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Business Watch: May 20, 2003


20 May 2003, Volume 3, Number 18
ENERGY
YUKOS, SIBNEFT FINALIZE MERGER TERMS
Oil majors Yukos and Sibneft announced in a joint 14 May press release that the companies' main shareholders have signed a final agreement on the terms of their merger. Yukos will pay $3 billion for a 20 percent-minus-one-share stake in Sibneft. Sibneft shareholders will also exchange up to 72 percent of the company's shares for a 26.01 stake in YukosSibneft, "taking into consideration all additional [stock] issues." "Vedomosti" reported on 12 May that Yukos will hold an extraordinary shareholders' meeting on 27 May to approve the additional issue of 1 billion shares, as well as $3 billion in loans to pay for the 20 percent Sibneft stake. For its part, Sibneft recently received $825 million when Tyumen Oil Company bought out Sibneft's 38 percent stake in oil company Onaco; $700 million of those proceeds will go to pay down debt in anticipation of the merger, "Vedomosti" reported on 14 May. Sibneft shareholders also approved a record $1.09 billion dividend payment at a 15 May annual meeting, the company announced in a press release the same day. Finally, Sibneft President Yevgenii Shvidler told minority shareholders, who hold some 8 percent of the company's stock, that they will be able to trade in their shares for a stake in the new company on the same terms as Sibneft's main shareholders, but only if the current ratio of the companies' assets remains unchanged, "Kommersant" reported on 16 May. Some observers took the statement to mean that minority shareholders could be left out in the cold with less advantageous conversion terms than the companies' main shareholders. DK

TRANSNEFT TO FINANCE BALTIC PIPELINE WITH BOND ISSUE
Transneft's board of directors gave the go-ahead at a 14 May meeting for the state-owned oil pipeline monopolist to issue a three-year, 12 billion ruble ($388 million) corporate bond to finance the expansion of the Baltic Pipeline System (BTS), ABN reported the next day. The issue will set a record for ruble-denominated corporate bonds, surpassing a 5 billion-ruble bond issue by Gazprom. Transneft plans to expand the BTS, which links oil fields in Siberia with the Baltic port of Primorsk, from its current capacity of 240,000 barrels per day (bpd) to 840,000 bpd by 2004, "Nefte Compass" reported on 14 May. At the same session, Transneft's board nixed a planned $350 million syndicated credit from a group of Western banks, "Vedomosti" reported on 15 May. The decision reflects a new policy to limit foreign borrowing by state-owned companies. Deputy Finance Minister Sergei Kolotukhin warned in early May that the government is concerned about the extent of corporate borrowing. According to "Vedomosti," Russia's sovereign debt decreased in 2002 from $113.2 billion to $104.7 billion, even as the country's overall debt rose from $150.8 billion to $153.5 billion. Borrowing by privately owned Russian banks and companies accounted for the difference. Central Bank Deputy Chairman Oleg Vyugin told Interfax that one of the few mechanisms the state has to limit borrowing abroad is to block new loans by state-owned companies. DK

FINANCE
DELAY IN GAZPROM SHARE TRADING ON MMVB
The Moscow Interbank Currency Exchange (MMVB) heeded a request from the Russian Central Bank to postpone plans to begin trading Gazprom shares, Finmarket reported on 15 May. The MMVB had planned to start transactions with Gazprom shares on 15 May, acting as a clearing center for the Yekaterinburg Stock Exchange (EFB) and the Moscow Stock Exchange (MFB). (A 1997 government resolution limited the right to trade shares in the gas monopolist to only four exchanges: the EFB, MFB, Siberian Stock Exchange, and St. Petersburg Stock Exchange.) The Central Bank asked in a 12 May letter for a postponement to determine whether the clearing-house arrangement poses additional risks to the exchange's currency and state-securities sections. Eduard Zernin, vice president of investment company Region, told "Kommersant" on 14 May that while the risks appeared minimal, it makes sense to put off trading to examine any possible dangers to the exchange. Market observers queried by "Vedomosti" on 14 May saw no risks in the new project for other sections of the exchange. MMVB spokesman Vadim Yegorov told reporters that, with necessary all documents presented to the Central Bank, he hopes that trading can begin as soon as possible, RIA-Novosti reported on 15 May. DK

FITCH BOOSTS RUSSIA'S RATING
International ratings agency Fitch bumped up Russia's sovereign credit rating two notches on 13 May to a record level one step short of investment grade, Interfax reported the same day. In moving directly from a BB- to a BB+ rating -- on a par with such countries as Egypt, the Philippines, El Salvador, and Kazakhstan -- Fitch jumped ahead of counterparts Standard & Poor's and Moody's, both of which have pegged Russia at two levels below investment grade. A coveted investment-grade rating could open the door to an influx of money from conservative institutional investors. Some observers noted that the market is already more bullish than the ratings agencies on Russia. Sergei Sidorov, head of the fixed-income securities section at Aton brokerage, told "Kommersant" on 14 May, "There's too much fuss over this upgrade. Financial markets have already shown that they can lead the way." Kirill Tremasov, head of the analytical department at the Bank of Moscow, told "Vedomosti" on 14 May that Moody's and S&P, which carry more weight with investors, are now likely to raise their own ratings to one below investment grade "within three months." A subsequent upgrade to investment level could take some time, however. Aleksandr Baranov, vice president of the Russian Funds investment group, told "Gazeta" of 14 May, "Russia's main problem isn't its current financial situation, which now looks stable, but the structural weakness of the economy." DK

REGULATION
RESOLUTION SETS AUTO-INSURANCE RATES
Prime Minister Mikhail Kasyanov signed a resolution on 12 May setting rates for mandatory auto-liability insurance, Interfax reported the same day. Basic annual premiums will be 1,980 rubles ($64) for individuals and 2,375 rubles ($77) for companies, with adjustments for the specifics of the region, driver, and car through a system of seven coefficients. Insurance will provide maximum coverage of up to 400,000 rubles ($12,900). All Russian drivers will have to get insurance by 1 January 2004 or face fines. Insurance companies themselves now need to get licenses as quickly as possible so that they can offer the new policies, tapping into what is seen as a $2 billion market, "Vedomosti" reported on 13 May. Konstantin Pylov, head of the Insurance Supervision Department, told "Kommersant" on 13 May, "We haven't received instructions from the government to develop licensing criteria, and without them we can't start issuing licenses." The newspaper went on to note that Pylov's department, which faces the task of issuing license to the 102 members of the Russian Union of Auto Insurers, employs a staff of just 12 people. DK

LAWMAKERS TIGHTEN PSA RULES
The State Duma voted on 14 May to tighten the requirements for production-sharing agreements (PSAs), RIA-Novosti reported the same day. The changes to the Tax Code and law "on PSAs" set tough conditions for future PSAs, which provide tax breaks for specific projects. Under the new rules, only four projects will be eligible for PSAs, "Kommersant" reported on 15 May: the Prirazlom and Shtokman oil fields, the Sakhalin-3 project, and the Caspian shelf. Even for eligible areas, PSAs may be concluded only if rights to the oil and gas fields fail to find buyers at a regular auction. Strict additional conditions will also apply, such as a requirement that 70 percent of equipment be purchased from Russian manufacturers. Vladimir Konovalov is executive director of the Petroleum Advisory Forum, which represents the interests of foreign oil companies working in Russia; he told "Vedomosti" on 15 May that the new rules make future PSAs unlikely. Industry publication "Nefte Compass" described foreign investors as "disappointed" in the wake of the decision. The changes do not affect the three projects currently being developed under PSAs: Sakhalin-1, Sakhalin-2, and Kharyagin. DK

COMPANIES
ALFA-GROUP MAKES BIG MOVE INTO SMALL SCREEN
The Alfa-Group financial consortium announced on 13 May that it is creating a company to distribute television serials, "Kommersant" reported the next day. According to the newspaper, Gamma Film has already purchased a 700-episode library that will make it the leading player in the market. The library consists of 540 hours of popular series produced by Vladimir Gusinskii's Media-MOST, as well as 196 hours currently being shot by other production companies. Press reports estimated that Alfa-Group paid between $50 million and $100 million for the cop shows and sundry, including some of the most popular shows of recent years. Alfa-Bank Vice President Vagan Abgaryan would only say that the price was "significantly less than $100 million," "Vedomosti" reported on 14 May. Some worried that the acquisition of such a large video library by a single company could affect the entire business. Tatyana Voronovich, director of studio 2B, told "Kommersant," "This will cause a natural monopolization of the market," Voronovich said. DK

NRB SETTLES DISPUTE WITH CREDIT AGRICOLE INDOSUEZ
Russia's National Reserve Bank (NRB) and France's Credit Agricole Indosuez (CAI) settled a long-standing dispute over 14 currency contracts that date back to the Russian financial meltdown of August 1998, Reuters reported on 13 May. The banks were tight-lipped on the terms of the agreement, noting only that they hope to cooperate again in the future, "Les Echos" reported on 14 May. CAI originally sued to obtain payment of $110 million on the ruble-denominated contracts; NRB refused to pay on the contracts, calling them fraudulent. Litigation dragged on for years in a variety of jurisdictions. Deputy Finance Minister Sergei Kolotukhin told "Vedomosti" on 14 May that NRB agreed to pay $70 million to CAI to end the conflict. NRB head Aleksandr Lebedev vigorously disputed Kolotukhin, telling journalists on 15 May that the minister "cited inaccurate figures," "Kommersant" reported the next day. DK

LANIT SNAPS UP DPI GROUP
Multi-profile IT holding Lanit announced in a 14 May press release that it has raised its stake in the DPI group of companies to a controlling 70 percent. Lanit (for Laboratory of New Information Technologies) is one of Russia's leading IT consulting, systems integration, and computer-distribution firms; DPI has been the exclusive distributor of Apple Computer products in Russia since 1996. The amount of the deal was not made public. Previously, Lanit held a 50 percent stake in ECS, the holding company that controls DPI. According to "Kompaniya" No. 18 (12 May), the two companies' combined annual sales will total $270 million. IDC analyst Dmitrii Feshin told "Vedomosti" on 14 May that the acquisition will aid Lanit's distribution business: "This will create a powerful, multi-profile company. For example, DPI is a major partner of Xerox, while Lanit's distribution department is a major partner of Hewlett-Packard." Sterling Group President Sergei Tokmakov told "Kommersant" on 15 May that the acquisition is unlikely to affect the market: "The Russian IT market is so spread out today that even if the biggest player were to disappear, no one would notice." DK

INVESTMENT
SAKHALIN ENERGY APPROVES $10 BILLION INVESTMENT
The Royal Dutch/Shell-led Sakhalin Energy consortium approved a $10 billion investment on 15 May to move ahead to stage two of its Sakhalin-2 project, Reuters reported on 16 May. The project's second stage involves the construction of a plant to produce 9.6 million tons of liquefied natural gas (LNG) annually, as well as two 850-kilometer pipelines to ports for export, "Vedomosti" reported on 16 May. The decision to go ahead with the project came only days after Tokyo Gas signed a preliminary contract to purchase LNG from Sakhalin-2. Tokyo Gas will buy 1.1 million metric tons of LNG per year from 2007-31, "Nefte Compass" reported on 14 May. The purchase price was not made public, but Reuters reported that Yutaka Kunigo, manager of the gas-resources department at Tokyo Gas, told journalists at a 12 May news conference, "We were able to reach a deal with low prices." A representative of Russia's Economic Development and Trade Ministry told "Vedomosti" on 13 May that the deal is a "milestone in the history of the Sakhalin-2 project." DK

MARATHON COMPLETES KHANTY MANSIISK ACQUISITION
U.S.-based Marathon Oil Corporation announced in a 13 May press release that it has completed its acquisition of the Khanty Mansiisk Oil Corporation (KMOC) and established Russia as the company's "new core area for growth." According to the press release, Marathon purchased KMOC for $280 million in cash plus the assumption of KMOC's debts. Marathon estimates that the U.S.-registered KMOC has approximately 250 million barrels of proven and probable reserves. Stiven Dashevskii, director of the Aton analytical center, told "Vedomosti" on 14 May that KMOC operates "extremely promising" oil fields with constantly rising production. "Oil Daily" reported on 14 May that Marathon President and CEO Clarence Cazalot and his colleagues were "hard-pressed to restrain their enthusiasm for the just completed acquisition" at a recent teleconference with investors and analysts. DK

RUSSIAN-AMERICAN TITANIUM 'UNITI'
Russia's VSMPO-AVISMA Group and U.S.-based Allegheny Technologies Incorporated (ATI) announced on 15 May that they are creating a joint venture called Uniti to produce and market titanium products, Reuters reported the same day. With headquarters in Pittsburgh, where ATI is based, Uniti will target the construction, automotive, power-generation, and consumer-goods markets; the two companies will continue to serve the aerospace, military, and medical markets independently. VSMPO Deputy Director Vyacheslav Bresht told "Vedomosti" on 16 May that the two companies each control about 20 percent of the world's titanium market; together, they hope to push their market share to 50 percent. Carl Moulton, assistance vice president of strategic initiatives for ATI, will head the joint venture. Uniti plans to begin taking orders on 1 June. DK

IN FOCUS
'IT TOLLS FOR THEE...'
Aluminum's lightweight alloys have made the metal an indispensable part of international industry. Russian aluminum producers' heavyweight lobbying skills have ensured that tolling will remain an indispensable part of their industry.

What's tolling? Under a tolling arrangement, the owner of alumina -- the raw material that is made into aluminum -- contracts out the processing to refineries located in another country. The alumina, and resultant aluminum, cross the border as tourists, staying one step ahead of the taxman. The refineries pay taxes only on the fees they receive for processing the alumina into aluminum. They do not, however, pay any customs duties or value-added taxes. The beauty of tolling is that no one does.

Russian aluminum producers pumped out 3.34 million tons of aluminum in 2002, 2 million tons of it under tolling arrangements. Recently, those arrangements faced threats on two fronts. As "RFE/RL Business Watch" reported on 22 April, Deputy Premier Aleksei Kudrin's Commission on Protective Measures in Foreign Trade boldly decided on 12 March to get rid of tolling. For its part, the State Duma's Budget Committee suggested on 7 April that the new customs code would benefit from the inclusion of anti-tolling measures.

The aluminum lobby sprang into action. A group of regional governors whose jurisdictions overlap rather handily with major aluminum production centers addressed a written appeal to Prime Minister Mikhail Kasyanov. The prime minister responded positively, stressing the need for "further study" of the issue.

Meanwhile, lawmakers voted in late April on the second reading of the new customs code. Although it imposes duties on goods that are processed for subsequently export, those duties specifically do not affect tolling arrangements, "Izvestiya" reported on 5 May.

In a move that could prove decisive, the Economic Development and Trade Ministry then reversed its position on tolling. Ministry officials had initially recommended the elimination of tolling. They did so in response to a request to get rid of import duties on alumina and export duties on aluminum. The abolition of those duties, officials calculated, would cost the budget $100 million, funds they hoped to get back by ending tolling. "Vedomosti" reported on 14 May that the ministry had reconsidered, deciding that losses from the elimination of import and export duties came to only $50 million-60 million, while losses from the elimination of tolling could adversely affect the aluminum industry's profits and overall competitiveness.

An anonymous source in the government told "Vedomosti" that the twists and turns derived from "a certain know-how" possessed by the managers of RusAl, Russia's leading aluminum producer. "It looks like we're seeing the results of this know-how," the source commented. The extent of the know-how should grow clearer by mid-June, when the Commission on Protective Measures in Foreign Trade is set to issue its final decision on tolling. DK

THE TAXMAN COMETH UP EMPTY
Seeking escape from the routine of rooting out fiscal skullduggery, the auditors of Russia's Accounting Chamber turned their attention from law enforcement to art appreciation at a meeting with Federal Council members on 12 May. As one auditor commented to "Gazeta" the next day, "This is a virtuoso performance with the tax code."

The virtuosity that so impressed the Accounting Chamber's auditors was that of oil companies Sibneft and Rosneft. The tax minimization stratagems that brought together auditors and Federation Council members were of the devilishly clever/perfectly legal variety that tend to leave tax collectors gnashing their teeth even as they warm the cockles of taxpayers' hearts.

Sibneft's approach to lessening the tax burden combined geography, mathematics, and the human factor. As an auditor explained, "All of the oil produced by Sibneft's affiliates was purchased by companies where more than half the employees were handicapped. [Editor's note: According to Russian tax law, if more than half of a company's employees are handicapped, the company pays only 50 percent of the tax on profits.] They paid 1,300 rubles [$42.50] for each metric ton and sold it for 2,200-3,800 rubles." Moreover, these profit-reaping trading companies were based in special economic zones. The combination of tax breaks for handicapped employees and advantageous location reduced the rate on profits from 35 percent to 5.5 percent, "Izvestiya" reported on 13 May. Auditors credited the audacious, and totally legal, scheme with reducing Sibneft's overall tax burden by a whopping 10 billion rubles in 2001.

State-owned Rosneft used so-called transfer-pricing mechanisms to minimize its tax payments. (We leave aside the implications of a state-owned company seeking to minimize its tax burden.) Transfer pricing refers to the specifics of price formation when related business entities (affiliates and the like) sell things to each other. In Rosneft's case, the company purchased oil from its own subsidiaries at artificially low prices to save money on extraction taxes, which are calculated on the basis of initial sale price. The company's savings totaled 2 billion rubles in 2001.

Company representatives stressed the legality of their tax-minimization strategies. A Sibneft representative told "Izvestiya," "We adhere to the requirements of acting legislation. The audit showed that all of Sibneft's efforts to minimize taxable income took place exclusively in the realm of what is legal." A Rosneft spokesperson echoed the sentiment.

Naturally enough, tales of tax minimization set Federation Council members thinking about tax maximization. Tatyana Safonova, deputy director of the Tax Ministry's Tax Policy Department, explained that tax breaks for companies with a majority handicapped staff are a "socially significant" issue that needs to be approached carefully, "Kommersant" reported on 13 May. As for transfer pricing, Article 40 of the Russian Tax Code forbids deviations of more than 20 percent from "market price" in transfer-pricing schemes; but in the absence of an oil exchange, Russia currently lacks a workable definition of "market price" for oil. A source in the Accounting Chamber told "Vremya novostei" of 13 May that legislative gaps are only the outward manifestation of a deeper problem: "It's not so much the obvious imperfection of our legislation as the fact that State Duma deputies lobby [the oil companies'] interests." DK

'ONE WINDOW' DRESSING
Even the name sounded like a breath of fresh air. The "one window" principle bespoke openness, simplicity, exchange, even insight. When it was introduced on 1 July, the new procedure for registering companies was supposed to simplify an ordeal that had pitted Russian entrepreneurs against a legion of hostile, and frequently rapacious, bureaucrats. "One window" promised streamlined procedures, five-day waiting periods -- in short, a new era of efficiency and ease.

On 12 May, Deputy Economic Development and Trade Minister Aleksandr Maslov admitted that it had not quite come off as planned. Or, as Interfax reported him saying, "Efforts to implement the 'one window' principle were not entirely successful."

Newspapers gleefully fleshed out the grim details of the foundering initiative. "Kommersant" reported on 13 May that, "according to government officials, the new registration process has cost entrepreneurs twice as much." RosBusinessConsulting cited the results of a study conducted by auditing and consulting firm FBK. The study found that the middlemen who two years ago were charging $350-400 to get the supposedly $100 process done within a month are now charging $350 to get the supposedly $200, five-day process done within a month.

Deputy Minister Maslov told the cabinet at a 15 May meeting that some tweaking will do the trick. Further simplification can rescue the registration process, and the relevant legislation is slated for introduction to the State Duma in the autumn session. The new date for streamlined procedures and five-day waiting periods is 1 January 2004. DK

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