The verbatim report of Alexander Ryazanov’s speech given at the annual Meeting with the RF President and Government’s regional authorities’ representatives.
First of all, I’d like to say a few words about the role Gazprom plays in delivering gas to Russian consumers. Gazprom is the world’s largest gas company with a 25% ratio of the global gas reserves.
As of today, Gazprom producers about 90% of the total domestic gas extraction volumes, thus, assuming enormous responsibility for all the gas consumers of the Russian Federation. By the way, we’d like to see the independent gas producers’ gas extraction keep up a rather rapid pace. As a matter of fact, a handful of large independent gas production companies are so far operating on the Russian market but, in contrast to Gazprom, their activities are not state-regulated. While these companies trade in gas at free pricing, Gazprom carries on business at state-imposed prices and suffers losses from gas sales in the country’s interior, which are offset, though, by the proceeds realized from gas exports.
Gazprom was and still is the largest source of currency proceeds, industrial output and gross domestic product for Russia. We provide 20% of the total payments channeled to the RF budget. I’ll pay special attention to it later on.
Here are some of the Company’s operating results for 2003. Gas deliveries inside Russia remained at the same pace achieved in 2002, meaning 280.9 bcm and, just like in 2002, this amount was almost fully paid for. In addition, consumers’ debt for previous gas deliveries has considerably declined to RUR 38 billion. Although we realize that we’ll have to face certain difficulties in collecting this debt since a string of the companies-debtors have already ceased to exist legally.
Gazprom’s exports are on the rise. In 2003 the Company exported a record high of 132.9 bcm, with 140 bcm targeted for 2004. Incomes realized from gas exports are allotted to subsidize the domestic market, which has unfortunately been unprofitable for Gazprom until now. Nevertheless, in 2004 the Company plans to avoid losses while carrying on gas business on the internal market, not to mention any profits. Thus, Russia’s internal market can’t raise finance for Gazprom’s operations, preventing the Company from adequately developing Russian gas networks and investing capital into new fields.
Gazprom’s market capitalization has grown significantly within 2003, averaging USD 38 billion at the year-end. And a year, may be a year and a half ago it accounted for USD 25-27 billion. Gazprom’s shares are growing in price and this signifies that our shareholders and investors do believe in Gazprom and its development.
Tax payments grew some RUR 70 billion in 2003, as compared to 2002. And, primarily, these are payments going directly to the federal budget. As you know, tax payments have been re-distributed lately: a new Mineral Production Tax (RUR 107 per 1,000 cubic meters of gas) imposed starting 1 January 2003, is, to a large extent, paid into the federal and not regional budgets. As a result, certain taxation problems arose in a range of Russian regions, including the Yamal-Nenets Autonomous, Astrakhan and Orenburg ones. And since we have plenty of the Gazprom Group’s employees living in these regions, we definitely can’t but forward full tax payments there. For this purpose, Gazprom has devised special tax payment schemes. What happens is that we re-channel a big chunk of our profits for the subsidiaries to make tax payments to the regional budgets. In 2003 Gazprom will allocate some RUR 363 billion in tax payments, which makes it about RUR 1 billion daily. This is a huge amount of money but we understand that the State surely needs it.
There are over 300 thousand employees working in Gazprom, plus members of their households, which makes it almost a million of people. At the same time, 100 thousand people currently employed by the Company, live in Western Siberia only.
Speaking of Gazprom’s actions aimed to spur the Russian industry development, we see here that the Company is making the largest investments on the domestic market. Gazprom annually spends USD 3 billion to acquire goods and services and the Company’s Management Committee has lately decided to additionally increase the scope of investments for 2005-2006. Thus, Gazprom contracts plenty of companies, which sometimes are unable to timely fulfill the order received. I’ am referring first of all to Russia’s machine building companies manufacturing gas pumping units for Gazprom. Another thing is that we’re facing a problem of purchasing enough quantity of pipes although the Russian metallurgical sector operates quite efficiently. In addition, Russia’s internal prices keep growing so rapidly that Gazprom often benefits from importing materials and goods. But Gazprom has set the task to purchase domestically not less than 80-85% out of the total procurement volume and we’re so far coping with this task and, thus, fostering the Russian industry.
And now I’d like to touch upon our regional policy. It’s been long time since we set up the Department of Relationships with the RF Regional Authorities and let me inform you that the Company has good ties with almost all RF regions. We’re operating in 71 out of 89 Russian regions and that’s surely a big amount. In addition, we have annual and long-term cooperation agreements adopted with 70 RF regions. And this is, in our viewpoint, an excellent incentive to fulfill mutual obligations and promote joint activities.
Gazprom adopted the Regional Policy Concept. I personally convene the Commission’s meetings held on a monthly basis. The Commission deals with a wide range of issues, including developing gas deliveries to Russian consumers, sponsorship aid, etc. The Commission doesn’t have the status of a managing body and its decisions are more like of the recommendatory nature. But most Gazprom’s departments are instructed based on the Commission operating results, and its recommendations are taken into account in devising various corporate programs. For instance, the Program on Russia’s Gas Supply System Development has been adopted lately. The Paper touches upon developing and upgrading low-pressure gas distribution networks. The Program is quite capital-intensive, worth RUR 8 billion and is to be implemented within 2004-2008.
And, ultimately, Gazprom annually spends some USD 200 billion on social events. The Program envisages for backing the native population, primarily, that of the northern areas, and financing cultural and sporting events and sponsorship activities. For the time being, the Board of Directors is rigidly examining the expediency of spending the corporate funds. However, there’s full understanding in Gazprom that these programs are necessary in the regions where Gazprom extracts gas. Wishing it or not but we are damaging the environment and, thus, must provide certain compensations to the native population, in the 1st place.
And now let me tell you some words about Gazprom’s gas deliveries to the RF consumers. They’ve started requiring larger gas volumes and that’s one of the major challenges Gazprom’s endeavoring to meet. I’ve already said that the Company builds up its export potential year-on-year: gas exports grow up to 5 bcm per annum. At the same time, the domestic gas consumption also experiences an annual boost of 3 bcm, as a minimum. But, as you are aware of, Gazprom never fails to deliver gas to the residential and housing sectors: we supply the amount required by our consumers.
Speaking of the industrial sector, we do face certain difficulties with these gas consumers. Sometimes Gazprom is forced to forward the consumers asking for additional gas volumes to independent gas producers since we’re occasionally unable to provide the required gas amount. But, I want to stress it once again, Gazprom guarantees 100% full-amount gas deliveries to the residential and housing sectors. The same policy is implemented towards gas exports: we never impose limits on those. Gas exports yield the bulk of our profits channeled to modernize the gas transmission system and to test new gas fields.
Thus, we have the following picture: Russia’s gas consumption annually grows by 3 bcm and gas exports, by 3-4 bcm. As a result, Gazprom must build up its gas production by 6-7 bcm per year while most of the Company-owned fields are facing depletion, meaning, Gazprom has to move further northwards where gas extraction certainly becomes more expensive.
Here’s the image showing gas volumes consumed by various sectors: power generation, metallurgy, cement and chemical industry, residential sector. I’d like to draw your attention to the fact that we unfortunately can’t reduce gas deliveries to the power sector. Practically the entire Russian power generation sector is gas-fired. We consider it to be threatening for the country as consumption of alternative fuels must be developed, as well, particularly in places where these fuels are at hand.
Let me give you an example of the Pechora State Regional Power Plant, which was intended for coal-driven operations with coal mined nearby. At present, the Plant is gas-driven and the region doesn’t use the existing fuel resources. Another example is the Kirishi Federal Power Plant projected to run on fuel oil. But today the Plant operates mainly on gas although there is the large Kirishi Refinery across the road, producing fuel oil. At the same time, there is a string of regions, particularly in northwestern Russia, where gas resources are restricted. Russia’s northwest is keeping up a quite rapid and efficient pace and, as a result, Gazprom fails to provide consumers with sufficient gas volumes. And the thing is that not only the power generation but also the metallurgical, cement and chemical sectors start consuming a great deal more gas. Gazprom would like gas volumes to be fairly distributed in the regions where various industrial, energy and housing companies are located.
I’d also like to expand a little on major issues of gas consumers’ interaction with Gazprom. These issues are mainly linked to gas payments.
Given the quite low gas pricing in Russia, which doesn’t offset our gas production and transmission expenses, Gazprom is facing considerable problems in receiving payments for the gas supplied. And the thing is that we’re not talking about industrial consumers here but the housing and residential sectors. A string of local budgets do not envisage for gas payments whatsoever. In addition, eligible consumer categories are provided with gas subsidies. Gazprom does not oppose these privileges but we just don’t understand why these are granted at the Company’s expense: Local budgets should either re-compensate those directly to eligible consumers or channel the money to Gazprom. Unfortunately, we do not see it this way today.
The power saving problem is quite critical in Russia, as well. While gas consumption grows, alternative fuels are consumed in a lesser and lesser amount. And the reason for this is the cheapness of gas. When gas is cheap, any power-saving costs have the long-term or no return at all. But it is clear though that gas pricing can not be raised up to USD 50-60 right away today. It is certainly a good thing however that there are regions in Russia that adopted power-saving programs: regional gas networks are expanded but gas consumption still doesn’t grow. Nevertheless, we do understand that most regions simply can’t promote these activities due to their budget volumes.
By the way, let’s touch upon the gas pricing dynamics. As you can see it on the image, in 1996 the domestic gas price was already USD 48.5 per 1,000 cubic meters, under the existing currency exchange rate. But after the 1998 default the price tumbled. We calculated our losses and came to some USD 25 billion. What happened, in effect, was that we took that money from the external market and handed it over to Russian consumers.
Gas pricing is on the rise today: Russia’s Energy Strategy adopted by the Government, says that 1,000 cubic meters of gas will cost USD 40-41 in 2006 and USD 59-64, in 2010.
However the Government is announcing somewhat different figures for the domestic gas pricing boost. The growth is expected to account for 20% in 2004 but will slow down its pace during next years. Thus, the real gas price will be below the notch set in the Energy Strategy. Nevertheless, we do consider the USD 40-50 gas price as optimal for Russia since it’ll, first of all, enable Gazprom not only to offset internal gas production and supply expenditures but invest in new projects, as well. We need investments as to build up gas production as to develop gas transmission piping arrangements and low-pressure networks, which are, in our viewpoint, in a very critical condition today.
With all this in mind, I’d like to draw your attention to the principles of Gazprom’s participation in developing the gas supply system of the RF regions. We annually allocate over RUR 3 billion for these purposes. These are certainly long-term financial investments with an extended netback period but for the time being the Company tries to deal with regional gas supply systems provided this or that project is economically substantiated. Some time ago we used to have a situation when gas was delivered to a 100-people locality and netbacks were beyond a century range. We think that our profitability must be not less than 10-12% while delivering gas to the RF regions.
In the meantime, we endeavor to devise the General Gas Supply Scheme in every region and recommend Promgaz, our core business Institute, for this purpose. The regions where this Scheme elaborated by Promgaz is being so far introduced, have the gas network efficiency considerably enhanced. At the same time, there’s been a significant cut in investments in the gas supply system development through constructing the required girths and uploading gas grids: we can invest less but obtain larger benefits. Gazprom also decided not to finance gas supply systems of the regions not making full payments for current gas deliveries. The regions certainly have old debts but we have the Debt Restructuring Agreements adopted with most of these. In this situation we have a number of ways to clear the arrears, in particular, we receive unowned and unoperated gas grids constructed in these regions as part of the debt repayment. The grids ready to be currently handed over are worth some RUR 3-4 billion. The Company has set the task to receive these by the 2nd half this year.
In addition, we’re doing our best to establish integrated gas distribution companies (GDCs) in every region. For the time being, in most regions there are several GDCs, which are independent joint stock companies dealing with gas transmission. The Federal Energy Commission proposes today to the GDC to make up the gas transit cost and add it to the gas price. In addition, the GDC calculates the investment amount to be channeled for the grid upgrading. When we have 5-6 GDCs in a region, it is impossible to calculate expenses of each of these. For instance, it happens that a GDC supplies gas to large industrial facilities and while gas volumes delivered are large-scale, the gas network length is insignificant. Given the conditions like these, even the least increase in gas pricing covers all expenditures and yields profits. And there’s a different situation when the gas consumer is the population: the gas supply amount is small and the gas grid length is huge. However, it is impossible to largely raise the gas price.
It is a difficult task to set up an integrated GDC in the regions since we have to deal with the private share capital. But we consider it to be a quite reasonable approach. One of the main problems the regions are facing today is a bad technical condition of low-pressure networks. Investments in modernizing these are justified only if the grids are controlled by an integrated company.
And, ultimately, a few words about Gazprom’s plans for the future. The Company strives to meet crucial challenges: to build up gas production to 540 bcm in 2003 and 580-590 bcm, by 2020. At the same time we’d like gas to be sold to industrial consumers at free prices on a free market. Regulations must apply to gas transmission tariffs only. The population and the residential sector will still enjoy the regulated gas market conditions.
We link our gas extraction growth to our promising projects. For the time being, Gazprom is mainly operating in Western Siberia, the Astrakhan and Orenburg regions. But the Company intends to implement promising projects in Eastern Siberia and the Far East, As well.
Another prospective challenge is to develop the Yamal Peninsula and the shelf of northern seas. This is a totally new approach to developing fields. In particular, we’re going to produce liquefied natural gas from gas extracted at the Shtokmanovskoye field. The Shtokmanovskoye field is situated on the shelf of the Barents Sea, 500 km off the coast and possesses big gas reserves allowing to produce some 100 bcm per year. At the same time, Gazprom plans to deliver gas via an underwater pipeline to the city of Murmansk where we intend to build a large gas liquefaction plant and from there gas will be transported by special gas carriers to end-use consumers. We’re first of all directing our attention towards the US market. This project is estimated at USD 10 billion and is expected to last for 5-6 years. At present, the Company is involved in the talks with large foreign partners, which will help us to implement this project.
So, these are Gazprom’s core large-scale and capital-investment projects. I’d like to name once again the regions the Company targets at in the short and long runs: the Yamal Peninsula, Irkutsk, Kemerovo and Krasnoyarsk regions, the Republic of Sakha (Yakutia). In effect, we’ve already reached those places and are establishing joint ventures there. And let me stress it once again: Gazprom is inclined to build up comprehensive cooperation with all the Russian regions without exception.
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