GAZPROM Can The Behemoth Fly In Russian Behemoth

GAZPROM: Can The Behemoth Fly? In Russian, Behemoth (of the Book of Job) is a synonym of Hippopotamus London, June 7, 2005 www. eegas. com 1

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 $13 bn to an estimated $40 bn – Profit from European exports went up from $2 bn to $9 bn (huge space for cost growth) • The market sends wrong signal to Gazprom – “Cost management is of low importance” London, June 7, 2005 www. eegas. com 2

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 965 Net of mineral tax increase 822 465 280 • Every year Gazprom applies for domestic gas price increase – Monopoly has no reason for cost management • Gazprom could have saved at least $0. 8 bn in 2004 London, June 7, 2005 www. eegas. com 3

Questions for Shareholders’ Meeting • Here are two good questions Gazprom shareholders may want to ask at the annual meeting on June 24, 2005 1. Does Gazprom need a broker to import 56” steel pipe? 2. Why Gazprom is overpaying taxes? • • We estimate the combined cost of these two issues at about $0. 8 bn in 2004 In 2005, the loss is likely to exceed $1. 0 bn, if no action is taken London, June 7, 2005 www. eegas. com 4

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 $100 M 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 $20 M to $60 M a year – Note that the broker would benefit from early start of huge pipeline projects London, June 7, 2005 www. eegas. com 5

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 Q 3 -2004 financial report of Gazprom, this change has caused tax growth of $550 M – We estimate the full-year tax increase at $0. 8 bn • 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 London, June 7, 2005 Annual Report of 2004: Gazprom proudly reports a daily tax contribution of one billion rubles www. eegas. com 6

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 $120/mcm at Russian border $150/mcm at Waidhaus • In 2004, this solution could have saved Gazprom about $0. 8 bn – In 2005 the overpayment will be closer to $1. 0 bn London, June 7, 2005 www. eegas. com Transit cost of $30/mcm paid by Gazprom 7

How to Save a Billion • There at least four simple ways to reduce the export duty 1. 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 Gazprom’s application is needed first – We assume that Gazprom does want to reduce tax payment (which may not be true) London, June 7, 2005 www. eegas. com 8

How to Save a Billion – 2 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 3. 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 London, June 7, 2005 www. eegas. com 9

The Way of Eural Trans Gas 4. 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 • $20 bn – It is a nice way of making new legal multi-millionaires or a billionaire • • London, June 7, 2005 Note that Gazprom benefited as well, though some analysts do not recognize this fact 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 Kremlin’s cooperation is a must www. eegas. com 10

A More Equal Shareholder • The overpayment continues now at the rate of $3 million a day • One shareholder does benefit from tax overpayment ~ $13. 0 bn – The shareholder’s 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 London, June 7, 2005 www. eegas. com ~ $0. 2 bn 11

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 – Ros. Ukr. Energo and Kaz. Ros. Gaz buy C. Asian gas in Kazakhstan and export it out of Russia – It saves Gazprom about $0. 8 bn a year of export duty • It’s hard to believe they do not see the overpayment problem – Gazprom’s Charter still says the Company’s goal is to make profit – Since Jan-2004, lack of action has caused a loss of about $1. 3 bn – Every day Gazprom loses $3 mill. – Mr. Miller’s responsibilities became unclear lately London, June 7, 2005 www. eegas. com 12

Side Effects of Tax Overpayment • The missed opportunity to increase Gazprom’s cash flow by $1. 3 bn 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 20042005 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 London, June 7, 2005 www. eegas. com 13

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