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Business Watch: November 26, 2002


26 November 2002, Volume 2, Number 36
ENERGY
RUSSIAN ENERGY REFORM SPARKS CLASH...IN BOSTON
A simmering feud over reforms in Russian electrical energy monopolist Unified Energy Systems (EES) boiled over into mutual, and very public, recriminations between Russian officials before the bewildered American attendees of a Harvard University-sponsored symposium, "Izvestiya" reported on 18 November. The restructuring plan presented to symposium participants by EES Deputy CEO Sergei Dubinin envisages splitting the monopoly into 10 generating assets with a single power grid and ending state regulation of prices by 2005. Foreign utilities will participate in tenders to operate two of 10 generating companies, and a "guarantee fund" will ensure a return on investments even if electricity prices stay low, "The Wall Street Journal" reported on 18 November. Presidential adviser Andrei Illarionov shocked symposium participants, deriding the scheme as "worse than [Soviet central-planning agency] Gosplan" and calling Dubinin a "professional liar," "Vedomosti" reported on 18 November. In an editorial the same day, the newspaper quoted a conference participant as saying that "after such remarks, investors should 'run as fast they can.'" With a long-suffering energy-reform bill currently staggering under 1,800 amendments in parliament, "Finansovaya Rossiya" speculated on 21 November that Illarionov's outburst in Boston may have been a coded message from the presidential administration intended "to free foreign investors from any illusions they might have about the timetable for reform in the Russian energy sector." DK

SURGUTNEFTEGAZ ANNOUNCES 2001 RESULTS
Third-biggest oil producer Surgutneftegaz on 20 November released its 2001 financial statement according to U.S. GAAP (Generally Accepted Accounting Principles) standards. The company's 2001 net profit was $1.57 billion, a 21 percent drop from $1.98 billion in 2000. Direct oil-production costs rose 16 percent year-on-year to $2.9 per barrel, more than the $1.8 and $1.7 per barrel that industry leaders Yukos and Sibneft posted, "The Moscow Times" reported on 21 November. Analysts feel that Surgutneftegaz needs to acquire new assets with the $4.2 billion in cash on its accounts and freshen up its reserves, "Vedomosti" reported on 21 November. The company will have an excellent opportunity to do both at the 18 December Slavneft privatization auction, where bidding is set to start at $1.7 billion. DK

GAZPROM TO BUILD BALTIC PIPELINE
Gazprom's board approved a North European gas-pipeline project on 18 November, "Izvestiya" reported on 19 November. The decision to go ahead with the project, which entails building a pipeline under the Baltic Sea to supply European consumers with gas by 2007, comes against a backdrop of ongoing difficulties with existing routes through Belarus, Poland, and Ukraine, "The Moscow Times" reported on 19 November. According to a report in "Vedomosti" the same day, the pipeline will cost $8 billion-$10 billion to construct and could involve cooperation with a major Western investor. Troika Dialog analyst Valerii Nesterov told the newspaper that "the Baltic Sea pipeline is expensive, of course, but unrivaled for dependability and diversification of export routes." DK

FINANCE
NEW GAZPROMBANK HEAD AMID SALE RUMORS
A shareholders meeting of Gazprom's in-house bank, Gazprombank, elected state-banking-sector veteran Andrei Akimov chairman of the board on 21 November, "Vedomosti" reported on 22 November, as rumors swirled that the appointment could pave the way for the creation of a new, state-run banking powerhouse. Akimov held various management posts between 1974 and 1987 in Vneshtorgbank, the Soviet Union's foreign commercial bank. From 1991-2002, Akimov was director of Austrian finance company IMAG, where he oversaw purchases of Russian oil. Gazprom announced in late September that it plans to sell a 49 percent stake in Gazprombank, which the gas monopolist currently uses to manage the bulk of its accounts. A 20 November article in "Kommersant" quoted anonymous insider sources who said that Mezhprombank (International Industrial Bank) is interested in the deal. Industry analysts quoted in "Vedomosti" fingered a "large financial-industrial group or energy-sector exporter" as the likely candidate. Gazprombank has the fifth-largest capital reserves (21. 5 billion rubles, or $676 million) and third-largest assets (117.8 billion rubles) in Russia; a merger with Mezhprombank would make it the country's second-largest bank. DK

INVESTMENT
CITIBANK OPENS DOORS TO RETAIL CLIENTS IN MOSCOW
U.S. banking behemoth Citibank opened its doors to individual Russian clients on 20 November with a retail outlet in Moscow, "The Moscow Times" reported on 21 November. Citibank is already the largest foreign bank in Russia, with $1.7 billion in local assets, but had held off on the move from corporate to retail services until now. The bank is betting on name-brand recognition and a range of Internet- and phone-based services to lure clients. Deposits above $3,000 initially will earn 1-1.23 percent annually in dollars, 2.68 percent in euros, and 12.02-12.04 percent in rubles. While Citibank will not set a minimum-deposit amount, it will require clients to prove that their funds were legally acquired, leading gazeta.ru to remark on 21 November that Citibank's transparency standards could scare off members of the "progressive middle class," whose earnings are often documented with more creativity than accuracy. Foreign banks are currently bit players on the Russian retail-deposit market. According to "The Moscow Times," the eight leading foreign banks can claim $547 million in deposits, with Austria's Raiffeisenbank leading the pack with $228 million. By comparison, state-controlled Sberbank holds $20 billion in deposits. Still, the financial turmoil of the 1990s sapped Russian confidence in banks, and by some estimates the mattresses and floorboards are the real leaders with up to $40 billion in snugly rolled deposits. DK

WAL-MART TO TAKE ON RUSSIA WITH GERMAN HELP
Wal-Mart Stores Inc. has reached an agreement with Germany's Real Holding GmbH, a part of Metro AG, in a deal that will give the American retail giant a 20-store foothold in the Moscow market, "Kommersant" reported on 20 November. Real Holding will collaborate with well-connected Moscow developer Chalva Chigirinskii on a $500 million project to build 20 hypermarkets beginning in 2003. Wal-Mart will then purchase the chain, presumably catapulting itself into a leading position on the Moscow retail market. Company representatives were tight-lipped on the deal, neither confirming nor denying, but industry watchers surveyed by "Kommersant" described the move as a logical way for Wal-Mart to expand to Russia. IK Prospekt analyst Marat Ibragimov told the newspaper, "This gives Wal-Mart a chance to enter the Russian market quickly and without risks,... since the Germans already have good contacts with the Moscow authorities." Interest in the Russian retail market has been on the rise of late. Wal-Mart representatives visited Moscow twice this year. Procter & Gamble spokesman Georgii Soustin told "Kompaniya" No. 39 in October that "[large retail] companies like Metro and Aushan have a bright future in Russia." British industry publication "The Grocer" reported on 26 October that a recent food-retailing conference described the Russian grocery market as "huge, untapped, and ripe for consolidation," estimating its total size at $89 billion. DK

DOUBTS GROW OVER SAKHALIN PROJECT
ExxonMobil and Royal Dutch/Shell are tying further investment in the Sakhalin-1 and Sakhalin-2 oil-drilling projects to changes in Russian legislation, "Energy Compass" reported on 22 November. Shell leads the Sakhalin-2 consortium, which plans to invest $8.5 billion in the project's second stage. Exxon heads the $12 billion Sakhalin-1 project. According to a 20 November article in "Vedomosti," Sakhalin Energy Chief Executive Steve McVeigh announced at a 19 November press conference in London that Sakhalin-2 investors worry that gaps in Russian production-sharing legislation could allow Russian lawmakers to set arbitrary tariffs and prices. Western investors want a "grandfather clause" added to the production-sharing agreement (PSA) to protect them from future changes to legislation. Olga Rybak, head of the Economic Development and Trade Ministry's PSA department, objected, telling "Vedomosti" that "the PSA already has a 'grandfather clause'.... We can't change federal laws just because Shell wants us to." Russian officials claim that Western investors are wary of further investment because they haven't done enough to ensure a market for the oil and gas the projects will produce. A 21 November editorial in "Vedomosti" noted that while Sakhalin Energy -- faced with weak demand in Japan, China, and Korea -- has dragged its feet on contracts with potential gas buyers, investors' fears are "justified." "Until the authorities curb their desire to control the oil and gas business, one can hardly expect them to observe the agreements they have signed with investors, or hope for an influx of investments into the country," the editorial concluded. DK

COMPANIES
AEROFLOT PURCHASE HITS TURBULENCE
An Aeroflot deal to buy 18 French Airbus airliners hit a snag, gazeta.ru reported on 23 November, when the company decided to postpone indefinitely a meeting of the board of directors intended to discuss funding for the purchase. The deal was inked on 18 November during Prime Minister Mikhail Kasyanov's visit to Paris, "Vedomosti" reported on 19 November. Aeroflot was to lease eight A319/320's directly from Airbus and another 10 through U.S.-based GE Capital Aviation Services, "Kommersant" reported on 19 November. While Aeroflot and Airbus did not comment on the total amount involved, press sources estimated the deal's worth at $600 million-$900 million. Aeroflot decided in early 2002 to modernize its fleet of foreign-made aircraft, but the company's charter requires that a shareholders meeting approve any deal that exceeds 50 percent of the company's assets, a condition met by a $600 million agreement. After two strife-ridden shareholder meetings earlier this year, "Vremya novostei" reported on 19 November that Aeroflot's management is eager to avoid a replay. According to gazeta.ru, the Finance Ministry reported on 22 November that allowances for Aeroflot and Transaero have cost the state $1.15 billion, casting doubt on future government assistance, and perhaps even the Airbus purchase. DK

NORILSK NIKEL ACQUIRES MONTANA MINING COMPANY
Norilsk Nikel, part of influential tycoon Vladimir Potanin's empire, has sealed a deal to acquire a 51 percent stake in Stillwater Mining Co., "The Wall Street Journal" reported on 22 November. Norilsk will pay $341 million for the company, putting up $100 million in cash and the rest in palladium. The deal, which still requires approval from Russian and U.S. authorities, will allow Norilsk to sell its huge reserves of palladium through Stillwater's contracts with major automakers like Ford Motor Co. and Japan's Mitsubishi Corp. Demand for palladium, which currently sells for roughly $275 an ounce, has fallen in recent years after the auto and electronics industries sought out substitutes in the early 1990s, when chaos in Russia sent prices skyrocketing to over $1,000 an ounce. Industry analysts told "Vedomosti" on 22 November that Norilsk got a good price for Stillwater, but the deal still indicates that the metals giant has trouble moving its product to market. Troika Dialog analyst Vasilii Nikolaev told "The New York Times" on 22 November that "it's probably a smart move to get this kind of access to U.S. consumers,... [but] the problem is not only a lack of trust in Norilsk as a supplier but also weak demand." U.S. investors had a tepid reaction to the low purchase price, as Stillwater shares on the NYSE dropped 5.1 percent on news of the deal to $7.03. DK

AVTOVAZ STOPPAGES ILLUSTRATE INDUSTRY WOES
After failing to ease an overproduction crisis with a 26 October-10 November stoppage, automaker AvtoVAZ will halt production again from 15 December to 15 January, "Kommersant" reported on 22 November. Faced with slumping demand and stiff competition from foreign carmakers, AvtoVAZ has not managed to make much of a dent in a production surplus that could be as large as 90,000 cars. Dealers fret that the automaker has no long-term solutions beyond cooling its conveyer belts. "The factory isn't doing anything to support sales," a LadaLend dealer complained to "Kommersant." Meanwhile, foreign automakers are making every effort to win over Russian buyers. The major players are Korea's Hyundai and Kia, German-owned Skoda, U.S.-based Ford, and France's Renault. All offer cars in the $8,000-$12,000 range that boast higher quality than Russian equivalents and more flexible credit options for buyers. According to a feature story in "Itogi" No. 46 on 19 November, Skoda's sales for the first nine months of 2002 rose by 45 percent to 7,745, Renault's by 58 percent to 6,042, Kia's by 31 percent to 2,824, and Hyundai's by more than 100 percent to 2,939. The absolute numbers remain small, but some feel the writing is on the wall. In an illustration of the trend, Renault is gearing up to assemble its compact Symbol in Russia, "Vedomosti" reported on 18 November. Initial production targets are a modest 20 cars a day. Renault joins Ford, Hyundai, and Kia, which also have assembly facilities in Russia. DK

OWNERSHIP AND TAX SCANDALS HIT DIAMOND MONOPOLIST
In two separate developments, the state retook control of a 5 percent stake in Alrosa and the Tax Inspectorate presented the diamond monopolist with a $1 billion bill for unpaid taxes. To kick things off, Deputy Prime Minister Aleksei Kudrin announced on 20 November that the Property Relations Ministry repossessed a 5 percent stake in Alrosa previously controlled by the scandal-plagued Garantiya Foundation, "Kommersant" reported on 21 November. The Russian federal government and Yakut local government each hold 32 percent stakes in Alrosa, enterprise workers hold a 23 percent stake, and eight Yakut villages hold a combined 8 percent stake. According to a 21 November report in "Vedomosti," a "highly placed official" explained that Garantiya's 5 percent stake, valued at $50 million-$100 million, was transferred to state ownership by decision of the foundation's administration. The foundation is embroiled in a struggle for control between two parties. According to embattled Director Roman Blokhin, the transfer decision, which Blokhin termed a "gross violation of the law," originated with a pro-Kremlin faction linked to the security services. Meanwhile, Alrosa management confirmed on 21 November that they received from tax inspectors a voluminous document detailing violations of the Tax Code totaling nearly $1 billion, "Kommersant" reported on 22 November. "Kommersant" noted that the tax dispute might stem from a tug-of-war between the federal center and local government. Alrosa rents its diamond mines from the Yakut government at a rate set in 2002-03 at 18.1 percent of revenues, or $320 million annually. The federal government would like to see the arrangement altered in its favor. Whatever the case may be, Alrosa Vice President Fedor Andreev told "Kommersant" he is confident the company will succeed in overturning "90 percent" of the Tax Inspectorate's charges. DK

COMMUNICATIONS
VIMPELCOM THIRD-QUARTER RESULTS A PLEASANT SURPRISE
Vimpelcom's announced better-than-expected third-quarter profits in a 21 November unaudited financial statement. The second-placed cellular operator's net profit jumped from $20.94 million in the second quarter to $40.49 million, 32 percent higher than analysts' forecasts of $30.88 million, "The Moscow Times" reported on 22 November. Third-quarter earnings before interest, tax, depreciation, and amortization (EBITDA) came to $102.57 million as compared to $71.76 million in the second quarter. EBITDA margin was 46.4 percent. Renaissance Capital analyst Aleksandr Kazbegi told "Vedemosti" on 22 November that Vimpelcom's higher-than-expected profits will serve to advance the company's regional expansion plans. DK

DELTA TELECOM GOES DIGITAL IN PETERSBURG
St. Petersburg-based cellular operator Delta Telecom has obtained the first Russian license to provide wireless-communications services using digital CDMA (Code Division Multiple Access) technology, "Vedomosti" reported on 20 November. Delta borrowed $15 million from the National Reserve Bank to purchase the third-generation (3G) technology from Lucent Technologies. The cellular operator will start with a 50,000-number pilot project in the same area -- St. Petersburg and adjoining regions -- where it now employs the analogue-standard NMT-450. Delta Deputy Director Aleksei Blyumin told "Vedomosti" that the new service, despite being advertised with the slogan "Not GSM," will not initially aim to compete with GSM networks. The test market will be middle-class and corporate clients. While CDMA technology (also known as IMT-MC 450) makes possible the conversion of existing NMT networks to digital with improved quality and range, gazeta.ru commented on 23 November that the "commercial potential" remains unclear. The CDMA Development Group, a nonprofit trade association, announced on 4 September that there were more than 127 million CDMA customers worldwide by the end of the second quarter of 2002, with 15 million of them using 3G CDMA-2000 technology. According to "Vedomosti," commercial CDMA-450 networks currently exist in Romania and China. DK

AROUND THE CIS
THIRD TIME'S NO CHARM FOR MOLDOVAN PHONE PRIVATIZATION
A Moldovan government commission rejected a bid by Moscow City Telephone Network (MTGS), acting on behalf of Russian financial group AFK Sistema and its telecommunications affiliate Mobile TeleSystems, for a 51 percent stake in national telephone monopolist MoldTelecom, Moldovan news agency BASA reported on 20 November. According to the agency, MGTS's offer of $20 million fell short of the $60 million Moldovan officials have hoped to receive. Aleksandr Goncharuk, who manages Sistema's telecommunications assets, sounded every bit the frustrated, world-weary, foreign investor commenting to "Vedomosti" on 21 November: "The Moldovan side doesn't have any experience with these things. Our guys had a rough time there but they're 10 times wiser and more experienced now." The Moldovan side, whose experience includes aborted privatization attempts in 1998 and 2000, had no word on whether a new effort is in the works after this latest failure. DK

ITERA CUTS OFF GEORGIAN CAPITAL TO COLLECT GAS DEBT
Russian natural-gas supplier Itera left the Georgian capital of Tbilisi out in the cold on 16 November, cutting off gas shipments in an attempt to collect on an outstanding debt for past shipments, "Kommersant" reported on 18 November. "At present, not a single gas stove is working in Tbilisi, and the temperature in the central heating system has gone down," the newspaper added. Itera's Georgian affiliate, Gruzgaz, told "Kommersant" that Tbilisi missed $1.7 million in payments for October shipments. Supplies were partially restored on 21 November after Georgian Energy Minister David Mirtskhulava met with Itera officials in Moscow to restructure Georgia's $80 million debt for gas shipments from 1996 to 2002, RosBusinessConsulting reported on 21 November. Such debt-collection tactics are increasingly common between Russian energy exporters and former Soviet republics, as illustrated by the recent spat between Gazprom and Belarus, which ended in a grudging Belarusian agreement to cough up cash for gas debts. DK

IN FOCUS
THE DOMINANT PARADIGM
Russian linguist Roman Jakobson's theory of the "dominant" dealt with the focusing component of a work of art. Yet, like other popular theories, the concept of the dominant is sufficiently broad to remain relevant beyond its original purview. Western coverage of Russia, for example, exhibited two main focusing components in the second half of the 20th century: Cold War standoff and post-Soviet transition. Recent coverage of Russia -- and, more specifically, Russian business -- hints that a new dominant might be in the offing.

If the dominant of Cold War coverage was the ideological standoff between two overarching systems for organizing human affairs, its successor was "transition" -- the long, hard road from one model of society to another. Just as the standoff had acted as a focusing component by aligning cliches and comments along an ideological spectrum symbolically mapped out between Washington and Moscow, the transition realigned the way Westerners wrote about Russia to include motion in the equation. The dominant in writing about Soviet Russia was a focus on how it differed from the West; the dominant in writing about post-Soviet Russia shifted to a focus on how Russia was becoming more like the West.

Transition remains the dominant in elite discourse about Russia. Leon Aron's "Russia's Revolution" in the November issue of "Commentary" makes a passionate argument for viewing Russia's ongoing progress as "a dramatic break with Soviet totalitarianism in all its guises." In "How Different Is Putin's Russia?" ("Foreign Affairs," November/December 2002), Daniel Treisman grumps, "On close examination, much that looks new and different in Russia today turns out to be neither."

When dominants change, however, the shift is often less evident in the ruminations of eminent analysts than in the tumult of the daily news, where editors are more willing to shrug off yesterday's paradigm in a quest for tomorrow's breaking angles. A 19 November profile in "The Washington Post" of Russian oil tycoon Mikhail Khodorkovskii and a 24 November "The New York Times" analysis entitled "Why U.S. Oil Companies And Russian Resources Don't Mix" suggest that transition may be giving way to something new.

"Russian With a Western Way" describes Yukos CEO Khodorkovskii's rapid ascent from oligarchic outsider to respectable Western businessman. Aided by "several billion dollars," Khodorkovskii has had the good sense to generate positive press through sponsoring admirable charities and hobnobbing with "the Great and the Good." As the CEO of a publicly traded corporation, he has a "direct financial interest in his own respectability." The article has no bone to pick with this, ending instead with the reasonable caveat that "Russian money is a new force in the land of lawyers, lobbyists, and think tanks, and we ought to remember that it's there."

The second article argues that while Russia's 49 billion barrels of oil and 1,680 trillion cubic feet of natural gas make it "too big to be ignored," "stubborn bureaucracies and hostile local oil companies" stymie cooperation and investment: "American oil companies are not buying." In conclusion, the article quotes an industry analyst who says that the major Russian players are ready and willing to go it alone: "Their feeling is that '10 years ago, no one expected us to be where we are now, and who's to say what we will be able to do in the next 10 years?'"

In neither article is the focusing component Russia's halting or bounding progress in the transition toward a more Western model of society. In fact, both articles treat the transition itself as old news hardly worthy of mention. Instead, the focusing component is Russia's -- and Russians' -- ability to parlay wealth, be it financial or fossil, into influence and greater wealth.

The money/power minuet is hardly novel. What would be new, and quite intriguing, is if it replaced transition to become the new dominant in Western coverage of Russia.

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