by Peter Lavelle

09-12-05 Russia's state-controlled energy giant Gazprom has experienced a day it will remember as the start of a new era. The government passed legislation allowing foreign investors to own up to 49 % of Gazprom shares, the company began building a pipeline directly to Europe, and the gas war with Ukraine is all but resolved.
Russia's lower house of parliament adopted a law lifting the ring fence from around common shares in Gazprom, thus ending foreign ownership restrictions. The law allows foreigners to freely buy the stock in Russia and abroad. Up to 49 % of Gazprom's common shares will be publicly traded with no ownership restrictions, though the state will retain its recently acquired majority control.

Share liberalization is expected to result in a huge increase in demand for the company's stock and significantly increase its market capitalization. With a current market capitalization of $ 150 bn, Gazprom is priced much lower than its vast reserves of 114 bn barrels of oil equivalent would suggest.
Judging by its international peers, in terms of prices and reserves, Gazprom's market capitalization should be in the area of $ 300 bn. Greater financial transparency and a higher share price are also expected to enhance Gazprom's attractiveness as an investment target and a partner for other international energy majors.

As portfolio investors turn their attention to Russia's "national energy champion," Europe -- Gazprom's largest and most lucrative consumer -- is set to receive increased natural gas supplies from the company.
At a ceremony in the Vologda Region town of Babayevo, about 310 miles north of Moscow, Prime Minister Mikhail Fradkov, Energy Minister Viktor Khristenko, head of energy giant Gazprom Alexei Miller and Germany's new minister of economics and technology, Michael Glos, were present to see work start on the North European Gas Pipeline, which will eventually take Russian natural gas to Germany across the bottom of the Baltic Sea.

Fradkov called the $ 5.5 bn pipeline, which will have a throughput capacity of 55 bn cm of natural gas, "the biggest cooperation project in the Russian and European gas industry." The first expanse of the pipeline, which will stretch for 750 miles and connect Russia to Germany's Greifswald region, is set to come on-stream in 2010. Offshoots may then be built to link it with the Kaliningrad Region, Russia's exclave within the European Union, and Scandinavia and Britain.
Significantly, the pipeline bypasses Russia's western neighbours Ukraine and Poland. Gazprom exports 80 % of its production across Ukraine. The new pipeline is designed to diversify its exports and maximize earnings. Needless to say, Ukraine and Poland are against the pipeline -- losing out on cheap natural gas from Russia (which is an indirect subsidy of their economies) -- and the loss of prized transit fees.

In another move to maximize earning, there are signs the simmering gas war pitting Ukraine against Russia is about to be resolved. According to EU Energy Commissioner Andris Piebalgs, the two sides have developed a draft protocol that will have Ukraine shift to a world gas price regime by 2010.
If agreed to by both governments, the protocol will maintain natural gas tariffs at current levels in 2006; prices and transit tariffs will then gradually rise in 2007-09. The document suggests Ukraine's Naftogaz has moved closer to Gazprom's original proposal. The Russian energy giant hopes to increase the price of gas delivered to Ukraine to $ 160/mm cm, with transit tariffs it pays also rising from the current $ 1.09/mm cm/100 km to $ 1.75/mm cm/100 km.

If the current round of negotiations succeeds, the agreement will bring Ukrainian gas prices to $ 163/mm cm by 2010, according to current oil price assumptions. This is in line with the gas price of $ 160/mm cm proposed by Gazprom.
According to the protocol, Naftogaz will pay current prices in 2006, then $ 90/mm cm in 2007, $ 109/mm cm in 2008, $ 133/mm cm in 2009, and $ 163/mm cm in 2010. The substantially higher payments, approximately $ 2.5 bn a year, for Russian gas will be somewhat offset by an increase in transit tariffs for Gazprom.

In one day, Gazprom has come close to achieving three of its core goals: Making the company's stock a must for international portfolio investors, diversifying its exports to Gazprom's more lucrative market -- Europe, and starting to end preferential gas contracts with its neighbours.

Peter Lavelle is a Moscow-based analyst writing for RIA Novosti.