The Economist`s failed assault on Gazprom

Author: us-russia
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The Economist`s failed assault on Gazprom
Published 5-04-2013, 05:18
Whenever the Russian gas giant does something remarkable, like approaching the final of a decade long process of negotiation to export natural gas to China, it is a safe bet that the Western press will try to prove that Gazprom is headed for disaster. The most recent attack on Gazprom came from the ever russophobic journalists of The Economist.
The article "Russia's wounded giant" published on March 23 bears the tagline "the world's biggest gas-producer is ailing. It should be broken up" and is a fine work of anti-Russian propaganda. The authors of this despicable hatched job used all the methods from the "black propaganda" playbook, including quoting unnamed sources, accusations without factual backing and very sloppy fact checking. The bias of the authors is so evident, that it leaves only two possible explanations: Either they are utterly incompetent or their bias is willful.

In this text, an attempt to do an analysis of the arguments presented by The Economist will be made. It will be up to the reader to decide, whose point of view is closer to the truth. All political aspects, like the accusations of serving as "a wallet for the Russia's rulers" and accusations of becoming "fat and lazy" will not be touched. Unlike The Economist, better named "The Politician", I still believe that economics is a science based on facts and not on political views.

The Economist's argument: Gazprom's "ageing gasfields are in decline"

The counterargument: This is a typical instance of "lie by omission". It is natural for an ageing gasfiled to provide lower yield but a 118% replacement ratio for 2012 shows that the overall "health" of the company's assets is fine.

The Economist's argument: South Stream is a project "of questionable economic value". One of the experts interviewed by the authors describes South Stream as a "commercial idiocy". Another criticism is that Nord Stream is running below capacity so it is nothing more than a "diplomatic coup for Mr. Putin".

The counterargument: South Stream is a project that will ensure that the political leaders of Ukraine can't hold Gazprom and its European customers hostage to their political ambitions and demands of price cuts. Liquidating the risk of non-delivery on the signed contracts is more than enough to justify the investment. Moreover, Gazprom is not alone in this project. South Stream is supported by ENI and Électricité de France, so it is hard to believe that three of the largest European energy companies are voluntarily engaged in a "commercial idiocy". If South Stream is not viable from a commercial point of view, then why are Brussels and Washington so angry at its progress? Regarding Nord Stream, the answer to the criticism is simple. The gas consumption in Europe will grow, so it would be stupid to build a pipeline with no spare capacity.

The Economist's argument: "On March 4 its shares hit a four-year low. Investors reckon Gazprom is worth only a third as much as it was in 2008. By one broker's calculation its market capitalization of $110 billion is barely half the value of its assets."

The counterargument: In today's world it often happens that the price of the shares doesn't reflect the true potential or the true value of the company. The financial markets are not always right in their evaluation of companies and entire sectors of economy, that's why we have bubbles like the housing bubble in the US.

If the calculation of the unnamed broker is correct (it couldn't be replicated in-house), then the shares of Gazprom are an exceptionally attractive investment. One of the "Buffet rules" is that you should never buy a stock with price greater than 10% above book value. In Gazprom's case, if the unnamed broker didn't botch the math, there is a 50% discount to the book value, making Gazprom shares a value investor's dream.

The Economist's argument: "Gas on the spot market is often much cheaper than Russian gas delivered under long-term contracts."

The counterargument: It is also true that gas on the spot market is often much more expensive than the Russian gas, so it's a matter of risk management for the customers. If history is any indication, end-consumers operating in commodity markets prefer long-term contracts to offset the risks of wild price gyrations in the spot market. William Hague, the foreign minister of Great Britain, mentioned that there is interest in supplies from Gazprom via Nord Stream. That proves that even the country with the most liquid spot market for gas is still interested in having a long-term supply relationship with Gazprom.

The Economist's argument: "Last August Gazprom and its partners, France's Total and Norway's Statoil, decided to freeze a colossal offshore project in the Barents Sea, which was intended to produce gas destined for export to America."

The counterargument: It makes no sense trying to export to America before the burst of the shale gas bubble. After the shale gas bonanza is over, then the prices will be more reasonable and unfreezing the project will make sense.

The Economist's argument: "The final threat to Gazprom's old way of doing business is legal. An antitrust probe launched by the European Commission alleges that Gazprom is using its dominant position in central and Eastern Europe to restrict competition and hike prices. If it loses the case, it could face a fine of up to $14 billion and lose the mighty lever of being able to charge some European countries more than others. An adverse ruling might also threaten its strategy of trying to dominate the European gas market by owning both the supplies and the means of distributing them."

The counterargument: This is a classic case of trying to use legal pressure in order to force Gazprom to reduce prices and it's a tool often used by European negotiators who are taking the problem from the realm of economics to the realm of geopolitical games. It should be noted that Russia has some potent tools to ensure that trying to hurt Gazprom will hurt Europe more than it hurts Russia. The political influence of Gazprom's European partners should not be underestimated. Also, the Cold War experience gives Russian politicians an edge in negotiations where the principle of mutually assured destruction is involved.

To put it bluntly, the Russian budget can survive a year without gas income, but can the fragile European economy survive a year without the supply of 25% of its gas consumption? A spike in energy prices will surely kill any hope of economic recovery and would exacerbate the European economic recession. It is also worth taking into account the fact that Russia holds a big part of its reserves in European bonds. For instance, how would the bond markets react to a decision to sell 45 billion euro worth of French bonds? All the talks about anti-trust litigation are nothing more than diplomatic posturing. The leaders of the European Union like to play with fire, but they are not going to burn their own house in order to hurt the profit of Gazprom.

The critics point out that Gazprom is facing competition at home and present this as a bad thing for Gazprom. At the same, they predict that Kremlin will stifle the competition in the home market to help Gazprom. The problem is that it was the Kremlin who created the competitive market in Russia in the first place. It is obvious that the authors of the hit-piece want to criticize both Gazprom and the Kremlin and do so even at the expense of basic rules of logic. In their world it is bad when the Kremlin creates competition in the home market and it is just as bad when the Kremlin supposedly stifles the competition. This is not economic analysis. This is pure russophobia disguised as economic journalism.

The Economist's argument: "Besides buying more LNG, some EU countries are keen to start fracking on their own territory. Exploratory drilling proceeds apace in Eastern Europe, though fracking is still banned in France, Bulgaria and the Czech Republic."

The counterargument: Starting fracking is not the same as "starting to produce gas from commercially viable boreholes". The illusion of a shale gas revolution in Europe has already been dispelled by the repeated failures of western companies that tried to frack in Poland and other European countries. It's not Gazprom's assessment, it's Bloomberg's assessment from February 2012: "Exxon Shale Failure in Poland May Lengthen Gazprom's Shadow". A recent report from Bloomberg New Energy Finance argues that hopes for a shale gas revolution in the UK are "wishful thinking". Fracking is likely to make the European ecology worse, but it won't help the European quest for energy independence. 

The hit piece from The Economist mentions that Gazprom has invested 40 billion dollars in 2011, with "nothing to show for it", conveniently omitting that in 2011 the proven reserves of Gazprom increased by 686 billion cubic meters or the equivalent of 138% of the whole year's production. If 686 billion cubic meters is "nothing" by the standards of The Economists' authors then what kind of factual basis can be expected from their other assessments?

The only valid argument made by the British propagandists is that Gazprom is a bit late to the LNG race, but that sole valid argument is definitely not enough to offset the omissions and outright lies found in their article.

The "conclusions" presented by the British mud-slingers show the real agenda behind the hit piece. Their advice to "heal" the "ailing" Gazprom is by gutting it. In their view, Gazprom should be split in several companies and its pipelines should be managed by another company. The European Commission wants the same thing and would like to see the vertical structure of Gazprom dismantled. Brussels would like to split Gazprom in two or three companies not to make it stronger but to make it weaker, because any vertically integrated company which owns everything from production to supply routes is strong and can charge higher prices. The propagandists from The Economist want to split Gazprom for the same reason. Since Gazprom is not ailing and is too profitable, they would like to see the company dismantled. This is pure poison presented as medicine. It is obvious that no one will listen to such advice, but some russophobes may enjoy dreaming about the demise of the world's biggest gas producer. Their dreams won't come true.


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