and Russell Gold at russell.gold@wsj.com