Rent control: Russia’s state oil and gas firms

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The Gazprom headquarters in Moscow

Oil and gas lie at the heart of Russia’s elaborate system of patronage structuring its politics and economy. Vladimir Putin and the current regime rely heavily on oil and gas tax revenues to finance state spending as well as oil and gas companies to provide billions of dollars’ worth of contracts to friends and supporters of the Kremlin. Russia’s premier state-owned energy firms – Rosneft and Gazprom – all play vital roles in cementing the regime’s grip on power and pursuing domestic and international policy aims.

Rosneft

Rosneft is Russia’s largest single taxpayer, a vertically-integrated oil giant that produces nearly 4.6 million barrels of oil per day. It enjoys status as the world’s largest publicly-traded oil company. More recently, it has expanded its role as an energy foreign policy instrument for the Kremlin.

In 2016, Rosneft provided over 1.3 trillion rubles to Russia’s federal budget. For the first half of 2017, Rosneft alone accounted for over 30% of all of Russia’s state procurements orders. The former earns it a special place in domestic political debates, since it enables social spending. The latter speaks to its outsized role in spending state money to generate economic activity in the form of construction projects, upgrading oil and gas equipment, bringing in consultants, and so on.

Rosneft’s domestic weight is largely a result of Igor Sechin’s efforts. Sechin spearheaded the destruction of Mikhail Khodorkovsky’s oil firm Yukos back in 2003. He used a 2013 oil supply deal potentially worth hundreds of billions of dollars with Chinese partners to finance his successful attempts to acquire TNK-BP and its oil assets from its owners. Most recently, he convinced the Kremlin to give him the go-ahead to buy out the oil company Bashneft, which had been nationalized and was meant to be privatized. Instead, it was “privatized” by another state-firm.

Rosneft’s domestic expansion parallels a more recent international expansion. Partially due to sanctions, Rosneft has become an active executor of Russian foreign policy in the Middle East and the Asia-Pacific. The company with a consortium acquired a refinery in India, has signed supply, financing, and joint venture deals with Iraqi Kurdistan for oil and gas, and also buys oil from Libya’s National Oil Company in preparation for future investments should the security environment improve considerably. These are just a sampling of the company’s expanding international ambitions. 

Asia-Pacific markets are the future of Russia’s oil export strategy and Middle East reserves have become increasingly important because of lower oil prices and the effects of Western sanctions on Russia’s energy sector. After much wrangling, the company has also sold 14.2% of its shares to the Qatar Investment Authority, linking the Gulf gas producer to Russia’s energy sector. More generally, Rosneft has become Russia’s primary geopolitical actor on oil markets while ensuring a steady flow of tax revenues and demand for state finances and state contracts. But it should be noted that Russia still has other oil companies with their own interests and roles in Kremlin policy. It should also be noted that Rosneft’s role has been greater than its tax burden suggests given that Russia levies an export duty on oil, technically not a corporate tax, giving it a great deal more influence due to its production levels.

Gazprom

Gazprom is Russia’s gas monopolist and maintains a legal monopoly on exports of natural gas via pipeline. The company used to have a complete monopoly on all exports, but lost its exclusive right to sell liquefied natural gas (LNG) abroad in 2013. The privately-owned Novatek was allowed to develop an LNG project in the Arctic.

This salient detail helps frame Gazprom’s traditional role and the challenge it faces. Gazprom supplies Russia’s residential and industrial consumers with natural gas at rates generally below long-term marginal costs of production and delivery. Exports to Europe have provided a majority of the company’s revenues since attempts to liberalize domestic prices proved politically unpalatable, particularly after the economy entered recession in 2014. Gazprom is central to the Kremlin’s social contract with businesses and the broader population, maintaining lower prices for electricity and heating to maintain standards of living and aid uncompetitive industries.

In 2016, Gazprom was Russia’s second-largest taxpayer, several hundred billion rubles behind Rosneft at around 1.12 trillion rubles. The structure of those taxes has been shifting. Domestic gas producers, including Novatek and Rosneft, have taken around 35% of the domestic market. Gazprom only increases sales when demand rises, since its competitors do not face the same tariff regulations. That means Gazprom has become increasingly dependent on its exports.

Gazprom’s exports accounted for 36% of Europe’s gas market in 2017, an important geopolitical tool in the Kremlin’s kit to maintain influence. Historically, Gazprom has done all it can to corner markets in Eastern and Central Europe so as to demand higher prices since gas is not yet a globally-traded commodity. More recently, the EU managed to use an anti-trust case to negotiate with Gazprom and secure binding obligations that undermine the company’s price-fixing practices and their political effects.

But Gazprom’s dominance on the European market – by far its most important – remains secure. The company is pushing ahead with three large pipeline projects, two of which are designed to drastically reduce gas deliveries to Europe through Ukraine. The third – the Power of Siberia – will give Gazprom a toehold on China’s market by the end of next year. While these projects have foreign policy implications, their actual value – and that of many Gazprom projects – is actually domestic.

Analyst Alex Fak estimated that Gazprom’s contractors, all of which are owned by important friends of the regime, earned $93.4 billion from Gazprom’s pipeline projects. It is well-known that Gazprom also opts for the most expensive variants of the projects it pursues, maximizing its ability to distribute state money and financing to businesses friendly to the regime. In short, Gazprom exists to enrich its contractors, not its shareholders, while fulfilling certain social functions at home and maintaining influence in Europe.

Energy and power

Rosneft and Gazprom play leading roles in securing Putin’s regime in Russia. Rosneft provides more in the way of taxes and public stimulus whereas Gazprom distributes wealth to domestic contractors rather than focusing on revenues. Oil makes more money in taxes and duties than gas. Their roles logically follow.

Abroad, the story is slightly more complicated as Rosneft pursues projects to eventually muscle into Gazprom’s gas monopoly. Gazprom also has an oil producing subsidiary doing a similar thing to Rosneft. But when it comes down to it, the Kremlin can push for and rely on them to pursue deals of geopolitical value by using its control over tax policy and other related levers of power.




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