POLINARES is a project designed to help identify the main global challenges relating to competition for access to resources, and to propose new approaches to collaborative solutions POLINARES working paper n. 47 April 2012 Case 3: Global value chains, state ownership and natural resources By Armando Rungi, FEEM The project is funded under Socio‐economic Sciences & Humanities grant agreement no. 224516 and is led by the Centre for Energy, Petroleum and Mineral Law and Policy (CEPMLP) at the University of Dundee and includes the following partners: University of Dundee, Clingendael International Energy Programme, Bundesanstalt fur Geowissenschaften und Rohstoffe, Centre National de la Recherche Scientifique, ENERDATA, Raw Materials Group, University of Westminster, Fondazione Eni Enrico Mattei, Gulf Research Centre Foundation, The Hague Centre for Strategic Studies, Fraunhofer Institute for Systems and Innovation Research, Osrodek Studiow Wschodnich. POLINARES D3.1: Analysis of current & recent practices & strategies of key actors in oil, gas & minerals; identification & assessment of major future risks for tension and conflict Grant Agreement: 224516 Dissemination Level: PU Case 3: Global value chains, state ownership and natural resources Armando Rungi FEEM Abstract Exploiting a unique dataset of 146,459 companies active worldwide in the extractive sector (coal, oil, gas, raw materials and supporting activities) grouped by 3,686 domestic and/or multinational corporations, I first explore the different investment strategy by type of property (national and international companies) and then the patterns of capital productivity as a proxy for the viability of the investment, at home and abroad. What I find is a strong duality of investment behavior by international and national companies, with the first more likely to relocate in upstream activities and the latter in downstream activities such as refining, transportation and distribution. Moreover, when looking at capital productivity, state-owned affiliates in 2001-2010 seem to be more productive, especially when they invest in their country of origin, with the exception of energy companies whose investment abroad is on average more productive than investment in the origin country. Finally, an overall positive time trend for investment performance is detected from estimations which is probably linked to the commodity boom of the last decade. Introduction The new surge of trade in natural resources during the last decade can be ascribed to the more general phenomenon of the internationalization of production as a result of the third wave of economic globalization begun in 1990s, that has seen both an increased demand from newly-industrialized countries and the development of complex global value chains for which production of final goods takes place across national borders (Gordon, Mataloni and Slaughter, 2005; Baldwin and Martin, 1999). In the context of an increasingly internationalization of production through global value chains, energy and raw materials are used more than ever as the first intermediate input in the production of final goods by networks of firms that are engaged across national borders with different stages of processing before reaching the final consumer. From the extraction of the raw materials to the sale of a final product, a division of labor occurs according to a combination of countries' comparative advantages and firms' competitive advantages. Networks of firms are organized either as multinational enterprises, exchanging intermediates on an intra-firm basis, or as independent firms linked by buyersupplier contracts, exchanging intermediates through arm's length international trade. As in other economic activities, multinational enterprises in extractive industries rely on some kind of competitive advantages when they expand internationally (Dunning, 1993, Dunning and Lundan 2008), but in the case of the extractive sector we can identify some peculiarities (UNCTAD, 2007) for drivers and determinants linked to companies' ownership advantages due to privileged access to Page 1 of 15 Version: 1.00 Status: Released © POLINARES Consortium 2012 POLINARES D3.1: Analysis of current & recent practices & strategies of key actors in oil, gas & minerals; identification & assessment of major future risks for tension and conflict Grant Agreement: 224516 Dissemination Level: PU capital, technology, superior organization and management governance of several parts of the value chain. Historically, since the independence of former colonies after the Second World War and the emergence of the Organization of the Petroleum Exporting Countries (OPEC), many governments in developing economies chose to nationalize their extractive industries and many state-owned enterprises have first gained control nationally in resource-abundant economies, then they have begun also to expand internationally, especially in the last decade (UNCTAD, 2007), challenging the involvement of private multinational enterprises that hitherto had been dominant. In this paper I exploit a unique dataset of 146,459 companies active in the extractive sector worldwide in the period 2001-2010, grouped by 3,686 domestic and/or multinational corporations, to first identify different investment strategies by type of property (state-owned or private) and then the determinants of capital productivity as a proxy for the profitability of the investment. The paper is organized as follows. In Section 2 I draw some stylized facts on global value chains in the extractive sector. In Section 3 I introduce a dataset for corporations in the extractive sector. In Section 4 I sketch the estimations strategies and discuss results, while in Section 5 I introduce Gazprom corporation and its value chain as a representative case study. Finally, Section 6 concludes. Global value chains and natural resources A firm that looks onto foreign markets is nowadays at the center of a Global Value Chain (Coe et al., 2008) and it has to decide whether to conduct an international activity in-house (internalization) or to entrust the same activity to another firm (externalization), which is a typical "make or buy" decision based on both features of the production process and on the economic environment of the foreign country. In the first case we would observe a Foreign Direct Investment (FDI) and trade of goods and services is conducted intra-firm, under the direct control of a Multinational Enterprise that emerges as a network of firms linked by proprietary linkages. In the second case, a network of independent firms emerges as linked by non-equity linkages and trade is conducted arm's length. Looking at global trade volumes, and including also natural resources, WTO (2008) estimated that trade in intermediates, i.e. trade whose end-user is generally a firm and not a final consumer, has increased two times faster than trade in final goods for the last three decades and Miroudot et al. (2009) estimate that in general intermediate inputs represent 56% of goods' and 73% of services' trade among developed economies, with even higher shares for emerging markets. In terms of global GDP, Multinational Enterprises have reached a historical high of 11% in 2009 (UNCTAD, 2010). In Table 1 I report the evolution of total Foreign Direct Investment stocks by host countries, first considering the overall category of developed and developing economies and then isolating among them the major producers of natural resources, distinguished in energy and raw materials. Unfortunately, detailed data on FDI in the extractive sector by host country and for such a long time series are not available and we have here to assume that the bulk of foreign activities hosted in major exporters of natural resources takes place in the extractive sector. Page 2 of 15 Version: 1.00 Status: Released © POLINARES Consortium 2012 POLINARES D3.1: Analysis of current & recent practices & strategies of key actors in oil, gas & minerals; identification & assessment of major future risks for tension and conflict Grant Agreement: 224516 Dissemination Level: PU Table 1: Foreign Direct Investment (stocks) by categories of host countries. Source: own elaboration from UNCTAD FDI database 1990-1999 2000-2005 2006-2010 (%) (%) (%) All countries Developed economies 74.88 75.76 69.48 Developing economies excl. China 22.37 20.15 24.79 2.75 4.09 5.73 100.00 100.00 100.00 Developed 0.54 0.55 0.77 Developing 1.83 2.60 4.55 Total 2.37 3.15 5.32 Developed 0.62 0.40 0.37 Developing 1.60 1.40 1.27 Total 2.22 1.80 1.64 China Total Major exporters of oil and gas Major exporters of raw materials As we can observe in Table 1, developing economies (including China) have reached a 30% of global FDI with an increasing trend from the beginning of 90s. In general, the weight of FDI in major exporters of natural resources represents only about 7% of the total, but we have a different trend for producers of oil and gas and for producers of raw materials. The share on the total has almost doubled with respect to the 1990s in the former case, while it is slightly less in the case of raw materials. The relative decline of the extractive sector in the twentieth century has been due to its slower growth compared with internationalization of activities in manufacturing and services. However, in absolute terms, FDI in energy and raw materials continued to grow increasing fourfold from 1990 to 2008, after a sudden stop at the outburst of the worldwide financial crisis, to resume again at the end of 2009. Indeed, FDI flows in 2010 are estimated at 254 billion dollars (UNCTAD, 2011) and with Netherlands, the United Kingdom and the United states still the largest home countries of investing companies, even though new players coming from newly-industrialized economies are gaining importance on the international scene. For example, in 2010, Repsol activities in Brazil were purchased by China's Sinopec Group for 7 billion dollars and the Carabobo block in Venezuela was purchased by an Indian group of investors for 4.8 billion dollars. Already in 2003 and 2004, the mining industry accounted for respectively 48% and 33% of China's FDI outflows, while oil and gas accounted for 19% of the overseas acquisitions by Indian multinational enterprises (UNCTAD, 2007). Corporations in the extractive sector: a sample In order to build a dataset of Multinational and Domestic Corporations (or Business Groups) operating in the extractive sector, including the complete network of their activities worldwide, I first had to define what a Corporation is and where the boundary of control on domestic and foreign subsidiaries stops. Indeed, if the intuitive notion of a Multinational Corporation, and hence its definition, is rather straightforward, the definition of the boundary of activities on which the MNC exercises control is Page 3 of 15 Version: 1.00 Status: Released © POLINARES Consortium 2012 POLINARES D3.1: Analysis of current & recent practices & strategies of key actors in oil, gas & minerals; identification & assessment of major future risks for tension and conflict Grant Agreement: 224516 Dissemination Level: PU more problematic. Following Dunning and Lundan (2008), a Multinational Corporation is "an enterprise that controls value-added activities in more than one country". More precisely, we can detail the definition as follows: a Multinational Corporation is a group of at least two firms in two different countries that are linked by a proprietary relationship . This clarification involves at least four different elements that are worth to be noted: a) firms belonging to a group are separate legal entities; b) they are located in different countries; b) there is a certain amount of stake that links each firm to the other ; c) the proprietary relationship is assumed to imply control, hence a coordinated economic activity. The legal separation leaves out, on one side, firms that simply relocate some functions in another country (marketing offices or commercial departments, for example), while on the other side an inter-firm (intra-group) linkage defined by stakes leaves out business alliances, i.e. independent firms that coordinate part of their activities through business agreements (for example airline alliances, see Hennart (1991)). In this context, a definitive notion of control is at least problematic because it depends on the interplay among stakeholders and it should ideally be assessed case by case. Here we will follow the approach of a 25.01% majority which is the threshold above which in many countries the communication of control is mandatory1 . A representative MNC can be depicted as in Figure 1 with its own hierarchical structure, where shaded nodes are firms belonging to the MNC once defining the control threshold and white nodes are firms external to the MNC that could however be linked through minority participations that do not exert influence on the management. At level 0 we have the headquarter of the MNC, whereas at different levels of distance from the headquarter we have affiliates located in the home economy or in host economies. Figure 1: The hierarchical structure of a MNC, source: Altomonte and Rungi (2011) The source of my data is Orbis by Bureau Van Dijk that reports financial accounts and ownership linkages for more than 80 million companies operating worldwide. What I eventually obtain, once adopting the definition of control and of MNC as above, is a dataset of 3886 headquarters of Multinational Corporations involved in the extractive sector with a total of 146,459 affiliates 1 Following this rule joint ventures, whose control is shared equally, are considered as affiliates of all the legal entities owning a stake above 25.01%. Page 4 of 15 Version: 1.00 Status: Released © POLINARES Consortium 2012 POLINARES D3.1: Analysis of current & recent practices & strategies of key actors in oil, gas & minerals; identification & assessment of major future risks for tension and conflict Grant Agreement: 224516 Dissemination Level: PU worldwide. Conventionally, we will take the country where the headquarter is located as the home economy of the Multinational Corporation and the countries where affiliates are located as host economies. Applying our routine to the original database by Bureau Van Dijk, we include only headquarters that operates in the extractive sector according to NACE rev. 2 nomenclature. In Table 2 I report the sample coverage of headquarters and affiliates by 2-digit industries of the extractive sector. A more detailed disaggregation is however possible once taking into account 4-digit industries and I will exploit once introducing estimation strategies. Table 2: Coverage of the sample: headquarters and affiliates, own elaboration on the basis of Orbis by Bureau Van Dijk NACE Denomination rev. 2 section 5 Mining of coal and lignite 6 Extraction of crude petroleum and gas 7 Mining of metal ores 8 Other mining and quarrying 9 Mining support service activities Total N. N. headquarters affiliates 269 15,030 878 16,015 698 11,807 1094 62,856 947 40,751 3886 146,459 For a comprehensive study of the investment strategies of Corporations operating in the extractive sector, we have also included information about affiliates operating in every other industry, whether extractive, manufacturing or service. That has allowed us to build a variable for the empirical analysis that catches the verticalization strategy (FDI in the same extractive sector) or the diversification strategy (FDI in industries different from the extractive) of the Corporation as a whole. At first sight, from our data, we can say that Corporations operating in the extractive sector have rather complex hierarchical structures, with a mean number of affiliates around 40, while Corporations operating in manufacturing industries, for example, have on average only 4 affiliates Moreover, the size distribution (by affiliates) of the extractive Corporations, as in other industries, is rather skewed since the median number of affiliates is usually much larger than the average, meaning that there are many Corporations with very complex structures and maximum number of affiliates above 1000, but also few small corporations with only one or two affiliates. The average complexity of the hierarchical structure seems however to be peculiar of the extractive sector, with no correspondence in the manufacturing and services industries, where very complex Corporations are the exception and not the rule. In Table 3 and Table 4 I report the geographic coverage of the extractive sample, first of headquarters and then of affiliates. Page 5 of 15 Version: 1.00 Status: Released © POLINARES Consortium 2012 POLINARES D3.1: Analysis of current & recent practices & strategies of key actors in oil, gas & minerals; identification & assessment of major future risks for tension and conflict Grant Agreement: 224516 Dissemination Level: PU Table 3: Geography of Corporations' headquarters Home economy N. headquarters OECD 2623 of which: EU 27 960 US 628 emerging economies 1263 of which: Russia 791 China 63 Africa 38 Middle East 34 Table 4: Geography of extractive affiliates Host economy OECD N. affiliates 83,399 of which: EU 27 27,174 US 38,872 emerging economies 88,057 of which: Russia 16,165 China 13,774 Africa 3,890 Middle East 761 South America 17,081 The majority of headquarters is located in advanced economies, while the affiliates are equally distributed among advanced and developing economies. Among emerging economies, Russia is both an important hosting country for affiliates and also the home economy for many headquarters. However, when looking at relative shares of revenues, Russian output accounts for 13.55% of the total and China for 11%, while affiliates located in the European Union catch almost the 39% of the total extractive market. In Figure 2 I plot trends of state ownership in energy and raw materials industries in the period 20012010. State-owned energy production is increasing through time and it reaches almost 30% of the total in 2006 and 2009. State-owned production in raw materials is less concentrated but however increasing, reaching a 17.23% share of the total market in 2006. Page 6 of 15 Version: 1.00 Status: Released © POLINARES Consortium 2012 POLINARES D3.1: Analysis of current & recent practices & strategies of key actors in oil, gas & minerals; identification & assessment of major future risks for tension and conflict Grant Agreement: 224516 Dissemination Level: PU Figure 2: State ownership and share of revenues in 2001-2010, own elaboration on Orbis by Bureau Van Dijk 35.00% 30.00% 25.00% 20.00% 15.00% 10.00% 5.00% 0.00% Energy Raw materials Energy trend Raw materials trend Empirical strategy and results In order to verify if and how investment strategies are differently correlated by type of property, I have performed a probit estimation where the dependent variable is a bynary variable called specific for each investment operation i and year t. Two possible outcomes are therefore possible for the investment strategy: the investment is made by an International Corporation ( ) or the 2 investment is made by a National Corporation ( ). Hence, a set Xit of independent variables is identified to influence the outcome so that: where the vector β measures the influence of the independent variables on the outcome of internationalization of the investment. The reference model is hence: As dependent variables I have included controls for what kind of vertical strategy they have been engaged in until the decision of the investment: is the number of already established coaffiliates in the same extractive sector at time t, is the number of already established 2 Extending the definition adopted by the US Energy Information Administration (EIA) only for oil companies, I define here a National Corporation (NC) operating in the extractive industry as a corporation fully or in the majority owned by a national government (above 25.01%, see paragraph 3). Page 7 of 15 Version: 1.00 Status: Released © POLINARES Consortium 2012 POLINARES D3.1: Analysis of current & recent practices & strategies of key actors in oil, gas & minerals; identification & assessment of major future risks for tension and conflict Grant Agreement: 224516 Dissemination Level: PU co-affiliates in downstream industries at time t. Further, I am able to control specifically for the size of the newly-founded (domestic of foreign) affiliate in terms of fixed assets ( ), for its capital productivity ( , calculated as the ratio of profit on total fixed assets), for the investment's capital intensity ( , calculated as the ratio of fixed assets on employment) and its financial constraint ( ). Time fixed effects are included in the estimation strategy ( ) for the entire period of analysis, from 2001 to 2010, in order to control for time-specific shocks that can determine the final outcome. Results are reported in Table 5, separately for investment in raw materials and energy. Table 5: Investment strategy along the value chain Raw materials Probit (I) Dependent variable: Investment by Corporations=1 Energy Probit (II) International Upstream -118*** -.116*** (.017) (.019) Downstream -120* .104* (.067) (.058) company size .127*** .071** (.035) (.032) .108* .274*** log of capital productivity (.058) (.044) .038 .143*** (.040) (.036) -.004** .009*** (.002) (.002) -2.815*** -3.193*** (.211) (.304) 8,363 2,180 Time fixed effects Yes Yes Pseudo R-squared .2186 .2519 -238.97 -301.35 133.72 202.95 capital intensity financial constraint Constant Observations Log likelihood LR chi-2 *,**,*** stand respectively for significance at 90%, 95% and 99%. Standard errors are robust to heteroskedasticity A first duality emerges for both raw materials and energy investment operations between International and National Corporations: the former are less likely to concentrate their efforts in the verticalization of their supply chain through investment in upstream activities if confronted with NC. We have a lower probability that IC invest in upstream activities, whether they operate in the raw materials industry or in the energy industry. This result is consistent with several studies (see for example World Bank, 2011) that showed how National Corporations in the oil sector are increasingly gaining upon Page 8 of 15 Version: 1.00 Status: Released © POLINARES Consortium 2012 POLINARES D3.1: Analysis of current & recent practices & strategies of key actors in oil, gas & minerals; identification & assessment of major future risks for tension and conflict Grant Agreement: 224516 Dissemination Level: PU traditional so-called Supermajors in the production and exploitation of national reserves. In this case we can confirm a similar trend for the whole extractive sector, including raw materials. On the other hand, a difference emerges between investment in raw materials and energy when considering the position in downstream activities: in the first case NC invest less than IC in sectors different from their core extractive activity, while international energy companies are more able to relocate in secondary activities such as refining, transport or distribution. The raw materials industry is becoming more dominated by state-owned National Corporation in all stages of the production process, while the energy industry is becoming polarized by NC more and more involved in downstream activities and IC are actively gaining ground in production and exploitation of their own reserves. We already know, however, that the majority of revenues in the industry is privately owned (Figure 2), notwithstanding a positive trend for state-owned companies. Also, the increase of investment operations by National Corporations is not fully reflected in a comparable increasing trend of stateowned revenues in the same period. Indeed, if we look at the results regarding investment size and at its profitability in Table 5, we observe that operations by International Corporations are on average bigger and more productive, i.e. they provide a higher share or revenues with respect to the ones by National Corporations. From this point of view, we can conclude that even if NCs are investing in a larger number of activities, ICs are concentrating on activities with a higher value added, where also a higher level of initial investment is required as showed by the coefficient of capital intensity. As for the financial solidity of the investment, affiliates to NCs extracting raw materials seem to be more solvent than affiliates to ICs in the same sector, while the opposite is true in the case of energy affiliates. A case study: Gazprom's value chain Production The corporation is vertically integrated with 1,479 affiliates3 (1,286 in Russia and 193 abroad) engaged in six business segments of gas and oil (geological exploration, production, transportation, storage, processing and marketing), electric power and heat energy production and distribution (13,1% of total revenues), and finance activities. Gazprom is a state-owned monopolistic incumbent on Russian gas market controlling 78% of national production and it is the only authorized supplier of natural gas on the domestic market. Local industrial barriers to entry are exceptionally high not only due to scale economies of extraction and research and development costs, but also because national regulatory environment is particularly restrictive for new potential domestic and foreign players. The company sells over 262.5 billion cubic meters of its natural gas (52.7% of total production) in Russia, 67.7 billion cubic meters of gas in other former Soviet Union countries (13.6% of production) and 167.6 billion cubic meters in other foreign countries (33.7% of production). 3 Data on affiliates are elaborated on the basis of the Ownership Database by Bureau Van Djik, as from paragraph 3, while the source for more detailed data about reserves, production and other stages of the value chain is Datamonitor Page 9 of 15 Version: 1.00 Status: Released © POLINARES Consortium 2012 POLINARES D3.1: Analysis of current & recent practices & strategies of key actors in oil, gas & minerals; identification & assessment of major future risks for tension and conflict Grant Agreement: 224516 Dissemination Level: PU Figure 3: Geography of gas sales (volumes, billion cubic meters), source: DataMonitor other foreign countries 34% Russian Federation 53% other FSU countries 13% Reserves In 2010 the corporation registered natural gas reserves of 33.1 trillion cubic meters (tcm) and 3.0 billion tons of oil and condensate, with respectively a yearly increase of 547.7 billion cubic meters (bcm) and 115.5 billion cubic meters after geologic exploration. Domestically, Gazprom accounts for 78% of natural gas production in 2010, with its 508.6 billion cubic meters. Over 90% of gas reserves are concentrated in only 14 largest fields4. Transportation and storage Considering all trunk pipelines, compressor stations and underground gas storage facilities (USGF), Gazprom owns the world's largest gas long-distance transportation system of natural gas to consumers both in Russia and abroad, which measured 161.7 thousand km only in terms of trunk pipelines in 2010. The network average distance covered was 2,592 kilometers to Russian consumers and 3,262 km for foreign consumers. The corporation has 215 compressor stations for gas transportation while the installed capacity of the company's 3,659 gas pumping units was 42,100 megawatts (MW). Storage capacity on aggregate has been of 65.4 billion cubic meters in 2010 thanks to 25 underground gas storage facilities (UGSF). Refining and manufacturing The corporation refining activities are owned by GazpromNeft, a branch with several subaffiliates that can also rely on processing agreements signed with various external contractors for the outsourcing of the refining process. At the end of 2010, aggregate hydrocarbon processing and refining capacity comprised 52.5 billion cubic meters of natural gas and 75.4 million tons of oil and gas condensate. Other activities: electricity and heat generation The corporation controls several affiliates involved in electricity and heat generation: Mosenergo (11,900 MW), OGK-2 (8,707 MW), OGK-6 (9,162 MW), Kaunasskaya teplofikatsionnaya elektrostantsiya in Lithuania (170 MW), OAO TGK-1 (6,266 MW). For its total generating capacity, Gazprom can be considered the third territorial generating company in Russia. 4 Urengoyskoye, Yamburgskoye, Zapolyarnoye, Medvezhye, Komsomolskoye, Yamsoveyskoye, Orenburgskoye, Astrakhanskoye, YuzhnoRusskoye, Bovanenkovskoye, Kharasaveyskoye, Shtokmanovskoye, Severo-Kamennomysskoye and Kamennomysskoye. Page 10 of 15 Version: 1.00 Status: Released © POLINARES Consortium 2012 POLINARES D3.1: Analysis of current & recent practices & strategies of key actors in oil, gas & minerals; identification & assessment of major future risks for tension and conflict Grant Agreement: 224516 Dissemination Level: PU Other activities: banking and finance In order to develop an internal capital market to sustain its investment strategies, the corporation owns 116 affiliates at home and 19 affiliates abroad (Netherlands, UK, USA, Switzerland, Lithuania, Belarus) registered as banking or finance activities for a total of over 512 million RUB in 2010. Profitability along the value chain To measure profitability by stage of the value chain we aggregate affiliates' EBIT (Earnings Before Interest and Taxes) by four main activities in the period 2001-2010: extraction (oil & gas, production and exploration); refining and manufacturing; transportation, sales and other services (including distribution); banking and finance. EBIT is converted in Russian rubles when the affiliates are located abroad5. In Figure 4 we report the relative importance (in % on total) of the main activities in terms of profitability in time series. From the beginning of the period, downstream activities were the most profitable, covering more than 73% of corporation’s EBIT. Notwithstanding a certain degree of volatility along the period, with the minimum in 2010 at 53.2%, services such as transportation, distribution and marketing represented always the main source of profits within the vertical corporate value chain. On average, however, the extractive activities accounted for about 30% of total profits throughout the period and it is always the second source of Gazprom's profits, while refining and manufacturing gave back a mere 6% on average. Group-level profits in banking and finance activities have been relatively low, deriving mainly from investment in the real estate industry in Russia and consisting essentially of credit supporting activities to energy core activities when located abroad. Figure 4: Profitability (EBIT) by stage of the value chain (2001-2010), own elaboration on Bureau Van Dijk's data 100% 1.0 1.8 0.8 0.3 0.9 1.5 1.3 60.4 68.9 68.0 61.2 58.8 59.5 2.2 2.8 4.6 11.1 25.8 29.5 35.1 2003 2004 2005 6.5 3.1 2.9 61.0 60.7 53.2 10.5 4.7 7.5 28.6 28.7 27.8 28.8 2006 2007 2008 2009 80% 60% 73.4 40% 20% 3.3 4.4 21.2 34.6 5.8 38.1 0% 2001 2002 extraction refining & manufacturing transportation, sales & other services banking and finance 2010 However, Gazprom seems to rely too much on exporting activities to cover losses registered on the national market. Indeed, while data are available on volumes as in Figure 3, the corporation doesn't provide disclosure of a more detailed geographical composition of revenues. We can however infer a 5 Exchange rate registered at balance sheet’s closing date for each foreign affiliate. Page 11 of 15 Version: 1.00 Status: Released © POLINARES Consortium 2012 POLINARES D3.1: Analysis of current & recent practices & strategies of key actors in oil, gas & minerals; identification & assessment of major future risks for tension and conflict Grant Agreement: 224516 Dissemination Level: PU duality of performance on national and international markets, first looking at the evolution of natural gas prices and then assessing the entity of single affiliates' losses by sector of activities from our data. Figure 5: Domestic and international price evolution of natural gas in Russia, own elaboration, source IEA (2011) 800 600 400 0 Sep-01 Feb-02 Jul-02 Dec-02 May-03 Oct-03 Mar-04 Aug-04 Jan-05 Jun-05 Nov-05 Apr-06 Sep-06 Feb-07 Jul-07 Dec-07 May-08 Oct-08 Mar-09 Aug-09 Jan-10 Jun-10 Nov-10 Apr-11 Sep-11 200 Russian natural gas price ( $ per 1000 cubic meters) on international markets domestic industrial consumer In Figure 5, we can observe an important gap between the evolution of natural gas prices on international markets, volatile but strictly increasing, and the ten-year trend of prices for industrial consumers. Even if the latter has more than doubled since September 2001, on international markets the figure in September 2001 has been fourfold. Several studies (for example Ahrend, 2004) had already underlined the high incidence of energy-related subsidies on the domestic market, a phenomenon already present in early 1990s from the beginning of transition to market, and the relevance it has in terms of fiscal and macroeconomic consequences. Essentially, Russia had the possibility for delaying industrial reforms, both in the extractive sector and in other resource-intensive industries, thanks to abundance of energy and raw materials and a state management of natural resources. Energy-dependent CSI countries were quickly forced to import at prices not different from those of world markets and the increasing trend of these latest, as we can see from Figure 5, allowed a further postponement of industrial restructuring, covering losses in home activities with revenues raised abroad. Indeed, especially in trasport and distribution activities, more than 185 Russian affiliates belonging to the corporation were at loss even at the end of 2010 for a total of over 12 million RUB. The most profitable activity is also the most problematic on home markets because the government regulates wholesale prices which Gazprom applies to the major portion of domestic sales, tariffs for trunk pipeline transportation services provided to independent producers, tariffs for transportation services via gas distribution networks, and charges for procurement and sale services, as well as retail prices for gas. In addition, despite the recent liberalization, the state is still regulating part of electricity tariffs, which account for a relatively high source of profits for Gazprom secondary activities. Page 12 of 15 Version: 1.00 Status: Released © POLINARES Consortium 2012 POLINARES D3.1: Analysis of current & recent practices & strategies of key actors in oil, gas & minerals; identification & assessment of major future risks for tension and conflict Grant Agreement: 224516 Dissemination Level: PU Figure 6: Activities at loss in home affiliates by stage of the value chain (th. RUB), own elaboration on Bureau Van Djik’s data transportation, sales and other services refining & manufacturing extractive finance -14000 -12000 -10000 -8000 -6000 -4000 -2000 0 The problem however seems to be in the reallocation of resources within the group, since besides activities at losses, highly liquid affiliates are present at the same time, with cash flows not reinvested in the industrial restructuring of less profitable segments. In Figure 7 we report the (weighted) average liquidity ratios6 of affiliates in both upstream and downstream core activities, observing that they have substantially increased throughout the period following the trend dictated by the commodity boom since 2003, with an exceptional increase in 2007 confirmed also in 2008 and 2009. Reduced demand expectations after the recent world financial crisis affecting energy consuming countries could have a role in explaining such a level of frozen liquidity: the company is probably adopting a "wait and see" investment strategy, looking forward to better future prospects. Figure 7: Liquidity ratio along the value chain, 2001-2010. Own elaboration, source: Bureau Van Dijk's database 3 2.5 2 1.5 1 0.5 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 extractive refining & manufacturing transportation, sales & other services Conclusions The last decade has seen a new surge of both trade and foreign direct investment in natural resources. A phenomenon that is linked both to the emergence of newly industrialized countries that demand energy and raw materials as intermediate inputs and a boost to the creation of global value chains 6 Liquidity ratio is calculated as: (Current Assets - Nominal Value of Stocks)/ Current Liabilities. The ratio is affiliate-specific and weighted by its share of group's revenues before aggregation by step of the value chain. Page 13 of 15 Version: 1.00 Status: Released © POLINARES Consortium 2012 POLINARES D3.1: Analysis of current & recent practices & strategies of key actors in oil, gas & minerals; identification & assessment of major future risks for tension and conflict Grant Agreement: 224516 Dissemination Level: PU across national borders, with networks of firms increasingly engaged in several stages of production according to location comparative advantages and firm-specific competitive advantages. The availability of microdata on ownership type and location of worldwide affiliates has allowed us to explore the different investment strategies along the value chains by corporations of the extractive industry (raw materials, energy and coal) and their patterns of investment performance. What we found was that International Corporations, both in energy and raw materials industries, are more able to relocate in downstream activities such as refining, manufacturing, transport and distribution, while on the other hand National Corporations are more able to position themselves in upstream activities. However, downstream activities still represent the stages of the production process where most of the value added is raised. Indeed, while the role of state-owned National Corporations increased relatively in the last decade in terms of revenues share on the industry total, investment operations by International Corporations are on average bigger and more profitable, i.e. they still provide a higher share of revenues with respect to the ones by National Corporations. These results are robust also after controlling for the commodities boom of the period 2003-2008. As an interesting case of National Corporation operating in the energy industry, Gazprom shows a duality of performance of investment at home and abroad, in downstream and upstream activities, already observed from aggregate data in the empirical strategy. Notwithstanding its vertical integration from extraction to distribution and its acquisitions abroad in the latest years, the corporation's profitability is still located in downstream activities, whether at home or abroad, where most of the rents are raised. At the same time, some domestic affiliates involved in the transportation, storage and sales of natural gas still operate at loss reflecting the dual pricing of the gas market, where domestic industrial consumers enjoy a lower price if confronted with foreign consumers and the extra-profits gained abroad are used by the corporation to cover non-profitable branches on the domestic market. References Ahrend, R. (2004), “Russian Industrial Restructuring: Trends in Productivity, Competitiveness and Comparative Advantage”, OECD Economics Department Working Papers, No. 408, OECD Publishing. Altomonte C. and Rungi A. (2011). "Organizational Complexity of Multinational Groups and Productivity in the European Union", mimeo Baldwin R. E. and Martin P. (1999). "Two Waves of Globalisation: Fundamental Differences", NBER Working Paper N.6904, January Superficial Similarities, Cameron A. C. and Trivedi P. K. (2005). "Microeconometrics: Methods and applications". 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