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Business Watch: November 5, 2002

5 November 2002, Volume 2, Number 33
Gazprom scored a precedent-setting victory over the Moscow Tax Inspectorate on 28 October, fending off charges that it evaded $940 million in taxes on natural-gas exports, "Kommersant" reported on 29 October. Tax Inspectorate No. 40 had charged the gas monopolist with classifying natural gas as lean (dry) gas for export purposes in 1999-2001. While lean gas -- produced from condensed gas and casing-head gas -- is identical to natural gas for commercial purposes, Russian law exempted it at the time from the 30 percent export excise levied on natural gas. Gazprom claimed significant lean-gas exports in 1999-2001, tidily reducing its tax burden. The Tax Inspectorate, noting that both lean and natural gas mingled in the pipeline, calculated Gazprom's taxes according to the proportions of gas introduced into the system for all customers. The difference came to a whopping $940 million. When the charges were announced in March, Gazprom shares tumbled 7.6 percent. The law firm of Pepelyaev, Goltsblat and Partners argued on behalf of Gazprom that the Tax Code insists on specific reasons and proofs, not general appeals to the laws of nature. "Vedomosti" wryly summarized the defense on 29 October as "the Tax Code has greater weight than a physics textbook." The court agreed. The Tax Inspectorate has not said whether it will appeal the case. DK

Moscow utility company Mosenergo, the largest "daughter" enterprise of Unified Energy Systems (EES), announced on 31 October that its losses for the first three quarters of 2002 totaled 3.393 billion rubles ($109 million), "The Moscow Times" reported on 1 November. The results, which were calculated by Russian accounting standards, represented a substantial decline from the 1.686 billion rubles in net profit for the same period in 2001. A 31 October Mosenergo press release cites "significant difficulties connected with rate formation and the late introduction of rates by Moscow's Regional Electrical Commission" but insists that the company will hit year-end profit targets. Sergei Suverov of Zenit Bank told "Vedomosti" on 1 November that while 2002 profits may be lower than expected, "everyone is much more interested in the company's restructuring and whether its shares are being bought out." "Vedomosti" notes that Mosenergo share prices have been on the rise since 24 October. DK

Sibneft announced in a 30 October press release that the company's net profit for the first half of 2002 fell to $457.5 million from $615.8 million in the first half of 2001. The consolidated, unaudited U.S. GAAP (Generally Accepted Accounting Practices) financial statement also revealed that revenues for the period rose 19 percent to $1.984 billion. First-half earnings before interest, tax, depreciation, and amortization (EBITDA) slipped from $870.5 million in the first half of 2001 to $786.1 million. The press release was careful to note that Sibneft's "indicators for net profit, EBITDA, and earnings per ton exceed indicators for the main companies in the Russian oil sector." Far more intriguing than the lower-than-expected earnings was Sibneft's admission that it spent $68 million and $313 million, respectively, for stakes in a large utility company and a Russian oil company. Though company spokespeople declined comment on the purchases, analysts were inclined to link the oil-company purchase with the upcoming privatization of Slavneft, "Vedomosti" reported on 31 October. Sibneft owns 25 percent of the trust company that controls a 12.8 percent stake in Slavneft; the $313 million may be part of an attempt to buy out the remaining shares in the trust company. "Kommersant" speculated on 31 October that the $68 million utility-company acquisition could involve either Omskenergo or Mosenergo, both of which are tied to refineries in Sibneft's sphere of influence. DK

Tyumen Oil Company (TNK) issued $400 million in five-year Eurobonds with an 11 percent annual yield, "Izvestiya" reported on 1 November. TNK had originally intended to issue the Eurobonds in May, but a mix-up over the company's International Accounting Standards earnings report delayed the release. Citing "sources in banking circles," "Vedomosti" reported on 29 October that Alfa-Bank, part of the same Alfa Group that controls TNK, made a presentation to investors on 28 October in preparation for its own Eurobond issue to the tune of $150 million-$200 million. Analysts saw both issues as part of a move by cash-strapped TNK to raise funds for the upcoming privatization of state-owned oil company Slavneft, which is expected to fetch at least $1.5 billion-$2 billion. DK

State-owned telecom holding Rostelecom announced in a 31 October press release a 4.9 billion-ruble ($154.63 million) net profit for the first three quarters of 2002, a 173 percent increase over last year's figure. According to the report, calculated by Russian accounting standards, revenues rose 6.2 percent to 15.18 billion rubles. Without 3.02 billion rubles in revenues from the sale of a 50 percent stake in Moscow operator Sovintel, net profit would have totaled 2.99 billion rubles, still a 67 percent jump over 2001 results. In other Rostelecom-related news, company spokesman Dmitrii Chukseev told "Kommersant" on 1 November that Rostelecom is interested in the upcoming sale of a 90 percent stake in Armenian national operator Armentel by the Greek Telecommunications Organization (OTE), which OTE announced on 31 October. DK

Cooperation during the recent hostage crisis between Moscow's main cellular operators and security forces under the aegis of the System for Operational-Investigative Activities (SORM) evoked comment, but little debate, in society and the press. Deputy Interior Minster Vladimir Vasilev announced on 26 October that security forces eavesdropped on mobile-phone conversations during the standoff, "Kommersant" reported on 27 October. "The Moscow Times" reported on 29 October that the signs many mobile users saw on their displays during the crisis indicated that cellular operators switched off encoding to aid law enforcement officials. SORM requires all communications operators to install special equipment at their own expense that allows security forces to monitor traffic. Security forces are not obligated to inform operators that they are listening in, and the legal prerequisites for monitoring are somewhat murky. The issue of surveillance passed largely unnoticed, however. Participants in cellular-focused Internet forums, who are usually "very critical" of cellular operators, "were unfazed by the decision to disable encoding temporarily at the expense of confidentiality," "Vedomosti" reported on 28 October. DK

Deputy Minister of Economic Development Maksim Medvedkov, Russia's chief negotiator in talks with the World Trade Organization (WTO), told reporters after two days of discussions in Geneva that Russia remains "open for dialogue" with the WTO but insists on its right to reduced domestic energy tariffs, AFP reported on 1 November. WTO General Director Supachai Panitchpakdi noted "important and constructive proposals from the Russian side that are speeding up the process [of Russia's entry into the WTO]," "Kommersant" reported on 1 November. The WTO working group on Russia is slated to meet on 16 December; Panitchpakdi plans to visit Moscow in the spring. Reduced energy tariffs for domestic consumption and the openness of markets to foreign competitors remain stumbling blocks in Russia's bid to join the WTO. DK

The Emerging Markets Creditors Association (EMCA) has appealed to Moody's Investor Services to refrain from raising Russia's rating until Russia converts the commercial debts of the former USSR into Eurobonds, "Kommersant" reported on 30 October. The Russian government had promised to restructure the debt into Eurobonds by April 2002, but thus far Vnesheconombank has managed to verify only $1.1 billion of the $6 billion debt. Moody's is considering a possible two-notch upgrade of Russia's rating by year's end, the "Financial Times" reported on 1 November. A representative of the EMCA told "Kommersant," "It's not that we don't want Moody's to raise Russia's rating, but we feel that this threat might speed up the conversion process." The EMCA has "repeatedly accused Russian officials of deliberately delaying the verification while buying up [these] debts through shell companies," reported on 2 November, since their value will rise dramatically once the debt has been verified and converted. The USSR commercial debt, much of which accrued from shadowy, unregulated import-export deals in the waning days of Soviet power, is a familiar source of frustration for disgruntled creditors and fascination for scandal-seeking journalists. DK

Aluminum tycoon Oleg Deripaska and financier Aleksandr Mamut have tightened their hold over leading insurance company Ingosstrakh, "Vedomosti" reported on 1 November. Tatyana Dubrovskaya, financial director of Deripaska's Basic Element (BasEl) and CEO of Ingosstrakh, told "Vedomosti" that Aleksandr Mamut's stake in Ingosstrakh is at least one third. Deripaska personally owns a 17.8 percent stake; the remainder is controlled through structures subordinate to BasEl. Deripaska and Mamut plan to consolidate their holdings in the company, simplify the structure of Ingosstrakh, and use it to create an industry-leading insurance holding company. The fly in the ointment is Andrei Andreev, who lost control of Ingosstrakh to Deripaska in a series of complex moves over the past year. In a 28 October interview with "Kommersant," Andreev estimated his losses on Ingosstrakh at $200 million-$300 million and promised to make every legal effort to regain control of the company. DK

Slumping auto giant AvtoVAZ could lay off up to 12,000 of its approximately 121,000 employees, "The Moscow Times" reported on 30 October. Faced with low demand and backlogged inventory, the carmaker imposed a two-week production stoppage on 26 October. Industry newsletter "Ladaonline" reported on 1 November that demand slowed further in the last week of October, leading some dealers in Toliatti, where AvtoVAZ is based, to consider "reorienting or completely closing their car businesses." DK

Ford Motor is preparing its Vsevolozhsk auto plant to work in two shifts to cope with demand for the Russian-produced Focus, "Vedomosti" reported on 31 October. The $150 million plant, which can churn out up to 25,000 cars a year, opened in July 2002. Dealers have already ordered 3,200 cars, but the plant will only manage to produce 2,800 units by year's end. Ford has benefited from a confluence of circumstances, offering Russian buyers a variety of flexible financing options at a time of rising incomes. Industry analyst Elena Sakhnova told "Vedomosti" that despite the current windfall demand is likely to level out in the foreseeable future. DK

RusPromAvto Executive Director Igor Kaluzhskii announced on 1 November that Iveco, the truck-making arm of Italian auto giant Fiat, will start assembling diesel engines at the Gorky Automobile Factory (GAZ) in early 2003, RosBusinessConsulting reported. RusPromAvto co-owner Oleg Deripaska and company General Director Dmitrii Strezhnev hammered out the deal with Iveco CEO Michel de Lambert at Iveco headquarters in Turin, Italy, on 25 October, "Vedomosti" reported on 1 November. The joint venture, which will kick off with 3,000 engines assembled at GAZ in 2003, envisions future expansion into truck engines and joint vehicle production, Reuters reported on 1 November. RusPromAvto will provide production facilities and Iveco will contribute technical know-how and financing. The only cloud on the horizon is Fiat's own financial health. Currently mired in losses, the company is staking its hopes on a 2.5 billion-euro ($2.5 billion) recapitalization program, the "Financial Times" reported on 1 November. The carmaker has less than six months to whittle its 5.8 billion-euro debt down to 3.2 billion euros to keep creditors from cashing in loans for shares in the company. Greg Melich of Morgan Stanley commented on the automaker's prospects to the "Financial Times," saying, "It is not inconceivable [that they will meet the target], but it is a really, really tall task." DK

DellSystems, which markets Dell personal computers in Russia, announced in a 29 October press release that it is "changing its business development strategy." The company plans to shift most sales to distributors, retaining "limited direct sales" and focusing primarily on "promoting the Dell brand." Industry reaction was tepid, however. Roksana Yanborisova, marketing director of distribution company OCS, told "Kommersant" on 30 October that "DellSystems' remarks about 'limited direct sales' remind me of the expression 'a bit pregnant.'" Vasilii Vasin, president of R-Style Group, told "Vedomosti" the same day that "I see DellSystems' desire to work through distributors in Russia as an attempt to use others to develop the market for Dell products, but that market remains small." According to "Kommersant," Dell captured only 0.81 percent of Russia's fast-growing personal-computer market last year. DK

Ukrainian state-owned Naftohaz Ukrayiny and Russian Gazprom signed documents on 29 October in Kyiv to found an "international consortium to manage and develop Ukraine's gas transport system," according to a 30 October Gazprom press release. Each company contributed $500,000 to the consortium's start-up capital for preinvestment research to be completed by the summer of 2003. The research will determine how much investment is needed to reconstruct Ukraine's gas-transport system (GTS) to ensure the delivery of Russian gas to Ukrainian customers. The next key step is an assessment of how much the Ukrainian GTS is worth. An EU-sponsored project evaluated it at $13.8 billion, "Vremya novostei" reported on 31 October. The Ukrainian side would like to see that number revised upward to give it more clout in the project. Ukrainian online newspaper "Versiya" expressed concern on 1 November over the modest start-up capital, saying that "the danger is great that the 'project of the century' will not be ready on time because of insufficient financing." DK

Russian oil major LUKoil signed an agreement with International Finance Corporation (IFC), a branch of the World Bank, to borrow $150 million to develop the Karachagank gas and condensate field in Kazakhstan, "Nefte Compass" reported on 30 October. IFC will put up half of the money and a syndicate of five banks will provide the other half. LUKoil will repay the loan over a nine-year period from project cash flow. The Karachaganak field is being developed by a consortium that includes Italian Eni (32.5 percent), British Gas (32.5 percent), Texaco (20 percent), and LUKoil (15 percent), "Konservator" reported on 1 November. The consortium has invested some $10 billion into the project, which is expected to generate $65 billion in revenues, with $47 billion earmarked for the Kazakh budget. DK

Russian gas trader Itera will form a consortium with state-owned oil companies Rosneft and Zarubezhneft to develop Turkmen oil and gas deposits on the Caspian shelf, "Kommersant" reported on 29 October. Itera President Igor Makarov and Rosneft Vice President Sergei Oganesyan announced the deal after talks with Turkmen President Saparmurat Niyazov in Ashgabat, christening the newborn consortium Zarit. Itera spokesman Nikolai Semenenko told "Kommersant" that Rosneft will join the consortium after it is registered in Moscow. Itera and Rosneft will hold 37 percent stakes; Zarubezhneft's stake will be 26 percent. The Turkmen government will later assign Zarit fields to develop under a production-sharing agreement. Troika Dialogue analyst Valerii Nesterov told "Vedomosti" on 29 October that "working in Turkmenistan is difficult and even risky, but the country has enormous oil and gas reserves and Itera has longstanding good relations with Ashgabat." DK

Nothing brings business, economics, and politics together in quite as passionate an embrace as war. With conditions for conflict in Iraq ripening by the day, the paucity of analytical attention to the potential consequences of this perilous menage a trois for Russia's economy is striking. The implications for Russia's future, and future role in the international community, are immense.

Support for this bold assertion comes from a markedly timid source. The World Bank's October 2002 "Report on the Russian Economy" tries very hard to stay bland. Its staid opening sentence politely remarks that the "Russian economy, on the whole, continues to function well, maintaining stable growth against a backdrop of events in the world that could render growth a rarity." Indeed, the Russian economy has been growing for some time now, and the authors have clearly decided to begin with this bit of good news. The peril, however, rears its head in the second sentence: "Prices for oil are high." The 27-page report trundles on with substantial detail on wages, production, investment, and reform -- finding cause for cautious optimism and rather less-cautious pessimism across the board -- but its true import is that exports of oil and gas make the money that keeps the Russian economy afloat. What progress has been made in other areas is not enough to change the fact of this crude dependence. Period.

The World Bank report appeared on 29 October amid the noisome aftermath of the Moscow hostage crisis. Reactions were understandably limited, but odd nonetheless. "Vedomosti" wrote in a 31 October editorial that the report "proves the Russian economy's increased dependence on natural-resources exports. This means that as soon as world market conditions deteriorate, we will again be threatened with a default." "Default" is a word with a brief and bitter history in Russian, and might tempt some writers to examine more closely any "world market conditions" capable of bringing about a recurrence. Yet the editorial blithely glides on through four paragraphs of neutral puffery without further discussion of this mysterious world and its precarious conditions.

Those who are less circumspect help to explain why silence is so prevalent. In a 15 October column in "Vremya MN," commentator Leonid Radzikhovskii rages at the "nonsense" that fills newspapers "while our fate, without exaggeration, is being decided in Washington and Baghdad." If Saddam falls and cheap Iraqi oil flows to world markets, "all of the 'accursed Russian questions' will come down to one -- how much will prices drop?" If the U.S. is able to keep oil prices low, Radzikhovskii sees "permanent crisis and collapse for our oil-dependent economy." What to do? Here, things get fuzzy. Radzikhovskii admits that Russia has no means of influencing American policy, and that an American victory would be "politically disadvantageous...and economically ruinous." But something more important "unites us with these dangerous and unpleasant cowboys" -- saving Christendom. "If Iraq and its allies achieve a moral victory, tomorrow a wave will rise that will wash away flaccid Christian civilization.... War in Iraq will be ruinous for us. But this is only the first payment we must make for our survival in the 21st century," Radzikhovskii concludes.

Radzikhovskii's economic logic has its merits, yet it is almost impossible to image a position less likely to garner support, either in Russia, where the Putin administration has quietly encouraged a willing recrudescence of great-power rhetoric, or the West, where the slightest whisper of clashing civilizations is sufficient for intellectual ostracism (as Oriana Fallaci will attest).

Similar confusions bedevil Western commentary on Iraq. In an article unambiguously entitled "Our Enemies, the Saudis" in the July-August issue of "Commentary," Victor Davis Hanson urges the U.S. to "recalibrate" its oil policy in favor of Russia and the former Soviet Union. "Not only would such suppliers increase the pool of the world's oil and gas, and thereby lessen Saudi influence, but at least in the case of Russia we would be buying from a struggling democracy rather than from a small elite already as rich as many of its silenced people are poor." Hanson concludes that "a new Iraq might start the fall of dominoes in the Gulf that could wipe away the entire foul nest behind 11 September." Leaving aside the questionable contrast Hanson draws between Saudi Arabia and Russia, what effect might this increased pool of oil and gas have on Russia's economy, and struggling democracy? Might not other dominoes fall elsewhere?

In a widely noted antiwar article entitled "Bush and Iraq" that appeared in the 7 November issue of the "New York Review of Books," Anthony Lewis hints darkly that "American business leaders and economists have started to express their fears about the effect of rising oil prices resulting from a war on Iraq." Now oil prices are going up, assuming their familiar American guise of economic bugbear.

Paul Klebnikov, who has written extensively on Russian business and authored a biography of Boris Berezovskii, somehow manages to avoid all mention of Russia in an optimistic piece on Iraqi oil in the 28 October issue of "Forbes." He does, however, sketch out what must certainly be the Russian nightmare scenario. "If a U.S.-led force succeeds in ousting Saddam," Klebnikov writes, "it's a good bet that [big American] companies will come in as soon as the fighting has died down." He then quotes Fadhil Chalabi, a former Iraqi Oil Ministry official turned emigre energy pundit: "I could see the price for West Texas Intermediate going from $30 today to $15...." Klebnikov's conclusion: "Saddam's fall bad news for some of his rival regimes in oil-rich lands. But for the rest of the world, a gusher."

It's not as though the question of Iraqi oil has elicited purely unambiguous commentary. A sobering survey of the complexities by Serge Schmemann appeared in "The New York Times" on 3 November. He notes Iraq's debts to Russia, the multibillion-dollar deals Russian oil companies have inked with Saddam Hussein's regime, the possible effects of a war, and the conundrum this poses for Russia. But his is a survey, not a contribution to the debate, and he leaves it at that.

Viewing the debate over war in Iraq through the admittedly parochial lens of the Russian economy has the distinct virtue of revealing the illusions behind the polemics. For Radzikhovskii, who accepts as axiomatic both Russia's inability to influence American foreign policy and the momentous implications of a U.S. victory in Iraq, the illusion is that of a grand historical narrative restored, with Russia resuming its place on the front lines of Christendom's struggle against the Mohammedan hordes. For Hanson, the illusion is that what is bad for our enemies, the Saudis, is good for the struggling, democratic Russians. For Klebnikov, the illusion is that American companies pumping cheap oil out of Iraq will unleash such a gusher of good that its effects on Russia merit no mention.

The first shot has not yet been fired in Iraq. But the fog of war seems to have settled over us already. DK