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Business Watch: October 21, 2003

21 October 2003, Volume 3, Number 39
BP chief executive John Browne took the occasion of a 16 October news conference in London to tout the virtues of his company's $8 billion commitment to TNK-BP, "Oil Daily" reported the same day. Browne downplayed risks, calling Russia "one of the great natural resource centers in the world," and noted that Russian energy stocks have gone up 40 percent since BP and Tyumen Oil Company (TNK) announced their joint venture, "The Moscow Times" reported on 17 October. Browne also stressed that BP paid only $4 per barrel of reserves, estimated by stingy U.S. standards at 4.1 billion barrels (more generous Russian standards put them at 9.4 billion barrels); by way of comparison, reserves went for $5.8 per barrel in the Yukos-Sibneft merger. With TNK-BP set to account for 15 percent of BP's production over the next five years, the joint venture's capital spending will stand at $1 billion a year, with 70 percent of that earmarked for exploration. Browne's Russian partners Mikhail Fridman, Viktor Vekselberg, and Len Blavatnik also attended the press conference. Blavatnik assured listeners: "We're not going to take the money and run. There is no reason for us to run. There is all the reason for us to stay and make much more money," "Oil Daily" reported. Investors reacted coolly, with BP shares dropping 1.4 percent on the London Stock Exchange to close at 4.265 pounds. Tony Alves of Investec Securities told the "Financial Times," "Expectations have been wound up a little and the market had been expecting to hear something materially better than what was known." Adam Landes of Renaissance Capital agreed, telling "Vedomosti" on 17 October, "People expected more." DK

Japan is willing to put up $7 billion to back a planned oil pipeline from Siberia to the Pacific, the "Financial Times" reported on 14 October. The newspaper quoted a "Japanese energy official" as saying that financial support would be divided into $5 billion for pipeline construction and $2 billion for oil-field development, with an unspecified amount in the form of low-interest loans. The report appears to confirm comments by Energy Minister Igor Yusufov, who told journalists at a 12 October press conference that talks are under way with the Japanese on a $7 billion investment, "Izvestiya" reported the next day. The minister said negotiations could lead to the formation of a joint venture, with Japan represented by Japan National Oil Corporation. "The Moscow Times" quoted a "Japanese Foreign Ministry official in charge of Russian affairs" on 15 October as saying that no proposals with specific figures had been made, however. If confirmed, the Japanese offer would raise the stakes in the ongoing debate over Siberian pipeline routes. One proposed route, supported by Russian oil company Yukos, would run from Angarsk in Siberia to Daqing, China; another route, pushed by state-owned Rosneft and Transeft, would connect Angarsk with Nakhodka on the Pacific coast. An Angarsk-Nakhodka pipeline with a spur to Daqing has also drawn attention, but analysts say current production levels are insufficient for such a project. Though the Russian government has played coy, both China and Japan are eager for a resolution. China, for example, recently offered Kazakhstan financing for a pipeline to China in a move some saw as an attempt to hasten a Russian decision, "Nezavisimaya gazeta" reported on 15 October. DK

Deputy Natural Resources Minister Aleksandr Povolotskii met with Exxon Ventures President Jeff Woodberry on 16 October to air the ministry's concerns over the Sakhalin-1 oil project, Interfax reported the same day. According to a 16 October ministry press release, Povolotskii voiced official displeasure over lagging exploration, a failure to establish a single area to store waste materials, and a tendency to blame environmental damage on subcontractors. The press release closed on an ominous note, remarking that the question of Exxon's participation in the Sakhalin-3 project "will be resolved on the basis of the company's existing practice at other sites." Exxon is the operator on the $12 billion Sakhalin-1 project and a holds a 30 percent stake; other participants are Russia's Rosneft (20 percent), India's ONGC (20 percent), and Japan's Sodeco (30 percent). Exxon does not yet have a formal license to develop Sakhalin-3, "International Oil Daily" reported on 16 October. "Kommersant-Daily" speculated on 17 October that the ministry's decision to call Exxon on the carpet over Sakhalin-1 could be linked to company's rumored plans to acquire an equity stake in Russia's embattled YukosSibneft. Glenn Waller, director of external affairs for ExxonMobil in Russia, told "Vedomosti" on 17 October that ethical considerations precluded any comment on talks with the ministry, but that the company still hoped to obtain a license to develop Sakhalin-3. DK

The State Duma threw a wrench into Russia's new system of mandatory car insurance with an unexpected 14 October vote to roll back implementation deadlines by an entire year, "Kommersant-Daily" reported the next day. The original law on mandatory insurance went into effect on 1 July; it requires all drivers to purchase insurance by 1 January or face fines. The bill the Duma passed in its first reading on 14 October would push all dates back by an entire year, stipulating fines only after 1 January 2005. Parliamentarians argued that the base price for insurance -- 1,980 rubles ($65) -- is too high. Duma Deputy Vasilii Altukhov (Communist) told "Vedomosti" on 15 October, "Everyone everywhere wants voluntary insurance and lower rates." Five million policies have already been purchased, however, and no viable mechanism exists for returns or refunds. Insurers reacted to the vote with anger and derision. "Apparently, the deputies set themselves the task of creating a totally idiotic situation. That they've done," fumed Aleksandr Koval, president of the All-Russian Insurers Union, "Kommersant-Daily" reported. Government officials dismissed the vote as a bit of populist grandstanding and vowed that the bill would die a quick death in the Duma. Still, Finance Minister Aleksei Kudrin told "Vremya novostei" on 16 October that the government was considering reduced rates for pensioners and the disabled. DK

Aeroflot's board of directors approved the creation of a subsidiary on 13 October to construct a new terminal for Moscow's Sheremetevo International Airport, the airline announced in a 14 October press release. Dubbed Terminal, Aeroflot's wholly owned subsidiary starts out with charter capital of 200 million rubles ($6.7 million). Despite a consensus that the overburdened airport needs a new terminal, the construction of the Sheremetevo-3 terminal has languished amid management wrangles since the cornerstone was laid in 2001. An upcoming tender to manage the airport has only added to the uncertainty surrounding the expansion. Set to be held by year's end, the tender terms do not mention Sheremetevo-3, according to reports. An official told "Vedomosti" on 15 October, however, "It seems that it will be the managing company that decides whether or not Sheremetevo needs a new terminal." National Reserve Bank, which holds a 30 percent stake in Aeroflot, is one of the companies that has expressed interest in the tender. Observers noted that Aeroflot might also have been looking to improve its balance sheet by creating Terminal. Sources in the company told "Gazeta" on 15 October that the airline plans to transfer the $19 million it has already invested in the projected terminal to the newly created Terminal subsidiary. "Kommersant-Daily" confirmed this in a report the same day, listing the amount invested as $17 million. The newspaper added that Aeroflot's decision to leave Sheremetevo airport out of the new subsidiary's equity could cause tensions between the two. DK

St. Petersburg brewer Tinkoff announced in a 15 October press release that it has signed a $75 million agreement with Germany's Krones AG for the latter to build a new brewery in the Petersburg suburb of Pushkin. Slated to come on line on 1 September 2004, the new production facility will be able to brew 2 million hectoliters a year, a massive increase on Tinkoff's current 200,000-hectoliter production capacity. The two sides did not disclose financial specifics. Citing Tinkoff owner Oleg Tinkov and Krones Vice President Reinulf Diepold, "Vedomosti" reported on 15 October that Germany's HVB Bank will provide a five-year loan to cover 20 percent of the $75 million, with Tinkoff supplying the rest of the money from its own funds and a two-year loan from Zenit Bank and Aton Capital. Tinkoff, which at present controls a miniscule 0.08 percent of the Russian beer market, hopes that the added capacity will catapult it into the top 10. Some analysts queried by "Vedomosti" were skeptical, with Turul Arbas, marketing director for Turkey's Efes, commenting wryly, "Welcome to the real world of competition." Whatever its chances, Tinkoff is not limiting its expansion to the domestic market. The company recently inked a deal with BMC Imports to sell 70,000 bottles of Tinkov Russian Pilsner in the United States, "Delovoi peterburg" reported on 16 October. DK

Tapio Hintikka, chairman of the board at Swedish-Finnish cellular operator TeliaSonera, held out the possibility of a merger between Russia's MegaFon and VimpelCom in 16 October comments to Finnish newspaper "Taloussanomat," "Kommersant-Daily" reported the next day. "TeliaSonera views the merger of MegaFon with competing operator VimpelCom as an alternative," "Kommersant-Daily" quoted Hintikka as saying. "The TeliaSonera board has discussed the question of an optimal time to get involved in the mergers that are about to begin in Russia." TeliaSonera holds a 43.8 percent stake in MegaFon, Russia's third-largest cellular operator. Rumors have flown of a merger between MegaFon and VimpelCom, Russia's second-largest cellular operator, since Alfa Group, which holds a blocking stake in VimpelCom, acquired a blocking stake in MegaFon in August. MegaFon's other shareholders reacted negatively to the acquisition, and Alfa Group is currently embroiled in litigation with IPOC International Growth Fund Limited, which owns 6.5 percent of MegaFon, in a number of offshore jurisdictions. The comments by Hintikka are the first indication from a major MegaFon shareholder that a merger could be in offing. DK

Credit giant Experian plans to set up shop in Russia by spring 2004, "Vedomosti" reported on 13 October. Central Bank Deputy Director Andrei Kozlov told the newspaper the Experian representatives have already cleared their plans informally with the Central Bank and confirmed that they can begin working in Russia even though the State Duma has yet to pass legislation on credit bureaus. With annual revenues of nearly $2 billion and divisions in more than 20 countries, Experian will be a heavyweight contender among Russia's fledgling credit bureaus. Some question whether the market is ready, however. Aleksei Volkov heads the Interbank Clearance System, a noncommercial partnership that is serving as the launch pad for a Russian credit bureau. Volkov told "Kommersant-Daily" on 13 October: "On the one hand, Experian has the experience and technology. On the other hand, there isn't a great need for a credit bureau yet. The market's not ready.... Before the creditor comes to a credit bureau, and the borrower agrees to provide information about himself, you have to explain to them what this is and why it's necessary." DK

Agriculture Minister and Deputy Prime Minister Aleksei Gordeev told journalists on 13 October that Cargill International SA is ready to invest $200 million into the Russian food industry, UPI reported the same day. Gordeev's comments came after a meeting with David Rogers, senior vice president of U.S.-based Cargill Inc. and head of Cargill International SA, which handles the food and agriculture company's European operations. According to Gordeev, Cargill will invest $100 million into a new vegetable-oil plant in Voronezh, $50 million into a malting plant in Tula, and $50 million into a glucose plant in which the company acquired a controlling stake in 1996. In a possible foreshadowing of competition, Russian agriculture powerhouse Rusagro also plans to build a $100 million vegetable-oil plant in Voronezh, "The Moscow Times" reported on 15 October. According to AP, Cargill employs 98,000 people in 61 countries and is one of the world's largest privately owned companies. DK

LUKoil President Vagit Alekperov announced on 13 October that his company and Kazakhstan's national oil company KazMunaiGaz are readying an agreement for the joint development of Kazakhstan's Dostyk oil field, AP reported the same day. If oil discoveries warrant, the two companies could invest as much as $3 billion in the Caspian shelf joint venture, which they will pursue on a parity basis. LUKoil Overseas spokesman Grigorii Volchek told "Kommersant-Daily" on 14 October, "The actual reserves could differ from projected reserves by several factors of 10 in either direction." Analysts queried by "Vedomosti" noted that Kazakhstan, where LUKoil is currently involved in no fewer than seven projects, is fast becoming one of the Russian oil company's priority development areas. Aton analyst Steven Dashevskii pointed out to the newspaper that operating expenses of $1.50 per barrel in Kazakhstan are less than half of the same indicator for Russia. According to Alekperov, the two companies will draw up a contract in 2-2 1/2 months. DK

Even as Russia boosters basked in the afterglow of last week's unexpected decision by international ratings agency Moody's to assign investment grade to Russian sovereign debt, an International Monetary Fund (IMF) delegation wrapped up a weeklong visit to Moscow on an ambiguous note. For the second time this fall, IMF experts tweaked their growth forecast, predicting that the country's GDP will rise by 6.25 percent by year's end. At the same time, they left their 2004 forecast unchanged at 5 percent and floated a raft of critical observations. Russia's economy remains beholden to natural resources, they charged, and structural reforms are lagging in the banking sector, natural monopolies, and government bureaucracy, "Nezavisimaya gazeta" reported on 15 October.

The fund's experts shrugged off third-quarter capital flight of $7.7 billion, reasoning that the money will return after December elections to the State Duma and a slight tightening of monetary policy. Lax fiscal discipline drew IMF ire, however, what with the government asking the Duma to add 69 billion rubles ($2.3 billion) in expenditures to the 2003 budget. (Almost certainly inspired by upcoming elections, the added outlays come mainly in the form of aid to the regions to pay state workers' salaries and provide agricultural subsidies.)

Long accustomed to the fund's nettlesome naysayers, Russian observers took the latest jibes in stride. The charge that structural reforms are stagnating met with widespread agreement, however. Two schools of thought contend on the topic. First Deputy Minister of Economic Development Andrei Sharonov spoke for the optimists in 13 October comments to "Vedomosti." "We're also dissatisfied with the slow pace of structural reforms," Sharonov said. "The IMF's experts understand this but count on reforms picking up after April [Ed. note: when presidential elections are scheduled]. We're counting on this as well." The newspaper's editors assumed the role of pessimists in an editorial the same day, writing: "The fund's experts are not convinced that the stagnation of reforms results solely from impending elections. They have even more doubts that after the reelection of Vladimir Putin, stagnation will give way to the energetic actions of a reformist government." DK

A lack of structural reform in one of the country's most important natural monopolies -- Gazprom -- has proved an increasingly troublesome stumbling block in talks over Russian accession to the World Trade Organization (WTO). The issue is a simple one: Gazprom sells natural gas within Russia at roughly one-fifth the price the market sets in Western Europe. All attempts to date to "liberalize" Gazprom in the direction of a freer domestic market have foundered.

Economic Development and Trade Minister German Gref's recent talks with EU officials on Russia's bid to join the WTO ended in Brussels on 8 October in what Gref described to Russian news agencies as a "dead end." EU representatives did not limit themselves to asking Russia to raise domestic gas prices. As "Kommersant-Daily" reported on 9 October, they put forward a laundry list of other demands: the equalization of foreign and domestic gas pipeline tariffs, the elimination or sharp reduction of the current 30 percent export duty on gas, an end to the state's monopoly on oil and gas pipelines, and the breakup of Gazprom's monopoly on gas exports.

President Vladimir Putin responded on 9 October with a burst of invective. As quoted by "Vedomosti" on 10 October, the president remarked: "The position of EU bureaucrats is incorrect and dishonest. We view this position as arm-twisting. Russia's arms are getting stronger and stronger. Not even such powerful partners as the EU can twist them." Putin drove home his point, adding, "We're not going to break up Gazprom."

Unsurprisingly, the gas-pricing issue loomed large at negotiations EU Trade Commissioner Pascal Lamy conducted in Moscow on 16 October. Lamy painted a bleak picture of the talks in a 17 October interview with "Kommersant-Daily." When the newspaper's correspondent inquired about the possibility of a compromise on gas prices, "the Eurocommissioner switched from English to his native French and indicated that this was not the place for bargaining -- Gazprom must be liberalized in accordance with a negotiated timetable."

Fiona Hill, a senior fellow at the Brookings Institution and the coauthor of a forthcoming book on Siberia, seized on yet another quotable comment Putin made the same day. On the possibility of raising domestic gas and electricity prices to please the EU, Putin remarked bluntly: "This is impossible. We would cause the whole Russian economy to collapse." Writing in the "Financial Times" on 17 October, Hill was equally blunt, arguing, "Mr. Putin is absolutely right." After explaining that the Soviet development of Siberia left millions of Russian citizens living in frigid, economically moribund communities that rely on costly subsidies to stay warm in the winter, Hill warned that changes in this area "will be a far greater challenge for Russia than any other structural reform of the past decade." DK

Even as Gazprom stubbornly resists change, structural reform is proceeding apace on the Russian rails. There, the vehicle for reform is Russian Railways, a newly created company that will assume the commercial functions formerly performed by the Railways Ministry, leaving the ministry to concentrate on regulatory issues and paving the way for eventual privatization. Russian Railways announced its investment program at a 16 October press conference, RIA-Novosti reported the same day. Projected investments in 2004 come to a whopping 135 billion rubles ($4.5 billion), nearly 30 percent of which will go toward modernizing and augmenting the company's increasingly decrepit rolling stock. Galina Kraft, head of the Russian Railways' investment department, told reporters that the company plans to buy 13,000 new open freight cars, 580 passenger cars, and 60 locomotives, Interfax reported.

Even as Russian Railways moved ahead with its investment program, the makeup of the company's board was raising eyebrows. Deputy Premier Viktor Khristenko will head the company's board. Khristenko also chairs the government commission that sets rates. As "Vremya novostei" noted in a 17 October article, the result is that Khristenko, in his capacity as Russian Railways' chairman of the board, has every reason to want higher rates. And in his capacity as head of the commission that sets rail rates, he has a very good chance of getting what he wants. The question, of course, is where this leaves the reform's stated purpose of separating commerce and regulation.

Law-enforcement authorities continued to display interest in Yukos, even as the oil company's legal travails appeared to have faded into the general business backdrop. As Zenit Bank analyst Sergei Suverov remarked to "Kommersant-Daily" on 14 October: "Everyone's used to the unpleasantness around Yukos and Sibneft. Nothing less than the arrest of top management could affect stock prices now." Though no top-management arrests were in the offing last week, we present an overview of the main events:

* Interior Ministry officials questioned Sibneft President Yevgenii Shvidler on 13 October in connection with an ongoing investigation into tax-evasion charges, "The Moscow Times" reported the next day. The Interior Ministry investigation stems from the Audit Chamber's examination of tax-optimization methods Sibneft employed on its 2001 and 2002 returns. The news comes as investigators on Yukos-related cases are focusing increasingly on tax charges. Shvidler is set to become the chairman of the board at YukosSibneft when the merged company begins operating as a single entity on 1 January 2004.

* The Russian Union of Industrialists and Entrepreneurs (RSPP) announced after a 15 October meeting that big business is willing to provide "organizational and financial resources" to support medicine, education, and the development of mortgages and consumer credit, "Kommersant-Daily" reported the next day. Though the RSPP made no mention of the events surrounding Yukos, some observers linked the industrialists' and entrepreneurs' sudden pangs of social conscience with a desire to improve their public image and forestall outbursts of anti-oligarchic populism as elections near.

* The Prosecutor-General's Office announced on 17 October that it is charging Vasilii Shakhnovskii, who heads Yukos Moscow, with evading 29 million rubles ($964,000) in taxes, "Kommersant-Daily" reported the next day. DK