Streetwise Professor

June 6, 2014

Putinomics: The Gazprom-China Deal

Filed under: China,Commodities,Economics,Energy,Politics,Russia — The Professor @ 6:16 am

Before the financial crisis, Gazprom CEO Alexi Miller boasted that his firm would be the first $1t market cap firm. Six years on, he’s only off by an order of magnitude: the company’s market cap is around $100 billion. Moreover, it sells for a comical 3x earnings (a little less, actually). The company’s capex is notoriously inefficient, and it is frequently cash flow negative. Other than that, it’s a financial marvel.

But that big China deal must surely have provided a boost for the company, right?

Apparently not. The other day Putin mooted the possibility that the company would have to be recapitalized by the state, i.e., receive an additional injection of capital from one of the state investment funds.

If the China deal were indeed favorable to Gazprom, it would have no problem financing the necessary investment in pipelines and greenfield production through the banks and/or the capital markets, rather than through the state. Putin’s suggestion of state funding strongly suggests that the economics and the risks of the deal are not favorable, and the necessary investments could not be funded externally: direct state funding would also suggest that Russian state banks are either unwilling or unable to fund it (or both), which speaks ill for the economics of the deal, and perhaps the financial strength of the banks. A further implication of this is that politics rather than economics was the main driver of the deal (if it exists, in fact), and that as a project intended to achieve state objectives, the state must fund it.

Reinforcing this perceived need for state rather than external funding ┬áis the fact that obtaining outside funding would require Gazprom to divulge many more details of the deal than it has so far. This would be highly embarrassing to Putin and the government and Gazprom if these details show that Russia got the short end of the stick. So keeping the details out of public view by avoiding outside funding also suggests that there is something to hide, namely, that the Chinese exploited Putin’s needs.

If the government indeed recapitalizes Gazprom, it will be just the latest of a long line of economic policy failures. Another example of where politics or corruption/rent seeking has prevented Russia from putting its natural resource firms on a commercially sensible footing, and another example of where state funds that were generated by resource rents in the first place were ploughed back into inefficient state-controlled resource producers, rather than to help diversify the Russian economy.

This, my friends, is Putinomics. This is why Russia will remain on the hamster wheel from hell.

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  1. Quite. This deal between Russia and China means that Gazprom will actually have to develop a gas field, build some facilities, and deliver something – preferably on time. No wonder the banks ran a mile. Either that, or the deal means China is going to be doing all the developing and constructing (if the Chinese actually want to see some gas, they would have been wise to insist on this) – and that’s not something Putin & Co. will want to advertise either.

    I’ll believe this gas deal was a success when gas arrives in China and neither party or population is screaming blue murder.

    Comment by Tim Newman — June 6, 2014 @ 7:00 am

  2. And this is why the Russians made a deal to invest in the expertise of North Atlantic Drilling/John Fredriksen and allow NADL to “look” on Russian soil (in addition to harsh water) I think Fredriksen, who pays himself with dividends from his companies, had a tax problem with Norway and Statoil which also prompted the deal with the Russians.

    There is one school of thought in investing -you make more money when a stock goes from horrible to very bad as opposed to good to great- but I am not buying that,- Russians in, I’m out.

    Comment by Tom H — June 6, 2014 @ 8:39 am

  3. More than anything, and I agree with the article and comments above, this gives an insight into how bad the Russian situation is. Assuming that the Chinese didn’t simply take them to the cleaners, someone must have thought that they really needed this deal for “strategic” reasons, and let the economics slide. A typical hold over in SOVOK mentality, where costs don’t matter, just output.

    If the Russian Federation was in the great condition the Putinites argue, it is hard to see why they would do this deal. Without giving any credit to Lurch and the empty O, it looks like acting like an irrational bully has cost Vlad (the Impaled?) more than he thought and he and his gang are looking for cover (i.e. legitimacy), or someone who will deal with them) as fast and as hard as they can.


    Comment by Sotos — June 6, 2014 @ 1:36 pm

  4. IMO the most important fact isnt recapitalization need , taking into account 50 $ bln expenses and being cut from western financing due to threat of sanctions but the fact that chinese didnt lend money. I’m sure russians asked for it but seems were denied.

    Comment by erik — June 7, 2014 @ 10:50 am

  5. SWP, a question a little off topic. Why does Gazprom sign contracts denominated in dollars? They could at least optically sign them in rubles, but at least do them in Euros or Renimbi. Or with Ukraine, it would seem best for Putin politically to have them pay in Rubles, and provide a bid for the currency. Thoughts?

    Comment by scott — June 16, 2014 @ 2:36 am

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