GAZPROM: Can The Behemoth Fly?

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

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” www.eegas.com

3. Net of mineral tax increase 822 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 www.eegas.com

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 www.eegas.com

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 www.eegas.com

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 www.eegas.com

7. $120/mcm at Russian border $150/mcm at Waidhaus Transit cost of $30/mcm paid by Gazprom 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 www.eegas.com

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 Gazprom’s application is needed first • We assume that Gazprom does want to reduce tax payment (which may not be true) www.eegas.com

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 www.eegas.com

10. $20bn 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 Kremlin’s cooperation is a must www.eegas.com

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 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 ~ $13.0 bn ~ $0.2 bn www.eegas.com

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 • 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 $1.3bn • Every day Gazprom loses $3 mill. • Mr. Miller’s responsibilities became unclear lately www.eegas.com

13. Side Effects of Tax Overpayment • The missed opportunity to increase Gazprom’s 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 www.eegas.com

14. Finally, Does Behemoth Fly or Not? www.eegas.com

15. Behemoth does fly! Because anything can fly at $50 a barrel www.eegas.com

16. For how long and how high? www.eegas.com