GAZPROM:

1

• GAZPROM
• Can The Behemoth Fly?
• In Russian, Behemoth (of the Book of Job) is a
  synonym of Hippopotamus

2
Is the Market Too Good?

• The first years of the XXI century were the most
  successful years of Gazprom
• Average price of gas in Russia went up from
  12/mcm in 1999 to over 43 in 2005
• Average price of gas exported to Europe increased
  from 65/mcm in 1999 to 165 in early 2005
• Revenue increased from 13bn to an estimated
  40bn
• Profit from European exports went up from 2bn to
  9bn (huge space for cost growth)
• The market sends wrong signal to Gazprom Cost
  management is of low importance

3
No Reason for Cost Control

• Gazprom showed the record growth of costs among
  Russian industrial sectors
• The cost of fuel gas (gas burnt at compressor
  stations) is a good indicator of the overall cost
  performance of Gazprom
• Fuel gas expense is reported at the delivery cost
  of gas
• Note that a part of the growth was caused by tax
  increase
• According to Gazprom, metallurgical price index
  is 466 of the level of 1999
• Every year Gazprom applies for domestic gas price
  increase
• Monopoly has no reason for cost management
• Gazprom could have saved at least 0.8bn in 2004

965
465
280
4
Questions for Shareholders Meeting

• Here are two good questions Gazprom shareholders
  may want to ask at the annual meeting on June 24,
  2005
• Does Gazprom need a broker to import 56 steel
  pipe?
• Why Gazprom is overpaying taxes?
• We estimate the combined cost of these two issues
  at about 0.8bn in 2004
• In 2005, the loss is likely to exceed 1.0bn, if
  no action is taken

5
Pipe Broker

• Gazprom uses a broker to import 56 steel pipe
  from Ukraine, Germany and other countries
• There were just two buyers of 56 pipe Gazprom
  and LUKoil
• Unlike Gazprom, LUKoil imported 56 pipe from
  Japan without a broker
• In 2004, the broker imported about 100M worth of
  56 pipe
• Import volumes are expected to grow with the
  start of Yamal development
• Kickback rate in Russia is reported at 20 to 60
• The broker is a relatively small issue of 20M to
  60M a year
• Note that the broker would benefit from early
  start of huge pipeline projects

6
Tax Overpayment Background

• In January 2004, excise tax was replaced by
  export duty
• Excise tax 30 of revenue net of transit cost
  out of Russia
• Export duty 30 of revenue
• According to Q3-2004 financial report of Gazprom,
  this change has caused tax growth of 550M
• We estimate the full-year tax increase at 0.8bn
• Note that Gazprom pays transit fees in kind (by
  gas) or by cash
• Gazprom could have avoided the additional
  taxation
• We do understand that it is an extremely hard
  time for tax optimization in Russia now
• However, paying tax on transit cost is absolutely
  wrong

Annual Report of 2004 Gazprom proudly reports a
daily tax contribution of one billion rubles
7
Paying Tax on Transit Cost

• The illustration shows how it works with exports
  to Waidhaus, Germany (sample numbers)
• In 2003, the tax was defined as 30 x 120/mcm
  36/mcm
• The 2004 tax 30 x 150/mcm 45/mcm
• In both years Gazprom carried transit cost of
  30/mcm
• The solution is very obvious
• The point of sale should be moved to the Russian
  border
• In 2004, this solution could have saved Gazprom
  about 0.8bn
• In 2005 the overpayment will be closer to 1.0bn

8
How to Save a Billion

• There are at least four simple ways to reduce the
  export duty
• Filing application for a change of definition of
  taxation base
• Customs Code of the Russian Federation allows the
  use of alternative ways for calculation of
  taxation base of export duty
• Gazprom should have filed the application on the
  first business day of January 2004 (it would have
  made the overpayment refundable)
• The regulation is very likely to be changed
  because this is the best way for the state, but
  Gazproms application is needed first
• We assume that Gazprom does want to reduce tax
  payment (which may not be true)

9
How to Save a Billion 2

• Changing contract terms with all gas importers
• Moving the point of sale to the Russian border
  and cutting the price by the cost of transit
• Dividing payment gas volumes between the relevant
  importers
• Importers would pay transit costs either by gas
  or cash
• Creating a 100 daughter company
  Gazexport-Ukraine
• Selling all export gas at the Russian border to
  Gazexport-Ukraine at the price reduced by the
  cost of transit
• Selling gas to all importers at the existing
  terms
• Showing no profit in Ukraine
• Setting a similar company in Poland

10
The Way of Eural Trans Gas

• Setting up a private company that would buy all
  export gas at the Russian border and sell it to
  importers
• Gazprom and the new company would split the saved
  export duty (3 mill. per day in 2005)
• In recent history of Gazprom, companies like
  Itera and Eural Trans Gas have benefited from
  helping Gazprom to reduce tax payment
• Note that Gazprom benefited as well, though some
  analysts do not recognize this fact
• It is a nice way of making new legal
  multi-millionaires or a billionaire
• It would be a bigger and a way more transparent
  business than Baikal Finance Group, that bought
  Yugansk
• This business would end with the change of tax
  regulation, so Kremlins cooperation is a must

11
A More Equal Shareholder

• The overpayment continues now at the rate of 3
  million a day
• One shareholder does benefit from tax overpayment
• The shareholders name is the Russian
  Federation
• For the state, taxes are a way more important
  than dividends
• The state also uses Gazprom in the
  stick-and-carrot play with neighboring countries
• Belarus has a better gas deal than any region of
  Russia
• Belarus pays the low Russian price of gas AND
  gets transit payment on top of that
• Reportedly, presidential fund of Belarus benefits
  from the deal, while both Gazprom and Russia
  suffer losses

13.0 bn
0.2 bn
12
Why Is Gazprom Overpaying Tax?

• There are no legal obstacles to stopping the
  overpayment
• Managers will or shareholders pressure are
  required
• Gazprom is using third parties for tax reduction
  for years
• RosUkrEnergo and KazRosGaz buy C. Asian gas in
  Kazakhstan and export it out of Russia
• It saves Gazprom about 0.8bn a year of export
  duty
• Its hard to believe they do not see the
  overpayment problem
• Gazproms Charter still says the Companys goal
  is to make profit
• Since Jan-2004, lack of action has caused a loss
  of about 1.3bn
• Every day Gazprom loses 3 mill.
• Mr. Millers responsibilities became unclear
  lately

13
Side Effects of Tax Overpayment

• The missed opportunity to increase Gazproms cash
  flow by 1.3bn has negative side effects
• Gazprom had to take additional loans, which
  resulted in additional financial costs
• Market capitalization of Gazprom could have been
  much higher
• The price of shares sold in 2004-2005 was not
  quite right
• The 2004 profit could have been higher and
  shareholders will get less dividends
• It is not all positive for the state neither
• To fill the financial gap, Gazprom lobbies
  increase of the domestic price of gas
• It results in higher inflation in Russia

14
Finally, Does Behemoth Fly or Not?
15
Behemoth does fly!
Because anything can fly at 50 a barrel
16
For how long and how high?