Streetwise Professor

May 24, 2018

Gazprom and Its Connected Contractors: The Credit Mobilier Scheme, With Russian Variations

Filed under: Commodities,Economics,Energy,History,Russia — The Professor @ 6:05 pm

A couple of SWP friends were kind enough to send me a copy of the swan song of one Alex Fak, an erstwhile senior analyst at Sberbank.  Alex lost his job because he committed a mortal sin: telling the truth, in this instance about the monstrosity that I have savaged for years–Gazprom.

Alex said that the oft-heard question “why does Gazprom do such stupid things?” is off base because it presumes that the company is run in the interest of shareholders: if it were, its unmatched record of value destruction would indeed be stupid.  However, Mr. Fax opined that the company’s actions over the decades are definitely not stupid if you evaluate them from the perspective of its contractors, who make massive amounts of money building obscenely negative NPV projects.

Why does this persist, in the Putin era, which allegedly cracked down on oligarchic thievery? Well, one reason is that the biggest contractors happen to be owned by–wait for it–the two biggest friends of Vova: Gennady Timchenko (a hockey buddy) and Arkady Rotenberg (a judo buddy).*  Putin did not eliminate oligarchs, so much as replace them with his cronies.  Calling out such connected men by name is no doubt why Mr. Fax is an ex-Sberbank analyst.  And saying this kind of thing puts him at risk of being an ex-person.

The Gazprom MO described by Mr. Fak  represents a continuation of, and a mega-sizing of, the bizness model of the 1990s, when the “red directors” of state-owned firms tunneled out huge amounts of funds by having their firms buy supplies and services at seriously inflated prices from firms owned by their relatives.

Indeed, in the pre-Cambrian days of this blog–2006(!)–I hypothesized that Gazprom and its contractors were in effect a Russian version of Credit Mobilier, the construction firm that the Union Pacific hired to build the railroad.

The WaPo article also mentions that Gazprom’s pipeline construction costs are two to three times industry norms. To me this suggests a Credit Mobilier-Union Pacific type situation, where inflated prices for materials and equipment flow into the pockets of companies owned by Gazprom managers. Just thinkin’.

Thomas C. Durant was the president of the Union Pacific–and the major shareholder in Credit Mobilier.  The UP paid Credit Mobilier around $94 million, and Credit Mobilier incurred only about $50 million in costs to build the UP.   The Gazprom arrangement is somewhat different given that neither Timchenko nor Rotenberg are executives at the Russian gas giant, but the basic idea is very similar. (I also noted early on that Transneft, the oil pipeline monopoly, operates on the same model.)  Gazprom and its contractors operate on the Credit Mobilier model, with Russian variations.

Once upon a time Gazprom CEO Alexei Miller boasted that he would make Gazprom the world’s first trillion dollar company.  Today it’s market cap is south of $55 billion.  Hey! anybody can be off by two orders of magnitude, right?

This is not surprising, because maximizing value to shareholders is not, nor has it ever been, the objective of Gazprom.  The objective is, and always has been, to divert resources to the politically connected via wasteful capital expenditures (that happen to be the revenues of the likes of Timchenko and Rotenberg).  Alex Fak understood this, and paid the price for shouting that the emperor had no clothes.

Both Gazprom and Rosneft are world leaders in destroying value, rather than creating it.  But this is a feature, not a bug, given the natural state political economy of Russia, which prioritizes rent creation and redistribution to the elite. And this is precisely why Russia’s pretensions to great power status rest on economic quicksand.  That should be blindingly obvious, and I am sure that Putin understands this at some level.  But revealed preference suggests that he values enriching his friends more than implementing the economic changes that would make his nation economically and militarily competitive.

*The sums tunneled from Gazprom to Timchenko make me laugh when I think about the oft-repeated allegation that oil trader Gunvor (half-owned by Timchenko) was a source of massive personal wealth for Putin (via Timchenko).  There was much more money to be made much closer to home, and completely outside the scrutiny of bankers and regulators.

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2 Comments »

  1. something that I ran across years ago, and something that was well-known:

    “Gazprom takes care of its own”

    Comment by elmer — May 25, 2018 @ 1:49 pm

  2. So the sale of Rosneft is Russian Variations, with Chinese Characteristics? Still the same stuff going back to the book of Kings.

    Comment by M. Rad. — May 27, 2018 @ 10:38 am

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