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.

-------
SUMMARY
-------

¶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 GAXPROM 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)xxxxxxxxxxxx, 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.

-------
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