Gazprom's a stock worth waiting for
Energy giant is the winner in the Ukraine/Russia natural gas battle. Can investors be winners too?
By Nelson Schwartz, FORTUNE senior writer

NEW YORK (FORTUNE) - The just-concluded battle between Ukraine and Russia over natural gas seems to have produced only losers.

Ukranians will end up paying more for gas, Russian President Vladimir Putin solidified his image as a heavy-handed autocrat when Russia briefly shut off the supply to Ukraine last weekend, and Europeans seem warier than ever of depending on Russia for natural gas, now that the idea of shivering through a Russian energy embargo isn't so far-fetched.

Russia-Ukraine settle gas pricing row

Lost amid the headlines is the affair's one winner -- Russian energy giant Gazprom. Not only will the Russian energy giant receive higher fees from Ukraine, it's also likely to get a leg up in its controversial plan to build a pipeline from Russia to Germany that bypasses longtime Russian rivals like Poland and Ukraine.

Europe is dependent on Russia for gas, and despite European talk about diversifying their supply, they really don't have anywhere else to go. So anything that makes that connection seem more reliable will appeal to Europeans, especially in Germany, Europe's largest economy. Former German Chancellor Gerhard Schroeder recently agreed to a top job with the Gazprom pipeline project, which only underscores Gazprom's top-flight political connections in Europe.

Although stories on Gazprom usually focus on politicians like Schroeder, Putin and Ukranian President Viktor Yushchenko, the rise of Russia as a gas power and the unique role of Gazprom have major implications for investors.

The Kremlin now controls 51 percent of Gazprom, but the Russian government agreed in late December to lift restrictions on foreign ownership of the other 49 percent. And that's got longtime Gazprom investors like Bill Browder, manager of the Moscow-based Hermitage Fund, very excited about Gazprom's prospects. Gazprom is by far his fund's biggest holding.

"Gazprom is the cheapest hydrocarbon company in the world," says Browder. "It trades at $1.50 per barrel while BP and Exxon trade at $15 per barrel."

And Gazprom has plenty of barrels. It accounts for roughly a quarter of global gas production, and its reserves are rivaled only by countries like Iran and Qatar. But its shares are traded mainly in Moscow, and are available in the U.S. only in thinly-traded, over-the-counter shares that sell at a premium to the underlying Moscow shares.

According to Browder, a U.S. American depository receipt (ADR) won't be available till later this year, but investors should keep an eye on Gazprom and pounce if and when a U.S. ADR becomes available.

"On an asset basis, Gazprom trades at a 90 percent discount to western oil companies and a 50 percent discount to Russian oil companies. I think it so undervalued it will ultimately eclipse the valuation of Exxon and Royal Dutch Shell at some point in the future."

That may be a bit bold, even for Browder. But he says the recent showdown will force Ukraine to pay up for gas and boost Gazprom's profits."I have been wondering why it was taking so long for Gazprom to finally hold the Ukranians' feet to the fire and get them to pay a fair price."

There's still plenty of evidence at Gazprom of its legacy as a state-dominated company -- murky accounting, bloated payrolls, and political leverage by the Kremlin. But as the company gradually becomes more like its Western peers, investors should be among the clear winners.

And with the political backing of the Kremlin and majority ownership by the Russian government, there's no danger of a Yukos-like seizure of its assets. As an investor, if you're going to have a partner in the Russian energy business, it might as well be President Putin.

If you want to see what happens when Putin isn't your partner, just ask the Ukranians. Top of page

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