Imagine you’re a typical middle-aged Russian citizen. You survived the dangers of growing up in the Soviet Union. Your parents and grandparents toiled under the constant threat of absolute state power. In school, teachers said your government was building a better, more equal society.
But by the time you entered the workforce, you realized that the Soviets were only good at building conditions for shortages and black markets. With no prices or profits, the economy was destined to collapse, and everybody would become equal – equally poor. Finally, in 1991, the Soviet Union officially dissolved. Your suffering continued as you bartered your way through the economic chaos of the 1990s. Economic productivity kept falling until the 1998 financial crisis brought your country to the brink of failure.
But ever since then, things have been getting better. Since 2000, President Vladimir Putin has been a strong, yet controversial force behind restoring Russian pride and power. You don’t have a problem with Putin’s tough tactics, thinking that Russia’s turnaround required bold action. But it’s hard for the West to relate to your experience. They don’t realize how hopeless the Russian people felt before Putin came along.
Regardless of what the West thinks of your president, Putin is a hero where it counts – in his own country. He’s so popular and powerful that TIME Magazine named him “Person of the Year.” The currency is strong, the stock market is soaring, and Putin wants to keep the boom going.
The Financial Times reports that the Russian government is pushing a plan to invest $1 trillion, roughly the size of its entire GDP, in modernizing its infrastructure over the next 10 years. Most of this investment would come from private sources, a clear reversal from the Soviet days.
Russia will follow the lead of other emerging economies in establishing its own “sovereign wealth fund.” Export earnings that the Russian government had parked in U.S. Treasury bonds will start flowing into infrastructure and natural resource projects with higher long term returns. It’s likely that some of this money will find its way to Gazprom, the state-controlled natural gas monopoly.
Lately, Putin has been setting the stage to consolidate his political gains. He’s endorsed his protégé, Dmitri Medvedev, in the upcoming March 2008 Russian presidential elections. Putin’s endorsement means certain victory for Medvedev, who also happens to be chairman of Gazprom.
As part of his consolidation strategy, Putin will be prime minister in Medvedev’s administration. There’s even a legal precedent for Putin to return to his current post – president Yeltsin resigned in December 1999, handing Putin the top job. Medvedev could do the same thing.
Some suspect Putin’s stake in the future of Gazprom extends well beyond his relationship with chairman Medvedev. In November 2007, the Moscow Times described Putin’s alleged personal holdings: “Stanislav Belkovsky, the well-connected insider who initiated the Kremlin campaign against Yukos in 2003, made specific claims about Putin’s wealth. He alleged that Putin owned… 4.5 percent of Gazprom, [a stake worth $13 billion].”
Whether or not the rumors are true, Gazprom will likely remain the world’s most politically influential corporation well into the future. Gazprom will get what it needs, and what it needs right now is to accelerate its drilling activity.
The International Energy Agency projects Gazprom’s natural gas production will decline rapidly through the year 2020, and it tends to issue optimistic supply forecasts. Gazprom management knows production is too dependent on a few large, mature gas fields, so they greatly expanded drilling activity from 2001 to 2006.
Thus far, it has yielded disappointing results. As you can see in the first chart, Gazprom expanded its drilling activity at a 30% compound annual rate from 2001 to 2006. Industry sources estimate this was the fastest drilling growth rate among all national oil and gas companies over this period.
Gazprom will probably try improving its supply shortfall by acquiring smaller independent gas producers, and try to strike deals to transport Central Asian gas to its European customers. But eventually, the company will not be able to ignore the need to redouble its drilling activity. Morgan Stanley oil service analyst Ole Slorer agrees, and described the amazing growth in the Russian rig fleet since 2000:
“Activity in Russia is now shifting from rig-less activity towards more drilling intensive services. According to the MI-Swaco rig count, there were only 40 active rigs in Russia in 2000 or about 4% of the U.S. onshore activity. This stabilized at about 75 rigs in operation over the 2001 through 2003 period (about 7% of average U.S. activity), before escalating by 70% to average 128. The growth has continued unabated and rig count averaged 246 rigs in 2006 although exiting the year at a 300 run-rate. In our view, we are entering a period of double-digit drilling growth.”
Gazprom management is on record with a goal of quadrupling the company’s market value to $1 trillion within a decade. “We’d like to be the most valued and most capitalized company in the world,” said Deputy CEO Alexander Medvedev in an April 2007 interview. He expects Gazprom’s market value will double in five years. To achieve this goal, there’s no question the company will have to drill heavily to stem its gas production declines.
Gazprom isn’t the only Russian energy company with aggressive growth plans. The December 2007 Lehman Brothers E&P Spending Survey estimates that the six largest Russian oil and gas companies will spend $28.5 billion on exploration and production in 2008, up 21% from 2007 levels. Out of all the Western oil services companies, Schlumberger has the largest chunk of this business – with Baker Hughes, Halliburton, and Weatherford contending as well. Russian companies still perform most oil service work. But they use inferior technology and equipment, so Western oil service companies should keep winning contracts.
On the equipment side, our own National Oilwell Varco (NOV) has repeatedly cited Russia as an enormous growth opportunity. Once NOV’s acquisition of Grant Prideco (GRP) closes, the combined company will be even more of a “one-stop shop” to retool and supply the Russian rig fleet. Tesco (TESO) has a huge opportunity to outfit this antiquated fleet with top drives, which improve productivity and efficiency. Natco Group (NTG) is a major player in wellhead gas processing equipment. As more oil and gas wells are completed, the opportunity for Natco equipment sales grows. Chart Industries’ (GTLS) equipment will play a key role in building LNG liquefaction plants to process the huge untapped gas resources under the Barents Sea and on Sakhalin Island.
Dan Amoss, CFA
for The Daily Reckoning Australia