Russian - Ukraine Gas Dispute

It´s fascinating to follow the current Russian-Ukraine Gas Dispute. If you still needed convincing to invest in Canadian Oil Companies and US Natural Gas Companies, this latest battle between Russia and the Ukraine should have you throwing in the towel.

Other than Canadian and US companies, I doubt there is any foreign entity (especially Russia, which witnessed, and still condones, the biggest corporate and social robberies in world history) that can be relied upon to provide the US with oil and gas, as supplies dwindle amid greater world demand and scarce resources.

For a quick primer on the Russian gas scene, I´ve pasted a short interview below with Kurt Wulff' from recent article in Barron´s. I don´t share his bullishness on Russian investments, given what is widely known about Russian business practices. It´s hard to believe that Mr. Wulff actually believes that Russian citizens will benefit from the future riches of Gazprom. On the flipside, however, if Russia is to become the ultimate natural-gas producer, better load up on Canadian and US companies, because the world is in for some big suprises. My favorites include: SU and BVI.TO. As the owner of the largest seismic library in Canada, Seitel (SELA.ob) also remains a great play.

How are you playing the LNG market?

I am paying very close attention to the linking of the global gas markets through LNG, but in the end you play it through natural-gas producers, and that leads to my ultimate natural-gas stock. My most interesting recommendation now is Gazprom . This month the Russian parliament has approved the lifting of ownership restrictions on Gazprom , and President Vladimir Putin should be signing off on that before the end of the year. Before, only 20% of Gazprom shares could be owned by non-Russians, and the stock could only be traded on certain exchanges. There was a little bit of a premium between the Russian shares and the non-Russian shares. Once the restrictions are lifted there should be so much demand for the stock that that premium will easily be absorbed.

What's your target for the stock?

It's $120 a share, and the stock is trading at $77. What's interesting about the present value is that it is tied to what they get for their gas, and that's only about one-fourth of world levels. The Russians are getting only 2.50 rubles per cubic meter -- coincidentally, rubles per cubic meter is the same as dollars a million BTU, or close enough. That's about $2.50 a million BTU based on $15 on a near-month basis, $12 on the next 12 months and $9 on the next six years. But we think the $9 is low, so there is a four-fold-type potential gain for Gazprom .

What are they doing to get the price to the world level?

It is controversial. Gazprom's pipeline to Europe goes across other countries, including Ukraine, and Ukraine apparently steals gas from the pipeline. They are arguing right now over transit fees. Gazprom wants to get the price up and Ukraine wants to get a big chunk of it. Gazprom is building a pipeline under the Baltic Sea that won't pass through Ukraine and other countries. They also built one under the Black Sea to Turkey and southern Europe. They'll have LNG going across the Arctic, and they will be part of an LNG project in far eastern Russia.

What about Russian price controls?

They are being relaxed gradually. There is no assurance they are going to go away, but I think they will. In Gazprom's case there is one oligarch who might own 10% or so. The Russian government now owns 50% of it, and presumably a million Russians own the stock. Twenty percent is owned outside of Russia by people in the global capital markets. So the interests are aligned, and if Gazprom makes a lot of money, the Russian government gets half of it and Russian citizens make a lot of money. The international guys can help drive up the price, and if Gazprom becomes a trillion-dollar stock eventually, it is a great flagship for the whole country. There is talk about Gazprom being bigger than Exxon some day.


Gazprom does have an ambitious energy strategy. They want to export LNG to the U.S. Russia has more natural gas than Saudi Arabia has oil. Gazprom has 90% of the production in Russia, and it is not hard to make the case they already own or have access to more resources than any other company. They are bent on marketing those resources, so it should follow they get more recognition in the stock market. It has the lowest McDep ratio of all the major companies at 0.64 on a net present value of $120. They generate $23 billion in cash flow a year. Put a multiple of 11 times on the unlevered cash flow, which is a little higher than normal because Gazprom has very, very long-lived reserves, and you get to $120 present value.

Comments

[JW]

Ugh. Don't remind me... I was looking at Canadian Oil Trusts in 2003 but never pulled the trigger. I was scared off by Canadian's less-than-savory reputation as a stock market.

Lesson learned.

Can you provide a bit more detail about how much more opportunity is left in these stocks? I feel like I've missed the low-hanging fruit here...

Thanks

[YF]

That´s a good question. It´s unclear what the upside still is, as the stocks are no longer cheap. There was an opportunity to pick up these stocks in the October correction. I suspect the next correction will happen in May, as it did last year.

All in all, it depends on oil prices. If they stay above $60, these stocks can easily go up alot more. If oil goes to $100??

You can also still find some value in the smaller names which big funds have yet to move into. I like SELA.ob alot, because it has the largest library of seismic data in Canada. I also think GHM (Graham), whose equipment helps process the type of crude produced in Canada, is still a great play. Both stocks are up alot, but can be bought on the inevitable dips. There are not many funds in these stocks yet.