2006 Gazprom Ukraine Russia Bill Browder Hermitage Capital

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GAZPROM:

A state within a
state

Clipped from

Calgary Herald

Calgary, Alberta, Canada
08 Jan 2006, Sun \u2022 Page 52

Fund managers say
the appetite for the shares among foreign investors will be strong but, as last
week's dispute with Ukraine only underlines, questions remain over how Gazprom
can become one of the world's leading energy companies with a share price to
match if it is just an arm of the Kremlin's foreign policy.

Over the past 18 months
Putin has reasserted the Kremlin's control over the country's strategic natural
resources away from the power of the oligarchs. He has also made it clear that
he intends to use Russia's immense natural resources to help him increase the
country's leverage in its relations with the West. As last week's dispute with
Ukraine showed, Gazprom is the ideal vehicle to help him do that.

Long regarded as
a state within a state, the company is responsible for eight per cent of
Russia's gross domestic product and provides about 20 per cent of earnings to
the federal budget.

Given the
company's importance to Russia, Miller is likely to have to continue his
difficult balancing act of trying to reconcile the interests of the state and
that of his institutional shareholders.

Last week,
long-term Russia watchers said that irrespective of the Kremlin's control,
foreign investors and analysts should not underestimate Gazprom.

"I don't
think people realize just how powerful an energy company Gazprom is," says
Stephen O'Sullivan, an analyst at United Financial Group in Moscow.

Many also believe
that Gazprom is simply too attractive an investment opportunity to ignore.
Investors shouldn't expect to receive any sizable dividends in the near future
the current policy effectively limits the payout to 17.5 per cent of net
earnings but its shares are cheap compared with those of Western rivals.

"It's an
enormously profitable business and you can buy its shares at a 90 per cent
discount to its Western counterparts," says Bill Browder, the chief
executive of Hermitage Capital Management, whose largest investment in
Russia is in Gazprom. He also makes the point that Gazprom's new pricing policy
towards Ukraine ultimately will benefit stockholders.

"For the
past 15 years, Ukraine has been receiving a gift of between $1 billion
and $4 billion a year from Gazprom. The company has had to subsidize the
Russian population and former Soviet republics. Other countries, such as
Poland, are now paying more (for their gas). There is simply no longer a
political reason to subsidize these countries," Browder says.

He concedes that
investors can't expect Anglo-Saxon-style corporate governance but he
insists that there is a move towards greater transparency. "It was truly a
disastrous company in the late 1990s. Although it is still far from perfect, it
is now more and more becoming a regular company. You can't expect Western-style
Anglo-Saxon practices but the trend is clearly there."

Much of the
credit for the improvement goes to Miller, who has helped to correct
some of the mistakes of the previous regime, led by Rem Vyakhirev, who
was chief executive from 1992 until 2001, when Putin fired him.

Under Vyakhirev,
the company lost market share and the volume of production fell. It lost an
estimated $5 billion through asset stripping, often to companies owned by
relatives of senior management.

Under Miller,
production is growing again and the company is opening up new markets. It is in
the midst of a program that will redraw the energy map of Europe by building
underwater pipelines in the Black and Baltic seas, extending its reach and the
scale of its sales to the West.

Gazprom recently
started construction of the North European Gas Pipeline which stretches 1,200 kilometers
across the floor of the Baltic Sea to Western Europe.

The pipeline
which is controlled by Gazprom through its 51 per cent stake, but is jointly
owned by the German energy companies BASF and E.ON has
raised considerable controversy in recent months. Last year the project
appointed former German chancellor Gerhard Schroder as its chairman just
weeks after he signed the pipeline agreement with Russia, just before he was
ousted from office following September's general election in Germany.

Importantly for
Gazprom, once completed, the pipeline will reduce its dependence on its
neighbours, including Ukraine. Aside from its program of pipelines, Gazprom has
also invited foreign oil companies to pitch for participation in a consortium
that should be ready by April to start developing the strategically crucial Shtokman
field, 555 km north east of Murmansk on the Kola Peninsula It is set to
become the world's largest offshore gas field with 3.2 trillion cubic metres of
gas contained in reservoirs two kilometres below the seabed.