Serbia’s Oil Industry: a Christmas Gift to Gazprom

Publication: Eurasia Daily Monitor Volume: 6 Issue: 2

On December 24, 2008, the Serbian government ceded control over Serbia’s Oil Industry (Naftna Industrija Srbije, NIS) to Russian Gazprom’s oil subsidiary, Gazprom Neft. Motivated to a large extent politically and negotiated poorly by Belgrade, the cession amounts to a Christmas gift for Gazprom and the Kremlin. Russia’s sequential presidents, Vladimir Putin (now prime minister) and Dmitry Medvedev (as Gazprom chairman earlier in 2008), were personally involved in the two phases of the negotiations and witnessed respectively the signing of the agreements in Moscow (Interfax, December 24; see EDM, December 15, 2008, January 28).

Belgrade chose Gazprom Neft without holding an international tender for the sale of 51 percent of NIS shares; and it agreed to sell that controlling stake for a mere €400 million ($537 million), even after the international consultants Deloitte & Touche had valued NIS at €2.2 billion ($2.95 billion)last September. By privileging Gazprom over other potential international partners, Belgrade implicitly rewarded Russia for continuing to oppose international recognition of Kosovo; and by selling the controlling stake in NIS at a deeply undervalued price, the Serb government expected Gazprom to reciprocate the favor by building a section of the South Stream gas transportation project in Serbian territory.

Moscow pocketed those concessions but decided at the last moment to break the linkage between the NIS sale and the South Stream project. Moscow’s decision contravenes the January 2008 Russian-Serbian intergovernmental agreement as well as the Serbian parliament’s September 2008 ratification of that agreement. Both sets of documents treated NIS and South Stream as inseparable aspects of the transaction. Indeed, the Russian side had insisted all along that NIS be thrown into the package with the gas project, in effect as a palm-greaser for Gazprom to include Serbia in South Stream. The Serb president and government have now ended up ceding control of NIS for a fraction of its value, without any assurance that Gazprom would or could proceed with South Stream.

Under the contract signed on Christmas Eve, Gazprom Neft will pay €400 million ($537 million) in cash up-front and invest another €547 million ($721 million) in NIS by 2012. To implement that investment program the Russian company will seek a €500 million ($671 million) loan. The agreement’s previous versions had stipulated an outright investment by Gazprom Neft, not a loan. This change reflects Gazprom’s deteriorating financial situation and introduces a further element of uncertainty for Serbia. The contract leaves open the issue of operating rights and management control over NIS. Gazprom Neft seeks full control, while the Serbs would prefer joint control (BETA, December 18; Radio B 92, December 23, 24; Interfax, December 24; Platts Oilgram, December 29).

The Serb government approved the NIS contract at a hurriedly arranged telephone conference call the day prior to the signing, with little time to read its details, let alone debate the documents. The issue had been decided politically in mid-December when President Boris Tadic and a majority of government members coalesced to remove the critics of the agreement from the negotiating team.

NIS is Serbia’s largest economic entity in terms of business turnover. It includes the refineries at Pancevo and Novi Sad, with a combined processing capacity of 6.5 million tons of crude oil annually (currently operating at an annual rate of 4 million tons), which meets the internal demand for oil products. Both refineries require modernization and ecological cleanup measures. NIS also includes an oil supply pipeline entering Serbia from Croatia, a fuel distribution network that holds a 72 percent market share in Serbia, and a modest oil extraction operation on Serbian territory. NIS assets are mainly located in Vojvodina province, the leadership of which openly favored partners from the European Union for privatization of NIS (Vecernje Novosti, December 15).

Tadic and Medvedev witnessed the signing of the contract in Moscow by Serbian Energy Minister Petar Skundric and Gazprom Neft CEO Aleksandr Dyukov. At the same time, Gazprom and Srbija Gas signed nonbinding agreements on the possible construction of a section of the South Stream gas pipeline in Serbian territory as well as modernization and enlargement of the Banatski Dvor gas storage site in northwestern Serbia. Each of the two projects is to be implemented, owned, and operated by a joint venture of Gazprom and Srbija Gas, with the Russian side holding 51 percent and the Serb side 49 percent of the shares in each project.

Final decisions on whether to go ahead are to be made during the first half of 2009. Clearly the decisions will be up to Gazprom. How Serbia could finance its share of the investment seems far from certain. Meanwhile, Gazprom has announced that it needs until the end of 2009 to prepare an economic and technical feasibility study for the overall South Stream project. An investment program would only be drawn up afterward for the overall project (Interfax, December 30). Thus, the prospect for implementing South Stream in general, including a possible Serbian section, seems to be receding due to Russia’s anticipated production shortfalls and Gazprom’s growing financial problems.