This could be a seminal event, with Gazprom on the verge of attaining downstream assets and finally breaking out of the former Soviet Union. Then again …

The Gazprom Cage

Gazprom's problems dictate its strategies. Though Gazprom is the world's largest natural gas producer and exporter by a massive margin, it is chronically cash-shy. The Kremlin forces Gazprom to supply natural gas to the domestic market -- primarily for electricity generation -- at sharply subsidized rates. As a result, all of Gazprom's profits come from its exports.

At first glance, it seems that this should be more than enough cash. After all, in 2005 Gazprom exported 150 bcm to Europe at a rate of about $230 per 1,000 cubic meters, netting approximately $35 billion in revenues. But there are three issues that must be taken into account. First, Gazprom is the Russian state's largest taxpayer, paying $15 billion in taxes in 2005 -- roughly 20 percent of the government's total intake. Second, nearly all of Gazprom's infrastructure and producing assets are more than 30 years old. In fact, only one significant field has been brought online since the end of the Cold War. Third, Gazprom is attempting to branch out into myriad fields, including power generation, nuclear energy and oil. In addition to the expense of attaining assets in such fields, building competence in them is an expensive process.

Considering these factors, maintaining control of Russia's natural gas exports is critical for Gazprom. Because it is a cash-poor state firm, Gazprom has never developed or applied the technologies that are in broad use in the oil and natural industries of the developed world today. It (correctly) fears that if foreign firms were allowed produce and export Russian natural gas themselves, Gazprom would quickly find itself competed out of business. Therefore, it uses its ample influence in the Kremlin -- CEO Alexei Miller and Chairman Dmitry Medvedev are both very close to President Vladimir Putin -- to prevent such a disaster. Foreign firms that enter Russia can only do so if they agree to partner with Gazprom, give it majority control of all projects, pay Gazprom's way, share any technology used or developed with Gazprom and commit themselves to supplying their share of any production to the nonprofitable subsidized market.

These terms might sound onerous or even self-destructive -- Gazprom is, after all, driving away much-needed investment -- but remember Gazprom's cage: If the firm's export monopoly ends, it fears it will soon be swept into history's dustbin. Gazprom is not trying to attract investment -- it is trying to survive. It should come as no surprise that since Medvedev and Miller took Gazprom's reins, not a single foreign venture has begun operations, and many that preceded Medvedev and Miller's ascendance -- the Sakhalin projects come to mind -- regularly face Gazprom-inspired problems.

Tool of the State

Medvedev is not simply Gazprom's chairman; he is also Putin's deputy prime minister and most likely successor. And Gazprom is not merely a large company or Russia's chief taxpayer; it is also a powerful arm of state policy. So Gazprom's strategies are not limited to keeping foreigners out, but extend to using energy and state power to further Gazprom's -- and thus, the Kremlin's -- power.

In particular, Gazprom is trying to use its massive natural gas exports to worm into what it knows best: the transport, distribution and retail of natural gas. Gazprom's logic is simple: Why supply natural gas to European distributors and let them make profits supplying it to European customers when Gazprom could control the whole supply chain itself and make money at every step?

Annual exports of 200 bcm of natural gas -- and full access to Kremlin decision-makers -- give Gazprom a wealth of tools from which to launch such expansion efforts.

Yet, despite these advantages, Gazprom's success in attaining foreign acquisitions has been remarkably limited. As one might suspect, foreign authorities and private companies alike are hostile to the idea of any single power, particularly a Russian government player, attaining too much control over their light switches.

Gazprom's efforts in energy-poor states have been the most successful, with the firm now in charge of the bulk of energy supply and distribution in Armenia, Kyrgyzstan and Tajikistan, and a somewhat hostile takeover in progress in Belarus. But as one might guess from that list, states that have other options have been successful in fending off Russia's advances.

Azerbaijan, Kazakhstan, Turkmenistan and Uzbekistan all possess their own natural gas industries and have been able to block Gazprom (although the company has made some recent progress in Uzbekistan; President Islam Karimov's government wanted to find a new foreign sponsor, and Moscow quite happily accepted the offer). Georgia and Ukraine -- because of their status as transit states for former Soviet Union energy -- have similarly been able to prevent Gazprom from gobbling up many assets. Ukraine has an added advantage in that local oligarchs dominate the very sectors to which Gazprom wants access, and they are not above using less-than-polite means to keep things the way they are.

In Europe, Gazprom's fortunes have been even worse; the company has been blocked at every turn by official and unofficial state and private actions that have prevented any but the smallest of deals. Only in Germany has there been any success, and that success has been limited. There, an asset swap with E.On has provided Gazprom with a 50 percent stake in a nascent marketing firm in exchange for a 24.5 percent stake in a Russian natural gas field (Yuzhno-Russkoye) that has not been brought on line. As one might guess, Gazprom's willingness to bring that field on line in a way that will profit E.On will determine just how much market influence E.On will allow that marketing firm to muster. So far, progress has been negligible.

A similar logic will soon come into play with ENI, and that is what will determine the success of Gazprom's latest effort to penetrate the European market. Under the extraordinarily vague terms of the Gazprom-ENI deal, Gazprom will get the right to sell natural gas. In exchange, Gazprom has committed no assets to ENI, pledging instead to work with the company to acquire energy assets in Russia and abroad. Since Gazprom holds a monopoly on the Russian natural gas sector, any such acquisitions would need to be greenfield investments, for which all of the "rules" Gazprom normally enforces would still apply. Think of the new deal as ENI making a good-faith gesture to Gazprom to see if the Russians will turn over a new leaf and grant the Italians access to upstream natural gas resources in a way that actually matters.

And do not bet too much on it.

RUSSIA/BELARUS: Belarusian President Aleksandr Lukashenko valued the national natural gas pipeline operator Beltransgaz at $10 billion to $12 billion on Nov. 13. That figure was based on sale of the Czech infrastructure, which sold for $5.5 billion. Belarus is in price negotiations with Russia's Gazprom for natural gas supplies for 2007 and beyond; Gazprom's offer is $200 per 1,000 cubic meters, up from the $46.68 Belarus currently pays. Russia has been raising natural gas prices for its former Soviet neighbors, and tensions between Lukashenko and Russian President Vladimir Putin contributed to the steep price hike. Belarus is willing to sell a 50 percent stake in Beltransgaz to Russia in return for lower prices from Gazprom, but the two sides have not been able to agree on the valuation of the operator. The Dutch bank ABN AMRO, hired by the Belarusian government, is scheduled to announce the results of its independent valuation Nov. 20.

KAZAKHSTAN/CHINA: Kazakh energy company KazMunaiGaz and China National Petroleum Corp. plan to start building a gas pipeline to China with a capacity of 30 billion cubic meters of natural gas in 2008. The route will roughly parallel the recently completed oil pipeline connecting the two states. Gazprom hopes to launch a similar project from the Altai region but that project still lacks financing and a feasibility study.

RUSSIA/U.S.: The United States and Russia on Nov. 10 agreed in principle on Russia's entry into the World Trade Organization (WTO), with the intent of ironing out the last wrinkles in time for the Nov. 18-19 Asia-Pacific Economic Cooperation summit in Hanoi, Vietnam. Three issues had held up negotiations in the past -- U.S. beef and pork exports, U.S. access to Russia's financial services market and intellectual property rights enforcement. Russia recently agreed to lift restrictions on U.S. beef and pork exports after spending several months inspecting U.S. exporters' meat-production facilities. The United States originally wanted Moscow to allow foreign banks and insurance companies to open branches in Russia; however, Washington appears to have settled for Moscow's allowing insurance company branches to open and creating the potential for foreign investment in the banking sector to rise from 25 percent to 50 percent. Russia also has agreed to improve intellectual property right protection and enforcement -- a major concern, given the rampant piracy that exists in Russia. In order to gain WTO membership, Russia will still have to conclude deals with Georgia and Moldova and then successfully navigate multilateral talks with the WTO in Geneva. Tense relations with Georgia and Moldova could make those bilateral agreements difficult and complicate the multilateral talks. Overall, Russia's accession to the WTO is unlikely to occur in 2006. Russia remains the largest economy in the world that is not a WTO member.

VIETNAM: The U.S. Congress failed to pass a bill Nov. 13 that would have granted Permanent Normal Trade Relations Status (PNTR) to Vietnam. One reason for the bill's defeat was the particular method -- expedited passage -- with which it was put to a vote, requiring a two-thirds majority for passage. It is expected that the bill will pass with a simple majority when put to a standard vote in December. Even without special status, Vietnam will still be eligible to join the World Trade Organization (WTO) as planned. However, trade between the United States and Vietnam will not be subject to regulation by the WTO until the United States grants Vietnam PNTR.

CHINA: International Business Machines Corp. (IBM) has joined a consortium led by Citigroup that is bidding for a stake in China's Guangdong Development Bank (GDB). IBM's addition is thought to have strengthened the group, since IBM is actively involved in assisting Chinese banks with the installation of modern computer systems for risk control, and is well-regarded by the Chinese government. GDB is a major Chinese bank with a nationwide license and assets of approximately $48 billion. The Citibank consortium was recently named the preferred bidder, with a formal sale announcement expected Nov. 17. The consortium's bid is reportedly worth $3.1 billion for a combined controlling stake of more than 80 percent. If the bid is successful, Citigroup will hold a 20 percent stake and IBM a 5 percent stake, in compliance with the 25 percent cap on foreign ownership in the banking sector. An earlier attempt by Citigroup to partner with The Carlyle Group that would have resulted in a 49 percent stake between the two was rejected when Chinese regulators refused to waive the 25 percent foreign ownership law.

EU/POLAND/RUSSIA: The Polish government Nov. 13 vetoed the start of partnership treaty negotiations between the European Union and Russia, saying its veto will remain until Russia ratifies the Energy Charter (which would allow third parties to access Russia's petroleum transport infrastructure) and ceases barring the import of several Polish agricultural goods. With the EU-Russian summit set to begin next week, there is little time for EU ministers to forge an agreement on a common position.

EUROPE: Several large investment banks are working on their own high-speed stock-trading platform to be introduced in 2007 with trading tariffs far below those of the London Stock Exchange, Euronext NV and Deutsche Boerse, Agence France-Presse reported Nov. 15. The investment bank group -- including Citigroup, Credit Suisse, Deutsche Bank, Goldman Sachs, Merrill Lynch, Morgan Stanley and UBS -- will be shareholders in a new company with its own board and executives. It is not clear how much the new trading system will cost to set up. The seven investment banks account for about 50 percent of all shares trading in Europe's leading companies, so creating a new platform would sap business from the existing exchanges. The decision to create a new trading platform could be an attempt to lower trading fees ahead of the November 2007 introduction of the Markets in Financial Instruments Directive, a new regulatory initiative intended to increase competition and curb exchanges' monopoly-like powers in financial markets.