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Business Watch: February 4, 2003


4 February 2003, Volume 3, Number 4
ENERGY
OIL MAJORS IRKED BY SEVERNAYA NEFT
Five of Russia's oil Goliaths took up arms against Severnaya Neft in a collective letter to the Supreme Arbitration Court, even as the industry awaited word on details of the oil company's sale, "Vedomosti" reported on 29 January. The heads of LUKoil, Sibneft, Surgutneftegaz, Tyumen Oil Company, and Yukos dispute Severnaya Neft's right to develop the 65 million-ton Gamburtsev Val oil field. The company won that right in a dubious March 2001 tender that saw the state receive only $7 million even as other companies were willing to pony up more than $100 million to develop the field. LUKoil has its own bone to pick with Severnaya Neft over an additional share issue that diluted LUKoil's stake in the company to insignificance. Andrei Vavilov, former finance minister and current Federation Council member and Severnaya Neft owner, recently announced that he sold his company and would reveal the buyer on 1 February. RosBusinessConsulting (RBK) reported on 3 February, however, that while Severnaya Neft representatives confirmed the sale, the new owner has not yet been announced. Speculation has centered on state-owned Rosneft. The oil barons' letter would seem to indicate that whoever steps forward as the new owner of Severnaya Neft will have to deal with some substantial difficulties. DK

LUKOIL ANNOUNCES DISAPPOINTING RESULTS
LUKoil announced its results for the first three quarters of 2002 calculated to U.S. Generally Accepted Accounting Principles on 31 January, Interfax reported the same day. The oil company's net profit fell 29 percent year-on-year to $1.349 billion. Revenues rose 5.8 percent to $11.108 billion. Pretax profit dropped 25.3 percent to $1.887 billion. Third-quarter profit came to $507 million against $473 million in 2001. "The company disappointed investors who had high expectations for LUKoil to succeed in cutting costs," Aton brokerage analyst Timerbulat Karimov told "The Moscow Times" of 3 February. Gennadii Krasovskii, LUKoil's head of investor relations, told "Vedomosti" on 3 February that higher taxes on production adversely affected results. Analyst Steven Dashevskii had a different explanation, telling the newspaper, "In the third quarter of last year, the company's operating expenses rose by 30 percent as compared to the second quarter, and administrative and commercial expenses went up 18 percent. This had a direct affect on net profit.... [E]xpenses rose by 16 percent and revenue went up by only 5.8 percent." DK

'TAX THE RICH,' IMF URGES
A visiting group of International Monetary Fund (IMF) experts reviewed the results of Russian tax-reform efforts and recommended increasing taxes for oil companies, "Vedomosti" reported on 30 January. Aleksandr Ivaneev, head of the Finance Ministry's Tax Policy Department, came out in favor of the idea, commenting, "The rise in world prices for oil isn't the oil companies' achievement." The base tax on petroleum production is 340 rubles ($10.68) adjusted by a coefficient that takes into account the monthly average price for Urals brand crude and the dollar exchange rate. Industry reaction to the idea of higher taxes was predictably negative. "These aren't super profits, they're investment resources," a LUKoil representative huffed to "Vedomosti." Khalil Shekhmametev, head of the analytical department at finance company International Trade, came down on the industry's side, telling "Profil" No. 250 (3 February) that an increased tax burden will make it difficult for oil companies to invest in future production when prices finally go down -- with lean times upon them, they will be forced to cough up taxes for the fat profits of the past. Strana.ru quoted Finance Minister Aleksei Kudrin on 2 February as saying that existing taxes are effective. Still, the minister added, "We will go further." DK

FINANCE
SECURITIES COMMISSION THREATENS STOCK EXCHANGE OVER VIOLATIONS
The Federal Securities Commission (FKTsB) has threatened to withdraw the RTS Stock Exchange's license for a failure to distinguish between directed and nondirected orders in calculating volume, "Kommersant" reported on 30 January. (A "directed" order applies to a specific exchange participant, whereas a "nondirected" order is open to all exchange participants.) A 1 July 2002 resolution stipulates that directed orders are to be distinguished from nondirected orders in calculating stock-exchange volume. The RTS failed to do so in its report for the fourth quarter of 2002. The FKTsB's actions struck some brokers as extreme. In the "classic market" structure adopted by the RTS, distinguishing directed from nondirected orders can be "quite difficult," "Vedomosti" reported on 30 January. While brokers suggested regulators were making a mountain out of a molehill, the FKTsB gave every indication of being deadly serious. FKTsB member Pavel Ivanov told "Vremya novostei" on 30 January, "If the exchange president can't convince us that everything's on the up and up, the FKTsB will examine the option of revoking their license." For their part, RTS representatives promised to make every effort to work with regulators and fix the problem by the FKTsB's 5 February deadline. DK

LISTED MUTUAL FUND DEBUTS ON RTS
Russia's first listed mutual fund began trading on the RTS Stock Exchange on 31 January, the RTS announced the same day on its website (http://www.rtsnet.ru/). Since it is a listed mutual fund, shares in it may be bought and sold like any other shares on the exchange. Region Asset Management's Dividend Stocks and Corporate Bonds mutual fund targets conservative investors with a portfolio of corporate bonds and blue-chip stocks, "The Moscow Times" reported on 29 January. The fund will reach more investors and gain liquidity by listing on the RTS. Additionally, investors may buy and sell shares in the interval fund whenever they please, not just once a quarter. "Finansovaya rossiya" wrote on 30 January that the appearance of a listed mutual fund will open up a broader range of investment opportunities to investors outside Moscow and St. Petersburg. Not everyone predicted a boom in listed mutual funds, however. Troika Dialog Portfolio Manager Oleg Larichev told "Kommersant" on 29 January that a far larger market will be required to draw investors' attention: "For now, there are only a handful of these funds. We shouldn't expect a very active market in the near future." According to "The Moscow Times," Russia has 66 mutual funds with $375 million in assets; the assets of listed mutual funds in the United States topped $100 billion in 2002. DK

BETTER LATE THAN NEVER FOR PHARMACY IPO
Pharmacy chain 36.6 had good news and bad news on 30 January, announcing that its delayed initial public offering (IPO) finally took place but garnered substantially less than what the company had hoped for. The company allocated 1.6 million shares (20 percent) at $9 per share, RBK reported on 31 January, raising only $14.4 million instead of the $17 million-$25 million it had wanted. The drugstore chain -- which includes more than 50 outlets in the Moscow region and three production facilities -- canceled its 23 January IPO the night before the big event amid rumors of slack demand and complaints of poor preparation (see "RFE/RL Business Watch," 28 January 2003). RBK termed the eventual offering "in essence, a private placement" to a small group of private investors who will subsequently trade the shares on the Moscow Interbank Currency Exchange. Ironically, one of the factors that put investors on guard -- the chain's announcement that proceeds from the offering will go to pay off debts -- likely made the offering inevitable. Troika Dialog analyst Andrei Ivanov told "Kommersant" on 31 January that "the offering was the company's only chance to get funds, since they've exhausted all other options of attracting financing." "Konservator" reported on 31 January that the company's debt stood at $35.5 million in December, with $10.5 million in payments due in the first quarter of 2003. Summing up the outcome, Renaissance Capital analyst Natalya Zagvozdina told "Vedomosti" on 30 January, "I feel that $9 per share is close to a fair price; given the situation, they made the best decision [in going ahead with the offering]." DK

COMPANIES
SISTEMA RAISES ANTE IN LUXEMBOURG BANK
Moscow-based AFK Sistema acquired an additional 5 percent of East-West United Bank from Vneshtorgbank, bringing its stake in the Luxembourg bank to 30 percent, Prime-TASS reported on 30 January. The deal reduces Vneshtorgbank's stake in the bank to 53 percent; other shareholders include the Russian Central Bank (15 percent) and Paris-based Eurobank (2 percent). Vneshtorgbank Deputy CEO Vladimir Dmitriev told Prime-TASS that talks are continuing with Sistema to increase the latter's stake in East-West United Bank. Sistema First Vice President Aleksei Buyanov told "Vedomosti" on 31 January that the "desire to have an infrastructure in the West is completely logical" in light of the company's real-estate and hotel projects abroad. Standard & Poor's analyst Ekaterina Trofimova told the newspaper that a Luxembourg bank could ease access to Western money markets, noting that Russian companies borrowed $7.5 billion in the West in 2002: "It's quite possible that this bank could help AFK Sistema to obtain funds abroad." Sistema acquired its initial, 25 percent stake in East-West United Bank in August. AFK Sistema is one of Russia's largest investment groups; it is the partial owner of cellular operator Mobile TeleSystems (MTS). DK

DIAMOND MONOPOLIST DENIES LEBANON DEAL
State-run diamond monopolist Alrosa angrily denied reports of a $500 million deal with a Lebanese firm in a 29 January press release on the company's site (http://www.alrosa.ru). The offending report surfaced in "Kommersant" on 29 January, when the newspaper reported that Alrosa had sealed a five-year agreement with Lebanon's Horizon Development to sell up to $500 million worth of uncut and cut diamonds in the Middle East annually. "Kommersant" quoted Alrosa First Vice President German Kuznetsov as saying the deal was on and office space ready and waiting in Beirut. Alrosa's press release stated that the company "has concluded no such agreements" and "is considering the possibility of taking measures to defend its professional reputation." Despite the denial, "Kommersant" stuck by its story, reiterating its original report on 3 February with additional details. In the 3 February publication, the newspaper cited a 29 January internal Alrosa memo that complained of a "confidentiality violation" and requested an internal investigation, seemingly lending credence to rumors of a deal. Rumblings of new arrangements come with a five-year, $4 billion Alrosa-De Beers contract in limbo because of objections from the European Commission. DK

LEAPS AND BOUNDS FOR RUSSIAN AD MARKET
The Russian advertising market notched a 51 increase to $2.6 billion in 2002, RBK reported on 30 January. Russian Association of Advertising Agencies (RARA) President Vladimir Yevstavev proudly announced the figures at a 30 January news conference, noting that the figures exceed 1998 pre-crisis levels of $1.7 billion-$1.8 billion. Television, Internet, and movie theaters were growth leaders, with television advertising jumping 76 percent year-on-year to $900 million in 2002, Internet ads 83 percent to $11 million, and cinema advertising 60 percent to $8 million, "The Moscow Times" reported on 31 January. According to RARA, Russian advertisers accounted for 61 percent, or $1.6 billion, of market volume. Individual agency spending went from $4.2 million in 2001 to $6.1 million in 2002, indicating that Russian ad agencies are consolidating, "Vedomosti" reported on 31 January. Yevstavev estimated that advertising could expand to a $4 billion market in 2003. Market watchers base such predictions on the low amount of per capita advertising spending in Russia, where each person rates less than $20 worth of advertising. By way of comparison, each American is the recipient (or victim, as some would have it) of $1,000 worth of advertising every year. DK

COMMUNICATIONS
VIMPELCOM FORGES ON WITH REGIONAL EXPANSION
Cellular operator Vimpelcom announced in a 31 January press release that it acquired a 90 percent stake in regional operator StavTeleSot for $38.4 million. Vimpelcom purchased a 49 percent stake from strategic partner Telenor Mobile and a 41 percent stake from Stavtelecom. Telenor is a Norwegian telecommunications group that owns a 29 percent stake in Vimpelcom. The seventh-largest operator in Russia, Stavtelesot has more than 193,000 subscribers -- a 63 percent share of the Stavropol market -- "Kommersant" reported on 1 February. ACM Consulting analyst Anton Pogrebinskii told the newspaper that Stavtelesot, Vimpelcom's largest regional expansion purchase to date, is a sound acquisition. "If you take into account Stavtelesot's debts, it turns out that Vimpelcom paid $275 for each subscriber," Pogrebinskii said, noting that recent acquisitions in Kaliningrad and Orenburg have been more costly. Also on 31 January, Vimpelcom announced the opening of a regional office in Makhachkala, Republic of Daghestan, the 40th Russian region in which the company will offer customers its Bee Line GSM brand of cellular-communications services.

CONSOLIDATING GOLDEN TELECOM ENDS OLD BRANDS
Golden Telecom will discontinue its Sovintel and TeleRoss brands and replace them with the Golden Telecom brand in the second quarter of 2003, ABNews.ru reported on 29 January. The move completes the integration of the companies after their acquisition from Rostelecom was finalized in September. Sovintel acts as a cellular operator to corporate clients, while TeleRoss offers data and long-distance services. Konstantin Chernyshev, head of the analytical department at NIKoil, told "Vedomosti" on 30 January that "Golden Telecom has been pursuing this strategy [of consolidation] for about a year and it's reflecting positively on the company." Golden Telecom Chief Operating Officer Stan Abbeloos also noted that the company currently has sufficient resources to continue its development strategy without resorting to borrowing or stock issues, "Vremya novostei" reported on 30 January. Even so, Director of Treasury and Investor Relations Nikolai Tokarev said the company would like to increase the liquidity of its shares. The 16 percent now traded publicly makes for volume of only $50 million. According to "Vremya novostei," the company's main shareholders are Alfa-Group (43.6 percent), Rostelecom (15 percent), Baring Vostok (7.6 percent), Capital International (8.8 percent), and Global TeleSystems Group (2.6 percent), with the aforementioned 16 percent in freefloat. DK

INVESTMENT
SAKHALIN-2 SET TO MOVE TO PHASE TWO
Shell CEO Steve McVeigh announced at a 30 January press conference that the $8.5 billion Sakhalin-2 project is ready to move on to its second phase, "Izvestiya" reported on 31 January. McVeigh revealed that project operator Sakhalin Energy is in the final stage of negotiations with Japanese buyers looking to purchase the liquefied natural gas the project will produce at a plant to be built on the island. The only production-sharing agreement in Russia yielding oil at present, Sakhalin-2 is set to pump nearly 10 million barrels in 2003, "The Moscow Times" reported on 31 January. For the project to advance to the next phrase, the lower house of parliament will have to review the parts of the Russian Tax Code that deal with production-sharing agreements. With lawmakers increasingly vocal about the drawbacks of such arrangements, "Izvestiya" predicted that the path of new legislation will "not be easy." McVeigh also used the press conference to allay environmental worries about Sakhalin-2, informing the press that Sakhalin Energy will spend $5 million to finance a research program on the endangered Pacific gray whales that frequent the waters in which the project drills, RusEnergy reported on 30 January. Sakhalin-2 fields contain 1 billion barrels of oil and 550 billion cubic meters of natural gas, "The Moscow Times" reported on 31 January. DK

AROUND THE CIS
TENGIZCHEVROIL DISPUTE ENDS
The Chevron-led Tengizchevroil joint venture resolved its financial differences with the Kazakhstan government and ended a two-month suspension on 27 January, the "Financial Post" reported on 28 January. Under the agreement, Tengizchevroil will pay an extra $810 million in taxes through 2005, and venture partners will help state-owned Kazmunaigaz to finance its 20 percent share of expansion costs. The agreement opens the door to a $3 billion expansion at the Tengiz oil field that will ramp production up to 480,000 barrels per day (bpd) from the current 260,000 bpd, "Petroleum Intelligence Weekly" reported on 29 January. U.S. officials welcomed the resumption of activity at Tengiz. State Department spokesman Richard Boucher congratulated the Kazakhstan government and Tengizchevroil partner companies on their accomplishment and opined that the project "will play a major role in developing the Caspian Basin and helping to diversify the world's oil supply," AFP reported on 29 January. Despite the warm feelings about getting back to business, the disagreement and two-month suspension left some feeling jittery over the possibility that Kazakhstan might be itching to tweak old contracts for new concessions. "Petroleum Intelligence Weekly" quoted a Western oil executive as saying, "We're all nervous about what happens next." U.S. Chevron Texaco has a 50 percent stake in Tengizchevroil; other partners include ExxonMobil (25 percent), Kazmunaigaz (20 percent), and Russia's LukArco (5 percent).

IN FOCUS
PIPELINES, PROFIT, AND POWER
Russia's ramped-up oil production has made for an international of strange bedfellows, bringing together environmentally concerned Finns, economically outraged Latvians, reverse-pipelining Ukrainians, disgruntled homegrown oligarchs, and even a hapless Greek tanker.

The 274-meter-long Greek-flagged "Stemnitsa" riled the Finns when it steamed into the Gulf of Finland on its way to the Russian port of Primorsk, where it is scheduled to pick up 100,000 tons of oil before setting sail for Rotterdam, AFP reported on 3 February. Brutal ice has plagued the region this year, with 50 centimeters to an entire meter of the stuff clogging up the Gulf of Finland, and Finnish officials fret that the hull of the "Stemnitsa" is insufficiently reinforced to cope with the harsh conditions. Memories of the "Prestige" disaster off the Spanish coast are still fresh enough to trigger fears along the Baltic, and Finnish President Tarja Halonen sternly informed national news agency FNB on 3 February, "This is not the right time and place for gambling."

Russian officials assured their Finnish colleagues that an icebreaker would shepherd the thin-hulled "Stemnitsa" through the perilous floes, RIA-Novosti reported on 3 February. Transportation Ministry representative Nikolai Monko even noted, "If necessary, the tanker can leave the port in the accompaniment of two icebreakers."

The ostensible reasons for braving the deadly ice and frosty Finns are a domestic oil glut, high prices, and stampeding international demand. One might also assume a lack of alternate export routes. Opinions differ on the last count, however. The Russian government gravely insists that nothing more can be done. Latvians, and even some of Russia's biggest oil tycoons, disagree.

Latvia's ice-free port and oil-export terminal at Ventspils can ship 16 million tons of oil a year, "The Wall Street Journal" reported on 31 January, and has plenty of experience with Russian oil. But while Russia's Primorsk battles the elements, Ventspils is cooling its heels. Transneft, Russia's state-owned pipeline monopoly, slowly choked off shipments to Ventspils throughout 2002, finally cutting off all deliveries in 2003. Transneft claims that export through Primorsk is cheaper and more efficient. Five of Russia's biggest oil producers objected vocally in mid-January, petitioning Prime Minister Kasyanov to resume exports through Ventspils. Their pleas went unheeded. Deputy Prime Minister Viktor Khristenko said on 29 January that the earliest the government will take up the issue is March, RIA-Novosti reported the same day.

The juicy bit is that the Latvian government is looking to sell its 38.6 percent stake in Ventspils Nafta, the enterprise at the heart of the dispute. A 47 percent stake belongs to Latvijas Naftas Tranzots. "Kommersant" connected the obvious dots on 30 January, writing that "pipeline shipments will likely resume when Russian oilmen or Transneft become co-owners of terminal owner Ventspils Nafta." With Ventspils Nafta starved for revenue, Latvian officials complained to EU External Affairs Commissioner Chris Patten, claiming that what they perceive as Russian strong-arm tactics are hardly in keeping with Moscow's oft-stated desire to join the World Trade Organization.

With all the excitement up north, one could easily overlook a pipeline going into reverse in Ukraine. On 28 January, the Pivdennyy oil terminal on the Black Sea handled its first shipment of commercial oil, "Zerkalo nedeli" No. 4 (1-7 February) reported. On its way to the port, the 90,000 barrels of Tyumen Oil Company black gold traversed a 52-kilometer section of the 674-kilometer Odesa-Brody pipeline in reverse (the section was originally intended for imports). Oleksandr Todiychuk, CEO of state-owned Ukrainian transport company Ukrtransneft, told "Vedomosti" on 28 January that contracts have been signed to move 4 million tons of oil through Pivdennyy (called Yuzhnii in Russian) in 2003. According to a 29 January "RusEnergy" article, Pivdennyy's capacity could be ratcheted up to 45 million tons in one year, as long as someone is willing to commit at least $100 million to the project.

Events in Primorsk, Ventspils, and Pivdennyy are only a small part of the very large jigsaw puzzle that is relations between government and business, and the state and its neighbors. With prices high and production booming, the privately owned oil sector is intent on boosting exports and maximizing profits. The state, which jealously guards its monopoly on pipeline transit within Russia, is traditionally tempted to use the economics of energy to increase its influence, especially over its neighbors in the "near abroad."

Pivdennyy shows that profits can reverse a pipeline. Ventspils shows that politics, albeit of the mercenary sort, can just as easily shut it down. By the time Primorsk unfreezes, we might learn what combination of these two powerful forces is required to get the oil flowing again. DK

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