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Business Watch: April 8, 2003

8 April 2003, Volume 3, Number 13
LUKoil President Vagit Alekperov and Gazprom CEO Aleksei Miller signed an agreement on 31 March under which LUKoil will sell Gazprom gas from fields in the Yamal-Nenets Autonomous Okrug, the two companies announced in a press release the same day. Under the "take-or-pay" agreement, Gazprom will be obligated to purchase LUKoil's gas, while the latter will be obligated to pay compensation if it fails to come up with the gas, "Vedomosti" reported on 1 April. Shipments will begin in the fourth quarter of 2005 and will require a $400 million investment, including a new $140 million pipeline, to get started, "Vremya MN" reported on 1 April. A Gazprom representative told the newspaper that the two companies are set to seal a 10-year contract within the next two months; Gazprom will receive 8 billion cubic meters of gas in 2006, when the field enters full production. Though the companies declined to reveal the sale price of the gas, press estimates set it no lower than $22.50 per 1,000 cubic meters. The agreement could initiate a trend in which oil companies simply sell the gas they obtain as a byproduct of oil production directly to Gazprom rather than waiting for gas reform and an opportunity to compete with the monopolist. Troika Dialog analyst Valerii Nesterov told "Vedomosti" that "this is a step toward liberalizing the gas market, even if the form is somewhat ugly." DK

The Federal Securities Commission (FKTsB) announced in a 2 April official statement that on 14 April a new resolution goes into effect with stringent measures to prevent price manipulation on securities markets. The resolution allows the FKTsB to investigate market participants for up to eight months while requesting a wide array of supporting documentation from them. The FKTsB resolution's definition of manipulation -- "actions performed to create the illusion of rising or falling prices or trading activity...with the aim of encouraging investors to buy or obtain securities" -- struck some as imprecise. A broker who asked to remain anonymous told "Vedomosti" on 2 April, "According to the latest documents from the FKTsB, any player on the market can be branded a manipulator." "Gazeta" reported on 3 April that some observers worry that overly broad grounds for initiating investigations could open the door to frivolous accusations from unscrupulous competitors. Valerii Petrov, head of the analysis department at Rosbank, told the newspaper, "There should be serious punishments for slander, much harsher than the potential punishment for manipulation." The FKTsB has stepped up its efforts to combat price manipulation of late, conducting a highly publicized investigation of the Russian Trading System exchange and suspending the license of brokerage Alor Invest, both in February. DK

AFK Sistema successfully completed a $350 million offering of five-year bonds with an annual interest rate of 10.375 percent on 4 April, Interfax reported the same day. The offering had initially been scheduled for 28 March. "Vedomosti" reported on 31 March that the bond was postponed because Sistema's lawyers felt the structure of the offering could draw sanctions from the U.S. Securities and Exchange Commission. Sistema planned to use the money from the bond to buy a 10 percent stake in cellular operator Mobile TeleSystems (MTS) from Deutsche Telekom, while backing the bond offering with the same 10 percent stake in MTS. The practice is prohibited by U.S. regulations. To avoid regulatory difficulties, the bonds were offered only to European investors. The yield was slightly higher than the 10 percent-10.25 percent Sistema had hoped for, leading Renaissance Capital analyst Pavel Mamai to tell "Vedomosti" on 4 April, "Investors had no alternative but to punish [Sistema]" for the postponement. The offering is the first from a Russian holding company since the 1998 economic crisis. DK

Metals giant Norilsk Nickel announced in 1 April press release a development strategy through 2015 that the company's board of directors approved at an 18 March meeting. The strategy envisages approximately $5 billion in total investments for the period and aims to increase the internal rate of return on production investments to "well over 20 percent" while making investments pay for themselves in a space of four to five years. The company also hopes to increase the amount of nickel it produces annually from the current level of 223,000 metric tons to 240,000 tons. "Kommersant" noted on 2 April that the projected 20 percent rate of return on production investment has thus far been achievable only in the oil industry. "Gazeta" reported the same day that analysts and investors were "disappointed" by the strategy's "limited scope." Troika Dialog analyst Vasilii Nikolaev told "Vedomosti," however, that the company is "making the right decision in pursuing an opportunistic strategy on production and sales, following market dynamics, and planning for the mid-term to produce more nickel, which is going up in price, and less platinum-group metal." A part of Vladimir Potanin's Interros empire, Norilsk Nickel is Russia's largest producer of nickel, copper, and platinoids. DK

Russia's largest carmaker eliminated regional pricing differences on 31 March, raising prices an average of 3.25 percent across the board, Interfax reported on 1 April. Overall shipping charges are now included in the single price that dealers pay nationwide, raising prices in areas close to the AvtoVAZ factory in central Russia and lowering them in more remote regions. Previously, the prices dealers paid depended on distance from the factory. Shipping costs had made AvtoVAZ cars uncompetitive in the Far East, where buyers opted for cheaper used Japanese and Korean vehicles. Troika Dialog analyst Andrei Kormilitsyn told "Vremya novostei" on 31 March that the unified price policy may not be ideal for a country like Russia: "It's not clear that it makes sense to sell a dealer in Samara a car that includes in its price shipping to Vladivostok." "Vedomosti" reported on 31 March that the move will primarily affect unauthorized shipments, which account for up to 30 percent of sales in St. Petersburg, for example. DK

U.S. District Court Judge John G. Koeltl on 28 March threw out a $3 billion lawsuit that pitted erstwhile Russian magnate Mikhail Zhivilo against thriving metals tycoon Oleg Deripaska, "The Moscow Times" reported on 2 April. The suit, filed on behalf of Base Metal Trading and Alucoal Ltd., alleged corruption and racketeering in bankruptcy proceedings that led to the acquisition of the Novokuznetsk Aluminum Factory (NKAZ) by Oleg Deripaska's Russian Aluminum in 2000. Judge Koeltl threw out the suit on the grounds that it did not belong in the U.S. court system. Zhivilo, formerly the director of NKAZ and a large shareholder in the enterprise, claimed in his suit that the Russian judicial system is too corrupt to produce a fair ruling. Zhivilo has tried other jurisdictions as well, unsuccessfully filing charges in Switzerland and Sweden, "Gazeta" reported on 31 March. Bruce Marks, who represented Zhivilo in the proceedings, told "Vedomosti" on 31 March that his client plans to appeal within 30 days. Zhivilo currently resides in the United States. Russian authorities had sought his extradition earlier from France to face charges related to an unsuccessful plot to kill Kemerovo Governor Aman Tuleev, "Gazeta" reported. The U.S. court decision drew wide coverage in the Russian press. "Moskovskii komsomolets" called the ruling "an unprecedented breakthrough in the image of Russian business" in a 2 April article, while a 1 April editorial in "Vedomosti" lamented that the public will not have a chance to examine the information on corruption in Russian business and political circles that a U.S. trial might have brought to light. DK

Mobile TeleSystems (MTS) announced on 3 April that it paid $61 million for a controlling stake in Tatarstan's largest cellular operator, RIA-Novosti reported the same day. MTS paid $51 million for 51 percent of the common shares in Taif-Telcom, and $10 million for 50 percent of the operator's preferred shares. MTS also received the option the buy the remainder of Taif-Telcom within two years for a minimum of $59 million, "The Moscow Times" reported on 3 April. MTS paid an average of $437 for each of Taif-Telcom's 314,000 subscribers, "Kommersant" reported on 3 April; MTS itself used a slightly different methodology to arrive at $580 per subscriber for 240,000 active subscribers, "Vedomosti" reported on 3 April. Aton analyst Nadezhda Golubeva told the newspaper that it was worth the price for MTS to gain access to one of Russia's most promising markets. Cellular penetration in the region now stands at 13 percent, leaving substantial room for growth. DK

Cellular operator Vimpelcom announced in a 3 April press release that subsidiary Vimpelcom Finance will undertake a three-year, 3 billion-ruble ($95.9 million) bond offering. The offering is slated for the second quarter of 2003, although an exact date has not yet been set. reported on 3 April that the company will spend $50 million to extend its network in St. Petersburg and the remaining $45.9 million to pursue regional expansion plans in the Urals and other areas. Seen as one of Russia's most promising companies, Vimpelcom's excellent credit history should ease its access to capital. Vladimir Bogdanov, an analyst at investment company NIKoil, told "Vedomosti" on 4 April, "There are few issuers on the market with such a good credit history.... I think that the yield will be 11 percent." DK

U.S.-based Metromedia International Group announced in a 31 March press release posted on that it has reached an agreement with Adamant Advisory Services to exchange some of its Russian interests for $58.6 million of its own bonds that Adamant holds. Adamant will also pay Metromedia $5 million in cash and release Metromedia from the obligation of paying $3 million in interest on its bonds. The assets involved include Metromedia's ownership interests in Moscow fixed-line telephone operator Comstar and Moscow cable-television operator Kosmos TV. "Vedomosti" reported on 2 April that AFK Sistema, a holding company with strong ties to the Moscow city government, controls Adamant, which is registered in the British Virgin Islands. Metromedia holds 50 percent stakes in Comstar and Kosmos. Metromedia CEO Mark Hauf commented in the press release that the transaction "relieves a significant amount of financial pressure that the Company faces." Vyacheslav Nikolaev, vice president of the research department at the Trust and Investment Bank, described the deal to "Vedomosti" as "mutually beneficial" and valued a 50 percent stake in Comstar at $45 million-$55 million. AFK Sistema already owns a 50 percent stake in Comstar, "The Moscow Times" reported on 2 April. DK

Russian gas monopolist Gazprom is poised to begin purchasing all of Turkmenistan's exportable natural gas, though questions remain about prices and existing contracts with other companies, "Vremya novostei" reported on 3 April. According to a 1 April Gazprom press release, CEO Miller reached an agreement the same day with Turkmenistan President Saparmurat Niyazov on a "long-term contract to buy Turkmen gas." According to the press release, the signing will take place "in the near future" in the context of an agreement on gas-sector cooperation between Turkmenistan and Russia. That agreement is likely to be inked during Niyazov's upcoming visit to Moscow in mid-April. According to "Vremya novostei," Turkmenistan currently produces 60 billion cubic meters of gas annually: 11 billion for its own use, 36 billion for sale to Ukraine's Naftohaz Ukraine through Eural TG, 10 billion for sale to Itera, and 3 billion-4 billion for sale to Iran. Current contracts expire in 2004, opening the door for Gazprom to acquire 45 billion-50 billion cubic meters of gas annually from Turkmenistan. Previous attempts by Gazprom to squeeze out competitors and purchase all of Turkmenistan's gas foundered on price disagreements, "Kommersant" reported on 2 April. "Vremya novostei" and "Gazeta" reported that this time Turkmenistan insisted on $42-$44 per 1,000 cubic meters, a price that industry analysts deemed high. A long-term agreement to purchase Turkmen gas would allow debt-strapped Gazprom to maintain current export levels without investing substantial sums to develop new fields. DK

The Belarusian Economics Ministry announced on 3 April that it will privatize 43 percent stakes in the Naftan, Polimir, Azot, and Khimvolokno petrochemical enterprises, "Kommersant" reported the next day. Minimum bids and investment requirements for the four companies are: $476 million for Naftan plus $246 million in investment; $311 million for Polimir plus $61 million in investment; $293 million for Azot plus $79 million in investment; and $71 million for Khimvolokno plus $42.5 million in investment. "Kommersant" noted that additional conditions, which extend beyond investment programs to encompass social policy at the enterprises, "sharply reduce the attractiveness of the assets to be privatized." While such Russian companies as LUKoil, Surgutneftegaz, Itera, and Sibur have expressed interest, one industry representative told "Vedomosti" on 2 April, "We'd like to get guarantees from [Belarusian President] Alyaksandr Lukashenka that we won't lose our investments. Belarus has never stood out for its positive investment climate." DK

Russia's awkwardly named "housing and communal-services sector" -- the heat, light, water, and other such amenities that are the preconditions for civilization -- has shown a long-term resistance to reform matched only by its recent propensity for spectacular decay. The winter of 2002-03 was one of bursting pipes and cold radiators. Television reports of entire neighborhoods without heat or running water dominated the evening news. As teeth chattered in the dark in the chilly Far East, Moscow's chattering classes indulged their penchant for pessimism and mulled the grim prospect of Soviet infrastructure in a downward spiral toward complete collapse.

At a 27 March cabinet session to sum up the results of the difficult winter, Prime Minister Mikhail Kasyanov concluded that "the sum of all society's ills is bound up with the housing and communal-services sector," "Gazeta" reported the next day. Amid all the darkness, however, Russia's most famous reformer suddenly announced the glimmering of a new dawn.

The reformer in question is Anatolii Chubais, currently the head of state-owned mega-utility Unified Energy Systems (EES). A national monopoly, EES is often referred to as "big energy"; the housing and communal-services sector that deals with ordinary citizens is "little energy." The master of "big energy" emerged from the same cabinet meeting that so dismayed the prime minister with a smile on his face, telling journalists, "For the first time, not one objection was addressed to EES." He went on to enumerate his accomplishments since assuming control of EES: fiscal discipline in the form of full payment for services rendered; prompt payment of taxes, uninterrupted service through the winter.

Yet all the achievements of well-run big energy disappear into the black hole of still-Soviet little energy. Thirty percent of the electricity big energy delivers to little energy simply vanishes, as does a quarter of the heat, "Kommersant" reported on 31 March. Worse yet, little energy owes big energy more than $1 billion for services rendered. As Chubais put it, "The problems of little energy have us in a choke hold. We're sick of listening to nonsense about reforms. We intend to act," according to "Kommersant" on 28 March.

Chubais went on to explain that he sees in the housing and communal-services sector the same problems he confronted at EES in 1998: "A mere 20 percent of payments made in cash, a total collapse of management and the sales system, five-month wage arrears, strikes. The damage borders on catastrophe. We have the experience and the managers to solve these problems."

The Chubais plan to save little energy became clearer after a 28 March meeting of the EES board of directors, when the board approved a plan to create a new company called Russian Communal Systems (RKS). "Vedomosti" described the new company's structure in a 31 March article based on materials from the board meeting. EES and Gazprombank will each own 25 percent of RKS. Interros, Renova, Kuzbassrazrezugol, Evrazholding, and Evrofinance Bank will each own 10 percent. The enterprise will kick off with start-up capital of 1 billion rubles ($32 million).

RKS will start work in 11 pilot regions in the summer of 2003. Over a five-year period, the company will invest $700 million, $500 million of it borrowed, in the housing and communal-services sector. RKS will initially acquire assets under a trust or rental arrangement for subsequent purchase, or it could exchange some of the $1 billion it is owed for assets.

Once it has its foot in the door, RKS will begin to "put affairs in order" -- changing management and clarifying contracts, payments, and sales. In Chubais's words, the primary task is "not to conduct reforms, but to establish order and move from the Soviet Mesozoic to normal business," "Kommersant" reported on 28 March.

Ownership of assets in the housing and communal-services sector has always been a touchy subject. Sergei Sivaev, executive director of the Institute for Urban Economics, raised the question in a 28 March comment to "Gazeta." "In and of itself, it's a good idea," he said. "The sector lacks effective management, and all of Chubais's theses are entirely justified. But the question of ownership gives rise to certain fears. On the one hand, they say that EES intends to work as a business operator without acquiring communal sites as its own property. On the other hand, they claim that they can only work effectively if they own them."

If RKS becomes the owner of large chunks of the infrastructure, Russian financial-industrial groups -- a nice cross section of which is represented in the proposed shareholder structure of RKS -- will carve out a beachhead in a hitherto cordoned-off sector of the economy. A 28 March headline in "Vremya novostei" described the newfound interest of the rich and powerful in infrastructure as "Oligarchs Head for the Sewers." "Vedomosti" editors seconded their colleagues the same day, albeit with less flair: "Oligarchs to Invest $500 million in Residential and Communal-Services Sector."

Critics have pointed out that RKS could simply serve to strengthen monopolistic tendencies in the housing and communal-services sector. Yabloko leader Grigorii Yavlinskii and Communist Party head Gennadii Zyuganov both noted at a 28 March meeting of parliamentary fractions that by creating a single company to manage housing and communal services in several cities, EES will monopolize "little energy as well as big energy," "Kommersant" reported on 31 March.

Oleg Sysuev, first deputy chairman of the board of directors of Alfa-Group and former first deputy presidential administration head, raised doubts about the potential risks, saying the little energy business only appears to be a "tasty morsel," "Vedomosti" reported on 31 March. In fact, he went on to explain, "investors will encounter many risks -- political risks, financial risks, risks to their reputation." A more prosaic question is whether any single structure, no matter how efficiently run, can impose a successful business model on a sector that includes such disparate elements as electrical distribution grids, heating mains, water- and gas-supply grids, sewers, and even waste recycling.

At least one official from a potential pilot region has expressed reservations about the plan. Sergei Nazarov, minister of energy and natural resources in the Rostov Oblast, told Regnum on 6 April that he has yet to hear any concrete proposals from RKS: "All of the intentions that are set out in the agreement are of a declarative nature: 'We want to take this, and take that, and we have money, and everything will be OK.'" Talks with RKS on the possibility of setting up a pilot project in the Rostov Oblast are set for 15 April.

At present, no one can say whether RKS is a flash in the pan of reform or the shape of things to come. There is more to the proposal, however, than the cozy relations between financial-industrial groups and the state that are the hallmark of post-Soviet capitalism. Reform of the housing and communal-services sector has stalled, and the infrastructure crisis so apparent in the winter months will only worsen. RKS would break the logjam by nibbling away at the very structure that no one dares to reform, ostensibly to "put in order" the little bits it bites off. Once the process is far enough along, the question of reform recedes as less and less of the original structure remains.

Whether or not RKS succeeds in uniting oligarchs and technocrats in an effective mechanism for the reapportionment and subsequent restructuring of Russia's ground-level infrastructure, the idea represents a bold attempt to institutionalize ties that have generally preferred the shadows to the limelight. With two significant phases in the history of post-Soviet capitalism -- the initial division of spoils and the recovery from the 1998 economic crisis -- already behind us, an institutionalized partnership between oligarchs and technocrats seems only natural in a new phase that marks the transition from fierce competition for control of assets to increased cooperation to ensure the efficient exploitation of assets. DK