The Russian Oil & Gas Producers - Novatek.

Gazprom in June 2006 reached a preliminary agreement to buy 19.9% in ZAO Novatek, Russia's second-largest gas producer, in a move which may clear the way for faster development at the independent company. The move may also be an acknowledgment by Gazprom that it will need to purchase more gas from independent Russian producers in order to deal with slowing growth at its own fields - with Gazprom controlling Russia's gas transportation network and being a monopoly over gas exports. Chris Weafer, chief strategist at Moscow's Alfa Bank, was then quoted as saying: "Gazprom has held companies like Novatek hostage because they can only sell their gas to Gazprom and can't build any independent pipelines, besides minor regional pipelines. This certainly suggests that Gazprom is planning to buy a lot more gas from the independents".

Novatek's CFO Mark Guetvay said the deal was still in preliminary stages and that he could not reveal more details. But he said the deal should help Novatek develop its main fields more quickly, adding: "We're developing our core fields, and we believe this will expedite the development of these particular projects".

Novatek's key partners, represented by the holding firms ZAO Levit and SWGI Growth Fund (Cyprus) Ltd, are the selling shareholders under the deal. Gazprom said the deal would be carried out at market value. A 19.9% stake of Novatek was worth about $2.44 bn at the June 23 closing price. Vladislav Metnev, oil and gas analyst at Moscow brokerage Troika Dialog, said: As a shareholder in Novatek, "Gazprom will be ready to offer more capacity in its pipelines, so that Novatek will have room to increase its production".

The deal goes somewhat against the grain of Gazprom's recent track record, which has seen it concentrate on acquisitions downstream in Central and West Europe, and with the growth of its own assets through projects like the North European Gas Pipeline which will supply Germany and other NEW markets from 2010. Gazprom said in its press release that the move would help the company boost sales to domestic customers. The announcement also confirmed Gazprom's intent to keep its strong monopoly position. Metnev said: "This shows that successful Russian gas companies will only come under Gazprom's control". Total in 2005 lost its US$1 bn accord for a 25% stake in Novatek.

Novatek produced 25.2 BCM of gas in 2005, 21% more than in 2004. On July 4 it said it could increase its target production to 60-65 BCM/year by 2012 if domestic demand requirements provide a big enough incentive for investment. The company currently has a target to produce 45 BCM/year by 2010.

At a press conference in London, Novatek CFO Gyetvay on July 4 said: "We have the productive capacity to do that if we see the demand there. If we have to deliver more we could make the capital investment now to secure that". Gyetvay said the potential need to increase production levels to meet Russian domestic demand could be a logical part of its deal with Gazprom, which is likely to have a gas shortfall to meet its indigenous requirements.

Novatek does not expect to be able to export gas as a result of its partnership with Gazprom. on July 4 said: "We don't have any illusion that we're going to be able to export gas in the near future. Our business model is not predicated on [exports], even the recent [Gazprom] deal is not going to change that. The [Russian] government does not want all these independent companies going out to Europe...they want a single channel. You as a producer [could] get an allocation of the export market but it will still be a single channel. That's logical. Russia wants security of demand, [so] they're not going to allow these [independent] producers to compete".

Gyetvay likened his firm's position to "a David and Goliath situation relative to Gazprom". Weafer of Alfa Bank said: "This suggests that Gazprom is going to be a much bigger purchaser of Novatek gas in the future".

Gazprom's output has plateaued at around 550 BCM/year. Weafer said: "Europe's incremental demand is going to be in the order of an extra 20 to 30 BCM per annum. Gazprom doesn't really have the gas itself", adding "60 to 65 BCM[/year] is a very good figure". Gyetvay remained optimistic that the domestic gas market will provide adequate development opportunities for Novatek, saying: "The era of cheap gas prices in Russia is over".

Gyetvay cited a decision by the Ministry of Economics and Trade Development to allow local gas price rises of 15%, 14% and 13% in 2007, 2008 and 2009 respectively, up from earlier plans for around half those hikes.

Faster-paced liberalisation of the Russian gas market will help Novatek expand its business because of the growth potential at its existing assets requiring continued low capital expenditure, but considerably improved price at home for its gas, Gyetvay said, adding that Novatek's ability to boost output could help counter any supply shortfall to Russia in the event that Turkemenistan cuts of gas volumes to the nation.

Contentious negotiations are currently ongoing between Gazprom and Turkmenistan over the price the former must pay for Turkmen gas for export to Russia and Ukraine which could in turn impact on European gas supplies. Gyetvay said: "We believe we can cover a portion of that supply shortfall. Our three core fields (in West Siberia) produce 25 BCM/year today...those have the capacity to produce between 60-65 BCM/year, so we have the ability to raise production if we need it".

Gyetvay conceded the firm could not fill a significant short-term supply gap, but added that if Novatek's production levels continue at the rate seen in the first quarter of this year, the firm could produce as much as 29 BCM in 2006.

Novatek is in talks with Gazprom over a gas storage facility of 1-1.5 BCM which would help it maintain its record first quarter 2006 gas output even during times of lower seasonal demand. Gyetvay said: "We've finished negotiations, in terms of volumes, for at least 1 BCM of underground storage, but we're working on commercial ends".