Russia’s Gas Market

Via The Financial Times, an interesting look the future of the Russian gas market as the long-awaited natural gas price liberalization slowly begins to take hold in that country.  As the article notes:

“…With energy prices riding high you might expect investors would be lining up to invest in a fund that bets on Russia’s secondary energy play: natural gas. While the world is focused on the staggering rise in crude oil prices, Russian gas, too, has seen a surge in demand and prices, both at home and overseas. Russia was a key gas producer and exporter even before this rise, and has since become more influential. Most notably, Gazprom, the former state-controlled gas behemoth with a current market value of $350bn (£180bn, €225bn), expects to surpass Exxon Mobil as the world’s biggest public energy company before 2014.
This backdrop creates the perfect milieu for Pharos Financial Group’s Pharos Gas Investment Fund, which touts itself as the only equity vehicle focused on Russia and its neighbours. Fuelled by rising prices and subsequent mounting corporate profits, this long-biased fund gained 38 per cent in 12 months to May 31, 2008. Its impressive performance stands out, especially when indices tracking hedge funds are mostly flat to slightly higher for the year.

Yet the Pharos gas fund is not the hottest ticket in town. Getting prospective investors on board had so far been a tough sell for Peter Halloran, the chief executive of Moscow-based Pharos, which has total assets of $150m. There are several likely reasons why: besides a handful of large producers and distributors, Russia’s gas sector remains nebulous with scant research coverage. Furthermore, the Kremlin’s grip on the country’s energy players remains strong. The defunct energy firm Yukos and more recently BP’s beleaguered Russian venture, TNK-BP, are examples of the Kremlin’s influence over the country’s dominant energy sector.

The Pharos fund, meanwhile, remains relatively small, at $45m, despite delivering impressive annualised gains of 55 per cent. Established in April 2004, the fund is run by portfolio manager Kevin Dougherty and senior analyst Nat Moser. Mr Halloran and his lieutenants have kicked their marketing efforts into high gear with hopes of scaling the fund up to $200m in short order.

That is partly because they view Russian president Dmitry Medvedev’s new gas liberalisation plan as a positive catalyst. Under the new president, who previously worked as the head of Gazprom, the government plans to increase domestic gas prices by 25-40 per cent over the next three years. Record-setting oil prices are partially responsible for these price rises. Russia, like much of continental Europe, prices gas in line with crude oil, which has more than doubled in 12 months amid festering geo-political issues, supply-demand imbalance and the weakening US dollar.

Eventually, Russia wants to bring its domestic gas prices into line with international ones. Russian consumers currently pay around $72 per 1,000 cubic meters. Outside, prices hover between $400 and $430.

Higher local prices will augment industry-wide growth, says Oleg Maximov, an oil and gas analyst at Troika Dialog in Moscow. Legacy fields are in decline, requiring companies to make significant capital expenditure to secure new production that can meet emerging demand.

The expectation is that the price increases will fill up corporate coffers and finance the increased infrastructure-spend required to safeguard future supplies. Prices could get some additional fillip if Russia pushes forward with plans to create the so-called “gas Opec” with Algeria, Qatar and other large gas producers as members.

“People are now waking up to Russia’s natural gas story,” says Mr Halloran, who established Pharos in 1997 after working at Credit Suisse in Moscow. “The assumption’s been there’s only one play and that’s Gazprom, but the reality is far from that,” he adds. As a result of the price liberalisation, the gas sector is at an “inflection point,” he says.

New producers are setting up while existing smaller ones, which had little market coverage, are now emerging from the shadows of the monopoly Gazprom. A case in point is Russia’s second largest gas company, Novatek, which is preparing to double its production by 2015. Meanwhile, it has seen its market capitalisation rise from $2bn to $26bn in the past three-and-a-half years.

The number of gas services companies – pipeline builders, equipment makers, distributors and the like – will also increase in the next year or so, says Mr Halloran. And as the sector expands, both buy-side and sell-side coverage is likely to improve. This would draw in investors who have been sceptical so far.”

This entry was posted on Thursday, June 26th, 2008 at 11:49 am and is filed under Gazprom, Russia.  You can follow any responses to this entry through the RSS 2.0 feed.  Both comments and pings are currently closed. 

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