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Bloomberg Businessweek

Gazprom’s Empire at the End of the Earth

The Russian energy giant has a lot riding on the success of a massive new gas field 250 miles above the Arctic Circle. So do Vladimir Putin and the Kremlin.

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THE PRIEST IN THE SEAT next to me grips a Bible on his lap as our helicopter flies north over desolation. A man could die out there, in the hard Arctic that passes by the porthole windows. Yet our traveling companions are not disturbed. The roughnecks of the gas industry drowse in their parkas to the restful cadence of the helicopter blades clipping overhead. These men carry another faith. They are heading toward its tangible confirmation, Bovanenkovo, one of the largest gas fields the world has ever known.

The development of Bovanenkovo is critical to the fortunes of Gazprom—the most valuable company in Russia, the world’s largest producer of natural gas, and an indispensable instrument of Prime Minister Vladimir Putin’s power. Gazprom accounts for 15 percent to 20 percent of global natural gas production. In addition to its deliveries across the former Soviet Union, it supplies a quarter of Europe’s natural gas. The company has posted record earnings the last two years: $35.2 billion in 2010 and an estimated $42.2 billion in 2011. Gazprom’s mammoth tax payments bolster the Russian economy, allowing the Kremlin to dole out subsidies and keep a lid on popular discontent.

At the same time, Gazprom faces challenges that threaten not just its dominance of the world’s natural gas market, but also the stability of Russia itself. As pressure rapidly decreases in Gazprom’s existing wells, the emergence of U.S. shale gas and the rise of liquefied natural gas supertankers are transforming the global gas market, providing alternatives to Russian supply. The company’s close association with the Kremlin, historically an asset and a hindrance, may invite greater scrutiny as domestic opposition to Putin’s rule grows. European clients and parliaments are contesting Gazprom’s continental influence with greater solidarity than ever before. A recent Morgan Stanley report determined that these tests may “leave Gazprom running a very different business,” diminished in scale and profitability and less favored at home.

That’s why so much is riding on Bovanenkovo. Beneath two feet of permafrost on the distant Yamal Peninsula, 1,500 miles northeast of Moscow, Bovanenkovo holds nearly five trillion cubic meters of gas. The field will begin delivering gas in July and for the next 35 years could on its own produce enough to meet 25 percent of European demand. Bovanenkovo affords the Kremlin peace of mind, although the price tag for its development—upward of $100 billion—allows Gazprom little margin for error.

After several hours in the air, the helicopter descends through the pale illumination of a retreating afternoon. A city materializes from the whiteout. Through the windows, power stations, barracks, and intersecting roadways appear. A pipeline leads south, away from it all, tucked beneath a dusting of snow like a tripwire. As the MI-8 lands at Bovanenkovo, Father Ioann, who has traveled here to minister to the workers, looks relieved, at least for now. He’ll still have to get back on the helicopter if he ever wants to make it out of here.

IT TAKES MONTHS to gain permission to enter the Yamal-Nenets Autonomous Okrug, the administrative region in which Bovanenkovo is located. The area is largely closed to foreigners, an indication of its strategic significance. Local fields yield as much as 85 percent of Russia’s total natural gas output. Blow up this operation, and you blow up the Russian economy. A U.S. diplomatic cable revealed by WikiLeaks in December 2010 described the regional pipeline junction as “the most critical gas facility in the world.”

“We were impressed when we learned how important we were,” says Sergei Menshikov, 43, the chief of the local Gazprom subsidiary, with a wink. He is holding forth in his office in Nadym, one of the first Soviet gas towns, just south of the Yamal Peninsula, a few miles from the Arctic Circle. We met several days before I left for Bovanenkovo. Fog had grounded all flights, nature being the only thing more obstinate than Russian bureaucracy.

Menshikov is bluntly charismatic in that power-vertical way, not interested in making new friends, yet oddly appealing as his suspicion thaws into a begrudging affability. He begins our talk with a harangue against the naiveté of Americans. By the end of the meeting we are discussing the merits of reindeer steak, the local specialty. I ask him what would happen if Bovanenkovo failed, like Gazprom’s disappointing Shtokman field in the Barents Sea, which has suffered from numerous delays born of harsh conditions. “We have immunity against such an occurrence,” he says. “Russian people are very creative and inventive.”

Gazprom has certainly thrived where others fear to tread. When locals talk about the reliably subzero temperatures, they do not say “minus.” They say, “35” or “45,” no modifiers necessary. The temperature once dipped to -65C in Nadym in May of 1973, the coldest day on record. This provided an unpleasant greeting to those arriving from Moscow, St. Petersburg, and other cities during the early 1970s. They came for the adventure of the new gas business, which emerged at the same time Alaska experienced its own energy-driven population boom. The Soviet government extended double pay to these early workers, as well as double vacation time and new housing in recognition of the cold choice they had made. In a country where everyone suffered, suffering a little more was worth it, if it meant suffering a little less. (Joseph Stalin didn’t offer those perks to Nadym’s original Slavic residents, political prisoners who began work on a railway in 1949.) For 40 years the gas business has been good to those who’ve built their lives around it. In all, 46,000 people live in Nadym, making it an anomaly in Siberia: a town whose population has increased over the past decade.

This population has helped Gazprom produce large gas volumes through turbulent times, enabling the company to morph from a state enterprise into a public company, albeit one that the Kremlin controls through a 50.01 percent stake. After the collapse of the USSR, Gazprom emerged intact from the Soviet Ministry of Gas Industry. Gazprom has since become a model for Putin’s push to create “national champions”: state-managed corporations designed to maximize profits abroad and subsidize national priorities at home.

Gazprom performs many functions traditionally reserved for the state, including funding public works projects directly from its budget. It’s the only Russian company that is compelled to pay its tax bill monthly, since this revenue makes up the single largest portion of Russian gross domestic product (10 percent) and is critical to the basic workings of government. Gazprom is less a company than a public trust, one that enjoys special advantages in exchange for fulfilling official wishes.

Such mixed status helps explain why the Medvezhye No.5 gas field, Nadym’s first, operates with control room technology dating to 1975, even though on an average day it extracts gas worth $1 million on the European market. This continues to be one of Russia’s charms, its ability to press on regardless. Frills are for the weak, planning for the dawdler.

Still, time is catching up with Gazprom. The old fields around Nadym, the foundation of the Soviet gas industry, are just that: Old and swiftly losing their vigor, operating at just 10 percent of original pressures. At Nadym’s pyramid-shaped Iceberg Hotel, the gas managers share a vodka at the end of the day. Their hair is pasted against their skulls after many hours under fur hats. Velmer Davletov, the director of Medvezhye No.5, talks of little besides the booster pumps he has installed in his wells, as he and his men use every trick to drain every last cubic meter.

Europe’s dependence on Gazprom for natural gas gives the Kremlin power to leave millions in the cold should it choose to do so (as it did to Ukraine after pricing disputes in 2006 and 2009). A deep freeze in Russia this winter has increased domestic demand for fuel, producing a shortfall in natural gas supply to Europe. Over the last year, as European customers have been squeezed by surging gas prices (generating Gazprom’s record earnings), some of Gazprom’s Western clients have demanded arbitration. European Union antitrust investigators stormed Gazprom offices in Germany and the Czech Republic, seizing contracts. (Gazprom insists its contracts adhere to international law.) And officials in Brussels are debating the Third Energy Package, anti-monopoly legislation focused squarely on Gazprom’s ability both to transport and sell gas in the territory of the EU.

For the moment, Europe is trying to flex a muscle it doesn’t have. “[They’re] still relying on Russia,” says Ilya Balabanovsky, the head of oil and gas research at Renaissance Capital in London, an investment bank specializing in emerging markets. “There is a limit to how hostile you can get.” Even so, the West’s efforts to challenge Gazprom have forced the company to look east. As difficult as it is to believe, Russia, the world’s biggest gas exporter, supplies no gas to China, the world’s biggest consumer of it. The Chinese government estimates that domestic gas demand will exceed 300 billion cubic meters by 2030, double current consumption. For more than 10 years, Moscow has courted the Chinese, but China has so far preferred the lower prices of gas from Turkmenistan. Russian President Dmitry Medvedev has said “there is no alternative” to competing for China’s business. Without it, Bovanenkovo, as well as other untapped resources on the Yamal Peninsula, which Gazprom predicts will translate to 360 billion cubic meters of annual production, will become diminishing assets.

IT TAKES VISION to see into the future. Vasily Serotetto lacks the conventional kind. He stabbed himself in the right eye a number of years ago. A sled-carving accident. The eye is ornamental now, a yellowed orb that has no iris.

Serotetto, 55, is Nenets, the original people of Yamal, cousin to the Eskimo. We meet in Yar-Sale, a settlement on the southern edge of the peninsula. Serotetto, who recently had a stroke, strides out of the Yar-Sale infirmary in his malitsa, a hood-to-heel drapery of reindeer pelt, pounding his chest in the Arctic cold. “I am strong,” he bellows. “I am my own man. I depend on nobody.” He hops on a snowmobile and takes off across the tundra to a way of life threatened by Gazprom’s express advance.

The Nenets were Yamal nomads long before Ivan the Terrible sent an exploratory party to make their acquaintance in the 16th century. Later, the Soviets tried to bring their misguided idea of collectivization here, but it didn’t take. Gazprom may be the one master that succeeds where others have failed.

Long sheltered by distance and the elements, the Nenets have become vulnerable to Russia’s progress. Gazprom is building railways, roadways, and pipelines across Yamal. That’s just fine for the company’s workers, but problematic for the reindeer that have until now moved freely across the peninsula’s 47,000 square miles. They cannot jump a pipeline. If the reindeer can’t roam, they won’t find moss to eat. If the reindeer die, the Nenets’ ancient livelihood dies. There are 13,000 nomads left on Yamal, and many fear that they’ll be the last to exist in this way.

Two hours across the tundra, the wind swirling, and Serotetto’s snowmobile arrives at his temporary encampment. His herd—2,500 head of reindeer—is waiting for him, milling about two tents, known as chums, set upon the snow. These animals are huge and healthy, with racks that would tempt any big-game hunter. The reindeer are highly domesticated, and several of their number close in on me, sniffing the new arrival. In the Nenets language, Yamal means “the end of the world,” and this is what it feels like.

Serotetto pulls back the heavy reindeer-pelt opening of one of the chums. He steps into the circular enclosure of another century. Rough wooden planks rest on the otherwise dirt floor. Hand-sewn pillows are strewn about. “We don’t want our people to fall behind,” Serotetto says. “We want to be involved.” He has taken advantage of new opportunities. He now sells his reindeer meat to clients in Europe. A gas generator powers the few naked light bulbs that dangle from the chum’s crossbeam. A government meat subsidy has increased the value of Serotetto’s herd, which on paper is worth $1.25 million. He’s become a wealthy man.

Natives like Serotetto have learned how to do business with Gazprom. Not long ago, Serotetto helped divert a roadway development away from a parcel of land that turns marshy in the short Arctic summer. In so doing, he aided both Gazprom and the local people who will use the road, saving the project from failure. “We know the region best,” he says. For his efforts, he received a medal from the provincial government.

Serotetto takes a sip of unfiltered black tea. The hollow sound of reindeer locking racks against one another scrapes against the wind outside. It is the sound of the past. Gazprom brings a new sound, of trains and drills and helicopters, and of the gas that hisses through pipelines. Serotetto does not hear it. “Their business is temporary,” he says. “Like all business.”

THE REINDEER PUSH BACK, in their way. Numbering in the thousands, searching for food, they often descend on Bovanenkovo with the suddenness of a blizzard. In these moments, production ceases, in case the reindeer break the pipelines. “I have lived in the north my whole life,” says Anton Dzhalyabov, the head of Bovanenkovo’s No. 2 station, the first to be ready for production. “But here there is always something extreme happening. You need to be stress-resistant.”

In more ways than one, Bovanenkovo represents a new frontier for Gazprom. Finally, the fog lifts enough for the helicopter to make the journey there. Upon landing, I hop into a UAZ jeep with Dzhalyabov, 31, and we drive along one of Bovanenkovo’s planned-city highways. Clearing a fogged-up window, Dzhalyabov points to a pipeline that runs alongside the road, 2,000 feet of which was recently damaged by strong winds. A few days prior, Dzhalyabov eyed the thermometer as the temperature fluctuated from 11 to 37 to 8 (minus, naturally), all within 40 minutes. “Nobody has ever tried to build a gas facility in such harsh conditions,” he says. “Everything that came before has no comparison to what’s here. So you need a strong country that understands goals.”

Czarist-era geologists discovered gas on the Yamal Peninsula just before the 1917 Russian Revolution, though they didn’t possess the wherewithal to extract it. Through the years, the litany of upheaval that is Russia’s burden prevented the exploitation of such an asset. Engineers discovered the Bovanenkovo field in 1971, three years after the death of Vadim Bovanenko, a geophysicist who had served as the head of Yamal Oil and Gas Exploration, an arm of the gas ministry. But it was only under Putin that workers were finally able to began building infrastructure at Bovanenkovo in 2007. The date for initial gas delivery was postponed on several occasions, causing observers to wonder if the project would ever be realized. The startup date was then pushed up to July 2012, sparking a new round of questions. Did Gazprom foresee a spike in European demand? Were Nadym’s gas fields in far worse shape than anyone had imagined? It’s hard to know why Gazprom behaves the way it does. Company executives aren’t known for sharing information. Several Gazprom officials replied politely to my interview requests but provided little revelatory insight.

Sharing profits, however, is part of being a national champion. In the last year, Gazprom has slashed investments and more than doubled dividends, increasing the yield of the Russian stock market and padding state coffers. As Putin prepares to reassume the presidency for what could be another 12 years, his ruling United Russia party increasingly turns to Gazprom, less to wield power abroad than to shore up support at home. In October, Gazprom absorbed a selective doubling of the tax levied for the extraction of mineral resources, which will result in $10 billion of lost profits this year. This money will help balance the Russian budget and pay for popular social programs.

“The reason that they are being treated differently is because they are different,” says Balabanovsky of Renaissance Capital. “Gazprom is a business that is operating at a profit. And at the same time, look, it’s a national gas company.”

It is a national company subject to national whims. It came as a surprise, though not a shock, when three top Gazprom managers were dismissed on the last day of 2011. Also disbanded in the shake-up was the company’s department of strategic development. This restructuring recalls Putin’s actions upon becoming president in 2000, when he engaged in mass firings of upper management, ensuring fealty from those left behind.

Moscow’s political intrigues occur more than a thousand miles away from Bovanenkovo and the engineers who carry out Gazprom’s actual affairs. Dzhalyabov concerns himself with one element simply: the upstream. The driver parks the jeep and Dzhalyabov gets out. He stands on the edge of Bovanenkovo, surveying the city that Gazprom has willed into being. “The pipeline is there,” he says. “The gas is there.” That’s all that matters.

The fog is closing in again, and after a brief afternoon stay, I make my way to the heliport, or risk being stranded in Bovanenkovo. The MI-8 is buzzing, its blades kicking up a storm of snow crystals. Inside the helicopter, a new group of roughnecks slumps in the seats. These men are heading home to Nadym. They stare through the windows, as Arctic night darkens Arctic dusk. The helicopter leaves the ground and lifts into the clouds, obscuring the view.