What Does Instability in Ukraine Mean for This Russian Giant?

Russian aid cop-out highlights energy firm's weak finances

Feb 21, 2014 at 9:36AM

While the world focuses more on violent Ukrainian politics, Russian President Vladimir Putin has been taking a break from the limelight. But with Russia reneging already on a portion of its promised $15 billion in aid, his position seems less stable than usual. Given that the portion of the aid package to Ukraine based on cheap energy prices seems destined to go unfulfilled, what does this mean for the Russian gas industry? 

The giant
Gazprom 
(NASDAQOTH:OGZPY) is the largest extractor of natural gas in the world. With nearly one-fifth of the world's production of natural gas flowing through its pipelines, the company forms an essential part of the Russian economy, contributing 8% of the country's GDP in 2011 and trending upward since.

Though set up on paper as a privatized company, the Russian state owns a majority stake in the firm and uses this position to extend its influence into other domestic sectors. While the industry is less a government entity than other completely state-run energy companies, the company has become a symbol of Russian state stability in recent years.

Ukraine's "contribution" to Gazprom
The recent Ukrainian protests, begun in response to its president moving toward closer ties with Russia, have forced this stability to look rather shaky. Russian stocks have fallen for the second day in a row, and while Gazprom has stayed within the $8.00-$8.75 per share range, there are indications that the stock will fall somewhat further. With no definitive idea as to when the situation in Ukraine will resolve itself, Gazprom will have to worry about diminished return as pipelines headed to European markets are potentially disrupted by the violence. 

Long-term problems on the horizon
With increased energy independence on the rise in former markets like the U.S., Gazprom (and by extension the Russian government) is facing a new set of challenges. Fracking is eating away at oil and natural gas markets alike, and as the technology becomes more accessible, traditional markets will be forced to offer lower and lower prices just to stay competitive. With the slow but steady expansion of green market technology, Gazprom will be further squeezed as other states turn to accessible domestic production over foreign investment.

As things stand Gazprom is trading at 60% of its peak price of $14 in mid 2012, a function of emerging energy production markets and the other concerns noted above. While the company is above its 52-week low of $6.44, it is still under-performing by at least 4%. There may be hope on the horizon in the form of further gas exploration efforts domestically, but these will take a great deal of time to develop. Until then, they will contribute to lagging production.

Final nail in the coffin of Russian natural gas?
Gazprom has historically sold natural gas domestically for a reduced price in what some call a marketing ploy. This seemingly altruistic act may only be the undoing of the company. While selling at reduced prices protects the domestic market from external sources, the decreased revenue gained turns the entire scheme into a downward spiral that doesn't allow for an easy out. If the feared disruptions do occur, than domestic prices may be forced up to balance the bottom line. But this rise in prices could also allow for foreign firms to enter the market, further eroding Gazprom's market share. 

The takeaway
Yes, the Russian economy is not built solely on the investments of a single natural gas firm. But the intrinsic value of the company cannot be denied as both a symbol for the state as well as a powerful contributor to the Russian economy. If the star companies of a state are found financially wanting, how long will it be before investors see the writing on the wall and pull out themselves. 

For investors, the path is clear. Despite the security that a state-run enterprise can bring, it may be better to wait for the events in Ukraine to run their course before looking anywhere near Russian energy markets. In the meantime, lackluster future prospects only mean that Russian finances will get worse before they get better.

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Kurt Avard has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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