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Business Watch: February 25, 2003

25 February 2003, Volume 3, Number 7
Prime Minister Mikhail Kasyanov met with the heads of the ministries of Finance, Economic Development and Trade, Energy, Railways, and Taxation on 18 February to discuss production-sharing agreements (PSAs), reported the same day. (A PSA provides a company with substantial tax breaks in order to attract investment; it is a staple of oil-and-gas-industry involvement in many developing-world locations.) The ministers decided that PSAs should be retained "only as an extraordinary measure to be used when necessary," "Vedomosti" reported on 19 February. The government's cautiously negative stance on PSA's comes as the State Duma gears up for a March vote on pro-PSA changes to the Tax Code. Russian oil majors are split on PSAs. Yukos head Mikhail Khodorkovskii has derided PSAs as harmful and unnecessary, and Yukos placed anti-PSA advertisements in all leading Russian newspapers on the eve of the ministerial meeting, "Vedomosti" reported on 18 February. Industry analyst Dmitrii Tsaregorodtsev told "Gazeta" on 20 February that Yukos and Sibneft oppose PSAs because their production plans are humming along without them. Tyumen Oil Company (TNK) Director German Khan, however, feels that PSAs will be needed to stimulate investment when existing oil fields begin to dry up, "Vedomosti" reported on 18 February. Foreign oil companies have traditionally supported stronger PSA legislation in Russia. DK

Oil major Yukos maintained its status as the darling of industry analysts, announcing solid results for the third quarter of 2002 on 13 February. The results, calculated to U.S. Generally Accepted Accounting Principles (GAAP), showcased revenues of $3.378 billion; a 30.1 percent year-on-year increase; net profit of $850 million; a 6.6 percent year-on-year increase; and earnings before interest, tax, depreciation, and amortization (EBITDA) of $1.375 billion, a 19 percent year-on-year increase. Troika Dialog analyst Kakha Kiknavelidze noted that net-income figures showed a noncash deferred tax charge that "exists only on paper" but must be shown on the GAAP report, Reuters reported on 14 February, meaning that adjusted net income was actually $1.156 billion. United Financial Group analyst Pavel Kushnir pointed out that Yukos's EBITDA per barrel came to $10.60, a 33 percent increase over the second quarter, "Vremya novostei" reported on 14 February. The same indicator for LUKoil fell 8 percent in the third quarter of 2002 to $7. Analysts polled by "Kommersant" on 14 February described the financial results as "better than other companies." DK

LUKoil international arm LUKoil Overseas signed a contract on 14 February with Norway's Norsk Hydro to acquire a 25 percent stake in a $137.3 million exploration project in Iran, "Izvestiya" reported on 15 February. The deal is subject to approval from the National Iranian Oil Company, which is expected to be forthcoming. According to LUKoil, the unexplored Anaran block near the Iran-Iraq border might contain reserves of up to 2.6 billion barrels, industry newsletter "Nefte Compass" reported on 18 February. A Norsk Hydro representative told "Vedomosti" on 17 February that project participants will get priority consideration to develop the field once exploration is completed in early 2005. Industry analyst Vladislav Metnev told the newspaper that LUKoil would be better off concentrating on domestic projects, however. Troika Dialog analyst Valerii Nesterov injected a note of caution, telling "Vremya novostei" on 17 February that the Iranians "usually give development rights to their own companies, which is why major players rarely work in the region." DK

Semen Vainshtok, president of state-owned transport monopoly Transneft, told attendees at the Institute of Petroleum's IP Week 2003 conference in London on 18 February that the state intends to keep its monopoly on Russia's pipeline system, "Kommersant" reported on 19 February. Vaynshtok's comments come amid increasing discussion of projects to up Russia's export capacity to take advantage of rising production. Possible projects include an expansion of the Baltic Pipeline System, the construction of a pipeline from Siberian Angarsk to either China or the Pacific coast, and a pipeline from western Siberia to the port in Murmansk. Representatives of LUKoil, Yukos, TNK, Surgutneftegaz, Transneft, and Tatneft gathered at the Energy Ministry on 14 February to discuss pipeline capacity with Prime Minister Kasyanov, "Finansovye izvestiya" reported on 17 February. Yukos head Mikhail Khodorkovskii, whose company would like to construct a privately financed pipeline to China, fretted that delays in boosting export capacity are costing the economy $10 million daily. Unimpressed, the prime minister calmly explained to the assembled oilmen that "the rate of oil production increases should be determined by the state." DK

The Federal Securities Commission (FKTsB) suspended brokerage Alor Invest's license for three weeks on 19 February, RosBusinessConsulting (RBK) reported the same day. FKTsB alleges that Alor Invest's attempts to spark interest in futures trading at the Moscow Interbank Currency Exchange (MICEX) amounted to price manipulation, "Kommersant" reported on 20 February. Another allegation holds that Alor Invest failed to provide regulators with sufficient information about potential money-laundering transactions. An industry source told on 19 February that the MICEX futures section suffers from "ludicrously" low volume of $2 million a day, and that Alor Invest and the exchange had an "agreement" that the former would try to draw business by pumping up trading volume with bogus transactions. According to the source, Alor Invest traded with itself, and "not without compensation" (presumably from the exchange). For its part, Alor Invest has refrained from commenting on the situation. Aleksandr Kandel, general director of brokerage Aton, told "Vedomosti" on 20 February that the license suspension is "a serious blow not only to the company itself, but to the entire market." According to "Kommersant," Alor Invest was the second-largest broker on the Russian exchange in the third quarter of 2002. DK

Russia's national currency continued to gain ground against the U.S. dollar last week, "Kommersant" reported on 21 February. With demand for dollars low, the Central Bank was forced to step in on 20 February and buy $500 million worth of hard currency at a price of 31.55 rubles to the dollar. The last time the ruble rode so high was in August 2001. With a glut of oil dollars on the market and the Central Bank wary of sparking inflation by pumping up the money supply, the ruble has nowhere to go but up, "Izvestiya" reported on 21 February. The strong ruble has even spurred talk of making it a fully convertible currency, "The Moscow Times" reported on 20 February. Yurii Ptitsyn, head of the Moscow Industrial Bank's Currency Department, told "Konservator" on 21 February that the Central Bank is unlikely to let the dollar fall to below 31 rubles, however, as an overly strong ruble would make Russian goods less competitive on world markets and hamper economic growth. DK

Representatives of Norilsk Nickel's second-largest union ended a 15-day hunger strike on 22 February without achieving their goals, RIA-Novosti reported the same day. Union leaders at Norilsk Nickel's arctic division began their hunger strike on 6 February after failing to reach an agreement with management on pay raises, vacations, and disclosure of management salaries. At its height, 54 people took part in the hunger strike; only 20 remained when the action came to an end, reported on 23 February. All-Russian Labor Conference President Aleksandr Bugaev had appealed to the protesters to end their action, Interfax reported on 20 February. Bugaev wrote, "Unfortunately, the majority of workers...are not prepared to resist what amounts to the confiscation of their labor by those who own the means of production. But today your lives are at stake." Management and labor are to discuss outstanding differences at a 12 March employee conference, although workers at Norilsk's largest production unit have already voted against a general strike, Reuters reported on 16 February. Union leaders had hoped to be the sole labor representatives at the upcoming conference. Management convinced workers to bypass the union and elect their own representatives, which prompted union leaders to begin their hunger strike on 6 February. Undeterred by the strike's failure, the unions have announced that they plan to picket Norilsk Nickel's Moscow offices on 25 February, "Kommersant" reported on 22 February. DK

Tycoons groused about cumbersome, corrupt bureaucracy at a 19 February meeting between President Vladimir Putin and a delegation of the Russian Union of Industrialists and Entrepreneurs (RSPP). Steel magnate Aleksei Mordashov illustrated the slow progress of administrative reform with the sad tale of a friend who needed to gather 137 signatures to open a store, "Vedomosti" reported on 20 February. The president agreed that 137 signatures is too many and suggested reducing the number to 20. Oil tycoon Mikhail Khodorkovskii complained to the president about the difficulty and high cost of litigation. On the general subject of corruption, Khodorkovskii noted that there was "more to" the recent purchase of oil company Severnaya Neft by state-owned Rosneft than met the eye, "Kommersant" reported on 20 February. He calmly explained that Rosneft needed to increase its reserves and asked -- rhetorically -- how Yukos had managed to acquire its own "super reserves." A 21 February editorial in "Vedomosti" noted that while the president's Kremlin chats with the RSPP have yet to bear fruit, the mere fact that they are broaching the subject of corruption is a positive sign. DK

Switzerland's Nestle Waters purchased Russia's expatriate-founded Clearwater to give itself a commanding share of the home-and-office-delivery (HOD) market for bottled water, Interfax reported on 19 February. Founded by American Scott Nicol in 1993 with $70,000, Clearwater has expanded to annual revenues of 15 million euros ($16 million) and control over more than half of Russia's HOD market, "Vedomosti" reported on 20 February. Although the parties were mum on the size of the deal, press estimates ranged from $25 million-$40 million. Nestle began its acquisitions on the Russian water market in July, paying $49 million for bottled water and HOD company Saint Springs. The HOD market, symbolized by the five-gallon coolers that grace many workplaces, is seen as one of the world's fastest-growing and most profitable market segments, "Finanosovye izvestiya" reported on 20 February, with Nestle forecasting that growth on the Russian HOD market could comprise 30 percent annually. Clearwater is poised to thrive in an expanding market -- a new bottling and distribution center in the Moscow area has the capacity to serve the needs of 120,000 thirsty clients, "The Moscow Times" reported on 20 February. DK

The State Statistics Committee announced on 18 February that total foreign investment in the Russian economy in 2002 came to $19.78 billion, a 38.7 percent increase over 2001, Interfax reported the same day. Foreign direct investment (FDI) totaled $4 billion, a 0.6 percent year-on-year increase. Leading foreign investors in Russia were Germany ($4 billion), Cyprus ($2.33 billion), Switzerland ($1.35 billion), Luxembourg ($1.26 billion), France ($1.84 billion), the Netherlands ($1.17 billion), and the United States ($1.13 billion). Although technically foreign, much of the money arriving from Cyprus, Switzerland, and Luxembourg is likely Russian cash stashed abroad for safekeeping now on its way home. Despite the meager 0.6 year-on-year increase in FDI, results for the third and fourth quarters of 2002 reversed a six-quarter decline, growing by $1.37 billion over the corresponding period in 2001. Still, Russia has a long way to go, "Vedomosti" wrote on 19 February -- China, for example, attracted $52.7 billion in FDI in 2002. DK

Belarusian President Alyaksandr Lukashenka signed a decree on 14 February that opens the door to the privatization of several petrochemical and oil-refining facilities, RBK reported the same day. Among the enterprises to be privatized are the Naftan oil refinery, with a starting price of $476 million for a 43.27 percent stake, and chemical factories Polymer ($311 million for a 43.19 percent stake), Grodno-Azot ($293 million for a 43.08 percent stake), and Khimvolokno ($71 million for a 43.66 percent stake), "Vremya novostei" reported on 17 February. Troubled relations with the West under the belligerent Lukashenka have stymied foreign investment in Belarus, which has largely resisted market reforms. The government will announce privatization dates later in the year, Reuters reported on 17 February. The most likely contenders for the facilities are cash-rich oil companies from neighboring Russia. DK

What better way to celebrate the 10th anniversary of a state-owned natural gas behemoth than with a Sunday evening pop concert on the nation's most widely viewed (and state-controlled) television station? The following couplets -- which, if "Izvestiya" of 21 February is to be believed, rang out across the land on 16 February between 7:10 p.m. and 9:50 p.m. -- should assuage any doubts:

In Russia, nothing ever was, or is,

More surefire than Gazprom.

Heat and light we give to all,

At the office or at home.

So let's drink to them, and drink to us,

And raise a glass for all of Russia's gas.

The anniversary was about more than pop concerts, of course. A blizzard of news timed to coincide with, if not always showcase, the joyous event kept boilerplate encomiums to a minimum.

As the musical festivities drew to a close, Gazprom made public its financial results for the first three quarters of 2002 calculated to international accounting standards. Third-quarter revenues totaled $4 billion, a slight decline over last year's figures. Net profits for the period came to $220 million, a significant year-on-year retreat from $809 million. Third-quarter operating expenses topped expectations at a whopping $3.3 billion.

The results evoked mixed reactions. Gazprom itself blamed lower prices for gas in Europe for the reduced profits. "Vremya novostei" described the results as "depressing" on 17 February and noted that most analysts had predicted a somewhat better performance. Still, "Vedomosti" reported on 20 February that Brunswick UBS Warburg upped its rating on Gazprom American Depository Receipts (ADRs) from "hold1" to "buy2," praising the gas giant for largely meeting expectations and taking steps to restructure its debt.

With the anniversary concert and financial results behind him, Gazprom CEO Aleksei Miller turned to the bread-and-butter business of hiring and firing when he returned to work on Monday, 17 February. Miller sacked Nikolai Gornovskii, head of Gazprom subsidiary Mezhregiongaz, temporarily appointing Anatolii Khripunov in his place, Interfax reported. The same housecleaning saw security chief Sergei Lukash and procurement division head Vladimir Leviyev receive their walking papers.

The dismissal of Gornovskii likely means the end for Mezhregiongaz and its role as Gazprom's domestic-sales arm. Miller had signed an order in December that transferred sales functions to Gazprom's own marketing division, touching off a spate of corporate infighting that now appears to have turned decisively against Mezhregiongaz.

The shakeups can also be read as a victory for CEO Miller over Economic Development and Trade Minister and Gazprom board member German Gref. Gref opposed the order to gut Mezhregiongaz and favors reforms that would split Gazprom into chunks. Gazprom's reintegration of domestic-sales functions into its own marketing department is a step in the opposite direction.

A word from on high preceded and sanctified the proceedings. Speaking at a 14 February meeting to celebrate Gazprom's anniversary, President Vladimir Putin said the state "will not support any plans to dismember or split up Gazprom," "Kommersant" reported the next day. As a company of strategic importance, the president continued, "Gazprom should have been preserved, and has been preserved, as a single organism." As is frequently the case, we can hardly know whether the president's comments on the "single organism" represent a top-down decision or reflect the outcome of an internal struggle at a lower level. What they, and the actions that followed them, do signify is a victory for the monopoly's status quo management and a defeat for Gref's Economic Development Ministry.

The extended celebration ended with a first. On 21 February, Gazprom shattered all emerging-market records with a $1.75 billion bond issue, a company press release reported the same day. The 10-year bonds will come due just in time for the next anniversary. DK

The sound-bite version of Economic Development Minister Gref's new plan for the economy is "accelerated diversification." Amid mounting fears that the Russian economy is starting to resemble a certain desert kingdom's in its dependence on oil, Gref's latest "whither the economy" program is an attempt to change the structure both of exports and the economy itself.

When the cabinet discussed and tentatively approved the 127-page plan at its 20 February meeting, economic growth was the dominant theme. "Kommersant" reported on 21 February that the following dialogue ensued after Gref's ruminations on reforms and mechanisms:

Prime minister: "So what growth rates will the country get in three years? Will we get eight percent?"

Gref [rustling through papers]: "I have it written down in three places. I can't find it."

Prime minister [with irony]: "The numbers are probably all different. Which ones do you believe?"

Gref: "Five and a half percent."

Prime minister [disappointed]: "We can use precisely targeted means to raise the GDP from 4 to 5.5 percent without your program."

Deputy Prime Minister Aleksei Kudrin [interrupting]: "Gref's program will definitely ensure 7 percent-8 percent annual growth in GDP!"

Prime minister [relieved]: "Well, at least we can be sure of that."

The program aims to prevent an oil-dependent economy from dragging growth rates into a direct correlation with world demand for fossil fuels, dooming GNP to anemic annual growth of 2 percent-3 percent. According to data from the Ministry of Economic Development, the energy sector accounts for 30 percent of all Russian industrial production, 54 percent of federal budget revenues, more than half of all exports, and 45 percent of the hard currency that comes into the economy,

RosBusinessConsulting reported on 18 February. "Nezavisimaya gazeta" reported on 19 February that a recent report by the Center for Macroeconomic Analysis and Short-Term Forecasting concluded, "The quality of economic growth deteriorated markedly in 2002. The economy's dependence on world commodities markets increased."

Gref's program proposes the following mechanisms for effecting change: tax reform, liberalized labor laws, World Trade Organization membership, a fully convertible ruble, small-business development, increased lending, and a reduced role for the state in the economy. Will it work? Experts weighed in with opinions ranging from "sounds good" to "not bloody likely." Morgan Stanley analyst Marcin Wisznewski carefully delineated the middle of the road, telling "The Moscow Times" of 20 February that "this is not a document that we expect to be implemented 100 percent."

For now, the Gref plan indicates a shift in focus from strict fiscal discipline to economic growth. Russia has gone a long way toward erasing memories of its 1998 default with several years of prompt payments on the national debt. The money that has made such exemplary behavior possible comes from oil and gas exports. Whether another, more dependable, source of revenue can be coaxed out of the economy's overlooked and underused nooks and crannies -- that is a question worth far more than $64,000. DK

The rapturous reception of British Petroleum's (BP) $6.75 billion swan dive into the Russian oil sector had scarcely begun to fade from the front pages of business sections before the cliches did an about-face. Clouds gathered, skeletons trundled out of closets, and a sullen gloom settled over the bright horizons of Vladimir Putin's newly investor-friendly Russia.

The spoilers were a diverse bunch -- bureaucrats from the Natural Resources Ministry, litigious minority shareholders, and a Canadian company still hopping mad about a little gunplay back in 2001.

The trouble began when "Vedomosti" reported on 17 February that the Natural Resources Ministry is gearing up to revoke Rusia Petroleum's licenses to develop the crucial Kovykta gas field and the Verkhne-Chonskoye oil field. (Rusia Petroleum is part of the new holding company that BP and Tyumen Oil Company (TNK) announced they are forming.) The "Financial Times" reported the same day that two obscure companies -- Indian Ocean Petroleum Services and Astian Group -- are threatening to sue BP unless they get $85 million to compensate for alleged dirty deeds done at Sidanco, another component of the deal. These latest headaches come on the heels of a 14 February report in "The Moscow Times" that Cyprus-registered, Canadian-based Norex is suing TNK over a 2001 takeover of production facility Yugraneft by armed guards.

There might be less to these issues than meets the eye, however. As reported on 20 February ("British Oil Investment Meets Odd Response,", the licensing tiff is likely a behind-the-scenes effort by cash-strapped Gazprom to muscle its way into a piece of the Kovykta action on the cheap. "Kommersant" reported on 18 February that the request for $85 million comes from offshore firms with a dubious history of "greenmail" attempts; moreover, Aton analyst Steven Dashevskii told "Vedomosti" the same day that the transfer-pricing practices to which the firms object "absolutely legal, if hardly pleasant for investors." Norex, which has seen its campaign against TNK dissolve in the murk of the Russian legal system, apparently hopes that it will be able to shift the onus to BP. The BP-TNK deal is a union of international financial muscle and local-lobbying know-how designed specifically to handle difficulties like the ones described here. While the licensing and litigation annoyances have probably emerged a tad earlier than expected, they should prove a good test run for the partnership's division of labor. DK