Heading way to Energy Company formation report theses by Alexey Miller, Gazprom’s Management Committee Chairman
Moscow keeps hosting Gazprom’s Annual General Shareholders’ Meeting. Alexey Miller, Gazprom’s Management Committee Chairman delivered his Report to corporate shareholders.
Outlining Gazprom’s operating highlights for 2003, Alexey Miller particularly underscored that the reporting year had been the best one in the corporate history.
“At the last year’s Shareholders’ Meeting we spoke about the Company’s shifting over from stabilization to growth. In 2003, Gazprom gathered a confident pace and achieved record high operating and financial parameters. The Company reached a qualitatively new level of development,” – stated Alexey Miller.
Above the target gas production growth and new long-term challenges
The progress in shifting over from stabilization to growth is clearly seen in the following gas production parameters. In 2003, the Gazprom Group produced 540.2 bcm of natural gas, 19.3 bcm up on the previous year and 8.5 bcm up on the target.
Last year we identified 530 bcm of gas production as a core long-term challenge but in the course of 2003 already the Company exceeded the level of 540 bcm and set new tasks to keep on building up gas extraction.
Under Russia’s Energy Strategy, Gazprom will increase gas production to 580–590 bcm by 2020 and to 610–630 bcm, by 2030. Simultaneously, the Company will draft certain gas production plans strictly in accordance with the gas market demand.
Gas transmission is a priority of Gazprom’s investment projects
A. Miller identified expansion of the Russian United Gas Transmission System as one of the top priorities of Gazprom’s investment programs. In 2003, the UTGS provided stable gas deliveries to domestic and foreign consumers, transmitting a total of 674.1 bcm of gas including 521.2 bcm piped by Gazprom’s subsidiaries and the rest (14.2%), by 30 independent gas suppliers.
Business outside former Soviet Union – expanding hydrocarbon supplies and retaining market share
Evaluating the Company’s operations on the European market, Gazprom’s top executive emphasized that in 2003, Gazprom had achieved record high parameters in the whole corporate history in gas exports to Europe and currency proceeds (132.9 bcm and USD 16 billion, respectively).
The results achieved stem from a favorable environment and aggressive work on cross-border markets. High gas prices drove income growth. But under the conditions of the European market liberalization, competition keeps growing and offer is exceeding demand and the Company has endeavored to retain its market share and supply growth.
Domestic deliveries – reliability is a priority
“Secure gas deliveries to Russian customers are still one of Gazprom’s top priorities,” – stressed A. Miller. Over the reporting year, Gazprom provided Russian consumers with 291 bcm of gas, 7.5 bcm up against 2002.
A. Miller paid special attention to the issue of gas pricing in Russia. “In contrast to many other business sectors controlled by monopolies, the Russian gas market enjoys not in the least high but “monopoly-low” prices. After a long period of artificial reservation, gas prices are on an annual rise. However, based on the results of 2003, price growth rates did not yield return on domestic gas sales,” –Gazprom’s leader was quoted as saying.
Good news is that the Company’s purpose-oriented and consecutive actions aimed at improving the gas payment discipline on the internal market yield fruits. In 2003, the Company received payments for 97.5% of the gas supplied and reduced the gas debt accrued in the past by some RUR 6 billion.
Operations inside the former Soviet Union – business expansion beyond just gas deliveries
A. Miller characterized the work done by Gazprom in the former Soviet Union. In 2003, the Company returned to the abandoned and accessed new markets of the CIS and Baltic countries, launched gas deliveries to Georgia and Armenia, signed a gas supply contract with Azerbaijan, promoted gas marketing in the Baltic region, carried on business within the International Consortium for the Ukraine’s gas transmission system management and development.
In addition, Gazprom entered into agreements and built up full-scale cooperation with Central Asia, focusing not only on gas procurement (that will significantly grow in the short run) but on gas production, development of gas transmission capacities and management of gas facilities in the region, as well. The Company also started implementing the Central Asia – Center comprehensive Program.
“We are positive that Gazprom used to undeservedly neglected this region, consequently, losing access to sales markets of the Ukraine and Caucuses. But, at present, the Company is carrying on business in all the republics of the former Soviet Union,” – said A. Miller.
Record income and profits
A. Miller told shareholders that Gazprom’s rational financial and economic policy in combination with a favorable market environment ensured last year the best financial parameters since the Company’s foundation. The Parent’s earnings and net profits boosted last year 29% and 2fold, respectively.
The corporate share price substantially rose, as well, with domestically traded shares and American Depositary Receipts growing over 60% and 2fold, respectively.
Addressing corporate priorities in the financial sector, A. Miller drew the participants’ attention to the importance of long-term growth of the Company’s share capital value.
“Gazprom’s top management considers it as one of the paramount objectives to enhance the Company’s capitalization and to create additional value for all the shareholders. Over the past years, Gazprom’s capitalization grew about 5fold. We’ll be enhancing the corporate governance system and making Gazprom more transparent for investors,” – maintained Gazprom’s Management Committee Chairman.
Better debt structure and lower debt servicing
Gazprom’s top executive emphasized high appraisal of Gazprom’s business by the investment and finance community.
“Gazprom’s financial standing is solidifying. This positive trend was evaluated by rating agencies (which raised the Company’s rating) and investors (the Company managed to successfully place a number of bond issues in 2003).At the same time, there’s been a considerable fall of the fund attraction value and improvement of the corporate loan portfolio structure,” – stressed A. Miller.
Gazprom’s debt amount is moderate, as compared to the Company’s earnings. We’re not expecting growth of borrowings and are giving priority to project financing. While, this year, financial borrowings are planned to amount to RUR 150 billion, in 2005, we’re forecasting a decrease to RUR 120 billion.
Openly-held tenders and cost management
“Cost reduction is also a crucial direction of our activities. And, although, expenditure growth is caused by a string of critical factors, we don’t stop resolving this issue. Cost reduction programs adopted earlier by Gazprom are yielding fruits. But, in future, we intend to radically change the subsidiaries’ expenditure system, passing over from an estimate and norm approach to a cost management system,” – runs the Report of Gazprom’s Management Committee Chairman.
Competitive tenders are playing key role at the Parent’s level. Centrally-controlled procurement has already been completed. Now, we’re proceeding forward. The Board of Directors ratified the Provision regulating preferentially contest-based awards of contracts on shipment of goods, completion of works and rendering of services. The Provision will be put into practice, starting the 2nd half of this year.
A special section in A. Miller’s Report is dedicated to the reforms launched within the Company:
“Gazprom’s restructuring pursues the objective of enhancing the efficiency of the Company’s business being conducted with maximum deliberation and consecutiveness.
Until now, we’ve largely met core challenges of the 1st phase of Gazprom’s restructuring, namely: improving the corporate governance structure, regulatory procedures and the Parent’s budgeting system. Gazprom is shifting over to the 2nd stage of reforms covering enhancement of Gazprom’s operating efficiency as a vertically integrated company and optimization of the subsidiaries’ core business management structure.
To meet these challenges, we plan to divide our subsidiaries combining gas production and processing with gas transmission and underground storage into several units with different specializations. As a consequence, we’ll finalize the work on disbandling financial flows in production, transmission, processing, underground storage and marketing of gas and liquid hydrocarbons.
In addition to the separation of core business sectors, we intend to single out repair services, gas distribution networks, social infrastructure facilities, differentiate between technological and commercial communications services. All the required decisions and legal acts will be produced and adopted within 2004.
The reforms will allow us to have absolutely transparent gas transmission, production and marketing expenses. This is substantial for fixing reasonable gas transmission tariffs. But what is most important is that core business consolidation will improve the efficiency and quality of control over the entire system of Gazprom’s subsidiaries.
Stronger competitiveness strategy
A. Miller stressed that the corporate restructuring in vertically integrated entity is a prerequisite for the Company’s competitiveness on the global energy market. The global hydrocarbon business is dominated by the vertically integrated oil and gas majors. These corporations are featured with the common organizational principle – full operational integration within the entire technological chain from geologic survey to hydrocarbons production, to transportation, to processing and to marketing. Capital concentration, common industrial facilities facilitate unit cost decrease and profit build-up. Vertical integration of corporation is highly esteemed and assessed by the capital and stock markets.
Gazprom is actually a vertically integrated company. Still, this is insufficient for the business. To maintain competitiveness on the global markets, the Company should be the best in the world community, but not only within its sectoral and regional activity.
“What is a global company? In terms of operational criteria – annual sales, mineral reserve base and industrial facilities, significant share on commodity markets, technical leadership in the industry – Gazprom is eligible to be a member of this elite club.
But much is left to be done. We need high liquidity of our shares and further capitalization build-up. Existing limitations set up in Gazprom’s share market transactions and dual approach to resident and non-resident investors significantly hampers progress in the area. Gazprom is strongly interested in the liberalization of share market and in ring-fencing system liquidation. The decision will be taken on the matter in the short run,” – stated A. Miller.
Making business globally means installation of entire industrial chain facilities set up within not only beyond one continent. Foreign business is judged not in the least. Gazprom is already working on the Indian and Vietnamese offshore development. Still, new projects are about to start. Gazprom will be expanding its business presence abroad.
We need our corporate logo to be worldwide acknowledged. Gazprom has already strengthened its good image among the European business society. Still, we’re only in the beginning of a long way to be esteemed globally.
So, at last, one of eminent characteristics of a globally integrated company is aggressiveness in realization of ambitious expansion plans. Gazprom’s strategy is vertical integration within the natural gas business and diversification in terms of related products and complex-processed commodity originating from natural gas,” – noted A. Miller.
Gazprom’s vertically integrated business begins with science and geologic survey. These businesses are fundamentally responsible for the corporate long-term development. We managed to maintain our scientific entities and are resolute to further expand activities aimed at practical implementation of R&D results. Science is to work for the corporate adaptability to a changing environment.
Gazprom adopted a program on the mineral resource base development up to 2030. Its major objective is to make reserve additions exceeding gas production. Geologic and geophysical surveys will cover the Nadym-Pur-Taz region (wirh the Obskaya and Tazovskaya bays), the Yamal peninsula, the Arctic Seas offshore, other areas where fields discovered are to be developed following production licenses grant. Special activity will be attributable to further development of existing and discovery of new fields in the vicinity to the United Gas Transmission System; setting up of a comprehensive gas production complex in East Siberia and the Far East; liquid hydrocarbons production increase; geologic survey abroad.
The reporter stressed that new technology implementation to enhance hydrocarbon production at existing fields, an extension of gas facilities life cycle are in the center of Gazprom’s business.
Gas strategy up to 2030 worded helps us name the fields to be put under development and in what order. The Yamal peninsula gas fields are among the most attractive with high production potential. Still, we adjust our plans to market requirements.
Gazprom put forward a strategic initiative – to form a new gas production province in East Siberia and the Far East of the Federal status. Russia has some 20% of the initial gas reserves there. This new area of gas production development should be optimally arranged with maximum monetization of the in place resources.
‘We are scrutinizing our gas production potential abroad. Away from business globalization, one should keep in mind that many countries prefer to conserve their own non-renewables for further generations. It will take time to understand a reasonableness of the fact in our country’, the Management Committee Chairman proceeds.
A. Miller said to the shareholders, that substantial expenditures in gas transmission business are planned to secure both further gas export growth and Russian domestic gas supply. So, gas transmission project expenditures for the current year was a priority of the Gazprom’s investment program.
Gas export flow diversification is a key element of the corporate export strategy. A program of gas transmission capacity enhancement, with the Yamal-Europe and Blue Stream pipelines capacity putting to nominal, is underway.
Keeping in mind the European market gas demand increase in future we are examining our gas export potential build up through the installation of additional gas transmission facilities. One of such facilities is the North European gas pipeline. Draft proposals on the Ukrainian gas transmission system development under the auspices of an international consortium and gas transit via Byelorussia and Poland expansion are on a table. Nevertheless, gas transmission facilities are set up provide for market requirements are structured viewing each market development prospects.
Natural gas transmission technologies are developing. Natural gas liquefaction processes add much to natural gas imminent qualities facilitating a globalization of international gas trade. LNG transportation costs tend to decrease, opening new horizons for Gazprom’s entrance to markets inaccessible earlier.
Gazprom is working on a feasibility study of the Arctic Seas offshore development (the Shtockmanovskoye field, as a premier) with LNG facilities installation necessary for the North American supply chain. Gazprom is resolute to capitalize on the entire technological chain from gas liquefaction to transportation to distribution.
We are discussing Gazprom’s potential involvement in the Sakhalin offshore development projects oriented to LNG deliveries to the American market as well as to the Asia Pacific.
Returning to Gazprom’s business on domestic market that remains to be loss incurring for the Company, A Miller stressed that operations on the internal market are about to become more attractive in the nearest future. State regulatory practice is seemingly to continue for a time. At the same time, inter fuel competition between gas, coal, fuel oil should be strengthening. Under such competitive environment only one may expect the reasonable market gas pricing.
State pricing policy needs sophistication through new prices (tariffs) set up integrating costs incurred in full and facilitating recovery of expenditures made in development of the domestic market.
In Mr. Miller’s opinion, the Company, notwithstanding the European market liberalization process, will not only maintain its positioning in Europe, but will be strengthening its presence in the region. Strong gas export long-term contracts portfolio and the corporate experience in making business in Europe are the prerequisites for the matter. Long-term contracts and common gas export channel are the major prerequisites for Gazprom’s activity on international gas markets.
‘Still, we are responsive to the European liberalization process now in progress. I must say, that Gazprom is among those gas traders who has been diligently studying this novelty since the beginning. A ramified gas pipeline and underground gas storage facilities system abroad have been installed in parallel with accompanying joint ventures operational. We are ready to work on the liberalized market and are now expanding short-term and spot transactions. It’s worthwhile saying, that we are spearheaded not so to increase our gas share on the European market as to enhance gas export efficiency’, the CEO noted.
In addition to the American market implications, Gazprom is in a position to go on with cooperation with the Asia Pacific countries. Negotiations between Gazprom and the Korean Kogas company to specify Russian gas sales are about to start. We are discussing gas deliveries from Russia to Japan with the Japanese companies. Gazprom is interested in the Chinese gas market development prospects and the corporate involvement in some projects to be finalized in China.
As of today, Gazprom controls 114 gas distribution organizations, and is s stakeholder in another 71 gas distribution organizations, which operate a combined 403,000 km of distribution pipelines (75% of the total in Russia). Russian consumers receive almost 70% of national gas supply via our gas distribution networks, although these assets are currently owned by both the holding company and subsidiary gas transmission companies, such as Regiongazholding and Mezhregiongaz. The second phase of Gazprom's restructuring stipulates consolidation of gas distribution organizations within a new subsidiary.
Gas distribution networks consolidation in one company will allow management effectiveness improvement by Gazprom, and facilitate more transparency in different business activities within a single vertically integrated company.
We consider promising our gas distribution business outside Russia – in Central Europe, where most of imported gas is supplied from Russia.
Alexey Miller stated: "I would like to emphasize that Gazprom has to conduct its business to be profitable in all segments of the gas chain. The same approach has to be implemented in projects outside Russia as well."
The vertical integration in natural gas business is complemented by diversification strategy in related products and "advanced gas processing".
We plan to establish an oil production company by the end of this year, which will be a wholly owned subsidiary of Gazprom, and make it an independent business. This fits the tasks of the second phase of corporate reforms, and will enable us to dramatically improve management efficiency and transparency of this particular business.
As a result, we will enhance our liquid hydrocarbons production several times over the current volumes of 10 million tons of condensate and oil.
Petrochemicals and gas chemicals
We have extensive plans within the framework of SIBUR development in terms of petrochemicals and gas chemicals. The company has yet to undergo a restructuring, but there is a foundation for development of this line of business. By paying more attention to gas chemicals and petrochemicals production facilities, Gazprom will be able to make profits in both raw materials sales and advanced gas processing products sales.
Synthetic Liquid Fuel
Synthetic liquid fuel industry development in Russia will bring about accelerated development of low pressure gas resources in traditional gas producing regions around Russia, as well as development of associated gas resources and gas fields located in remote areas away from the existing national gas transmission infrastructure.
An additional advantage of synthetic liquid fuel is its environmental friendliness compared to traditional fuels produced by petrochemical industry.
Gazprom can advance itself to an entirely new level within the world motor fuel market and become one of its leading players by developing synthetic liquid fuel technology.
We are in a position to become more actively involved in electricity generation. Gazprom already has its own electricity generating facilities, although currently these are separate projects for covering corporate needs. Our role in electricity generation industry will expand significantly.
Alexey Miller stated in his closing remarks that "Broad diversification will allow Gazprom to secure business stability and additional profits. We view Gazprom as an international vertically integrated energy corporation embracing exploration, production, transmission, storage, sales and distribution of natural gas, and production of a wide range of advanced processing products. We have every reason to believe that Gazprom will become a prominent world energy market participant, and a market maker as well."
Chairman of Gazprom's Management Committee, Alexey Miller's report
Information Directorate, OAO Gazprom