Russia's biggest company, gas giant Gazprom, has managed to avoid being a target of Putin's recent crackdown. Yet a June 8 report by Hermitage Capital Management Ltd. -- Russia's largest equity-investment fund, with assets of $1.5 billion, including shares of Gazprom -- harshly criticizes the way the company is managed. Hermitage points to financial anomalies at Gazprom that it says cost shareholders some $2 billion in lost profits last year. The government itself is Gazprom's largest shareholder, and Chairman Alexei Miller is a Putin ally.
The quality of Gazprom's governance could soon come under international scrutiny. The Kremlin has hinted it intends to remove restrictions on foreign ownership of Gazprom's domestically traded shares by the end of the year. When that happens, Gazprom's size ($27 billion in sales) and importance mean it is set to become one of the biggest investor draws in any emerging market.
That would be good news, if it weren't for persistent worries that Gazprom minority investors are getting a raw deal. Hermitage alleges that the company underreported income from joint ventures with foreign partners by more than $500 million over the past three years. It also says that Gazprom's operating expenses rose by more than 23% last year, and it is not clear why.PIPELINE PAYOUT
What worries hermitage most is a controversial deal to transport gas from Turkmenistan to Ukraine. Hermitage alleges that last year Gazprom gave away $767 million in profits by contracting out these gas supply operations on highly favorable terms to the Eural Trans Gas trading company. Eural Trans Gas enjoys an exclusive contract with Gazprom to send gas from Turkmenistan to Ukraine through pipelines 100% owned and maintained by Gazprom. "I can't understand why Gazprom wouldn't be maximizing its own interests," says William F. Browder, Hermitage's CEO. "Giving three-quarters of a billion dollars to another company just doesn't make sense."
Gazprom rejects Hermitage's charges. "We are thankful for the criticism, but unfortunately [Hermitage] made mistakes in facts and figures and wrong assumptions," says Denis Ignatiev, head of Gazprom's foreign relations division. In a statement, Gazprom said a rise in the value of the euro had added to equipment costs, and transit costs had risen in some export markets. It also said the discrepancy in joint-venture income was due to loss-making joint ventures.
The charges all sound painfully familiar. Back in 2001, investors were delighted when Putin sacked the former Gazprom management and installed Miller. They hoped Putin's new team would put an end to schemes that critics alleged were draining profits from the company. Under Gazprom's old boss, Rem Vyakhirev, a scandal broke concerning Gazprom's links with Itera, a Florida-registered trading company. Itera made profits by buying gas from Gazprom cheaply and selling it at market prices to countries such as Ukraine. Critical shareholders and the media speculated that Itera was linked to the old Gazprom management, although no ties were ever proved.
Gazprom no longer uses Itera as an intermediary for selling gas. The bad news, in the eyes of investors such as Hermitage, is that Eural Trans Gas appears to have stepped in to fill its shoes.
The origins of Eural Trans Gas are shrouded in mystery. The company was registered on Dec. 6, 2002, in Hungary. The shareholders were three Romanians and an Israeli. The day before it was registered, a contract between Gazprom and Ukraine's national oil-and-gas company, Naftogaz, had appointed Eural Trans Gas the agent for transporting gas from Turkmenistan to Ukraine. In return for these services, Eural Trans Gas gets to keep 38% of that gas -- some 13 billion cubic meters (bcm) a year -- without paying for it. By selling the gas, Eural Trans Gas has been able to capture 57% of the Ukrainian gas market and a growing share of more lucrative markets further west, where it is emerging as a major rival to Gazprom.
Hermitage estimates that in 2003, Eural earned $510 million from selling 7.7 bcm of gas to Ukraine and an additional $682 million from selling 5.2 bcm at higher prices to Germany, Poland, and Slovakia, bringing its total 2003 revenue to $1.19 billion. Yet Eural Trans Gas paid Gazprom just $425 million for the use of its pipelines, which is the only way to transport gas from Turkmenistan to Ukraine. The net profit to Eural Trans Gas was $767 million, according to Hermitage. Eural's Web site says the company made $220 million in gross profit last year, still a lot for a company with no hard assets. "A middleman in this type of transaction doesn't make sense," says Kaha Kiknavelidze, an analyst at Moscow brokerage Troika Dialog.`WE ARE NOT RELATED'
So who are the lucky beneficiaries? In an October interview with Ukrainian newspaper Zerkalo Nedeli, Eural's Hungarian managing director, Andras Knopp, said that the four shareholders were temporarily acting on behalf of Gazprom and Naftogaz in order to qualify for Hungarian tax breaks, which the two companies couldn't claim. Gazprom denies this. "We are not related to Eural Trans Gas," says Ignatiev. He says the Ukrainians demanded that Gazprom ship gas from Turkmenistan via the company. Officials from Ukraine's Naftogaz were unavailable for comment.
The story doesn't end there. In March, Eural Trans Gas announced it had been acquired by three new shareholders: Atlantic Caspian Resources, a small British oil-exploration company; JKX Gas, a Dutch-registered company; and DEG Handels of Austria. The new CEO of Eural Trans Gas is Cedric Brown, chairman of Atlantic Caspian PLC and a former chairman of British Gas. In a statement to BusinessWeek, Eural Trans Gas said: "It is not really appropriate for us to be drawn into any dialogue between Hermitage and Gazprom."
The new shareholder structure hardly sheds much light on who is really behind the company. JKX was sold to an undisclosed buyer in December, 2003. Atlantic Caspian declared it was technically insolvent last November -- but was rescued at the last minute by Denby Holdings, a newly formed company registered in Cyprus. Its two shareholders, both British citizens, are described as co-directors of a hotel company with interests in Russia.
Confused? So are Gazprom's minority investors. "Why would the governments of Russia, Ukraine, and Turkmenistan allow two guys from England to take away three-quarters of a billion dollars of economic benefit from this?" asks Browder. That's a question that no one seems to be in a hurry to answer. By Jason Bush in Moscow