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Business Watch: December 3, 2002

3 December 2002, Volume 2, Number 37
A foursome of Russian oil majors announced on 27 November their intention to embark on a pipeline and port project with an eye to expanding their export capacity and conquering new markets, "The Wall Street Journal" reported the same day. In a rare show of cooperation, Yukos CEO Mikhail Khodorkovskii, LUKoil President Vagit Alekperov, Sibneft President Yevgenii Shvidler, and Tyumen Oil Company (TNK) director German Khan signed a memorandum of understanding to construct a pipeline across Siberia to a deepwater port in Murmansk. The preliminary agreement calls for Yukos and LUKoil to provide two-thirds of the financing for the $3.5 billion-$4.5 billion project and to supply 1.2 million barrels per day (bpd) when the project becomes operational, reported on 27 November. TNK and Sibneft will be jointly responsible for supplying the remaining one-third of money and oil, and oil-company spokesmen hinted that other investors could join the bandwagon. If the project goes on line as scheduled in 2007, it will link Russia's remote oil-rich regions with a year-round ice-free port, reducing export costs and upping capacity, currently hampered by an overburdened pipeline system and lack of viable ports. Project participants see added incentive in estimates that Russian oil could account for 13 percent of the U.S. market by 2010. Despite the obvious benefits, "Petroleum Argus" analyst Mikhail Perfilov sounded a critical note to "Vedomosti" on 28 November, calling the U.S. market "ephemeral," especially if Washington manages to install a friendly regime in Baghdad and gain access to cheap Iraqi oil. (DK)

President Vladimir Putin's 1-3 December visit to China could add political impetus to a pipeline Yukos plans to build to move oil reserves from eastern Siberia to China's burgeoning market, "Nefte Compass" reported on 26 November. According to "Ekspert" No. 44, China National Petroleum Corporation will invest $700 million in 800 kilometers of pipeline through China, while Yukos will cover the Russian leg of the $1.7 billion project. Chinese crude imports from Russia jumped 65 percent over the first 10 months of 2002 to 65,000 bpd. Most of that volume belongs to Yukos, which hopes to increase shipments in 2003 to 50,000 bpd. Set to become operational by 2005, the Angarsk-Daqing pipeline highlights efforts by Russian oil producers to position themselves as an alternative to the politically unstable Persian Gulf region. The project could also provide a test case for altering Russian pipeline legislation, "Nefte Compass" reported. Yukos has made its commitment to financing the pipeline contingent on obtaining the right to set tariffs. The issue of pipeline tariffs is a contentious one, and foreign investors have grumbled that national pipeline operator Transneft's power to set tariffs hampers the further development of major export projects. (DK)

The Belarusian Currency and Stock Exchange's auction of Belarus's 10.83 percent stake in soon-to-be-privatized oil company Slavneft failed to generate either excitement or juicy offers, "Nezavisimaya gazeta" reported on 27 November. The newspaper reported that the sole offer of $207 million came from Slavneftebank, acting on behalf of oil major Sibneft. The offer fell by the wayside when Minsk, buoyed by news of the $1.7 billion starting price the Russian Federal Property Fund set for the 75 percent stake in Slavneft Moscow will put on the block on 18 December, revised its expectations upward to nearly $250 million. Sibneft had initially estimated the value of the Belarusian stake at $100 million-$120 million, a company source told "Vedomosti" on 25 November. Sibneft already owns part of a trust company that holds a 12.98 percent stake in Slavneft, and while an additional 10.83 percent stake would give it an edge in the upcoming privatization auction, most analysts felt that $250 million is simply too high a price to pay. Behind-the-scenes negotiations between Minsk and Sibneft, and perhaps other Slavneft suitors, are likely to continue until the gavel falls in Moscow on 18 December. (DK)

The volume of MasterCard transactions in Russia increased by 104.2 percent over the first nine months of 2002, Interfax reported on 26 November. According to data supplied by MasterCard International, debit-transaction volume came to 634,661 euros ($630,409). The number of transactions for the period in question rose by 87 percent, topping the 3 million mark. A recent study by Interactive Research Group confirmed plastic's growing popularity in Russia, "Vedomosti" reported on 27 November, with 47 percent of survey respondents naming debit-card transactions as the most important service they expect from a bank. Unfortunately, the incidence of fraudulent transactions has kept pace with plastic's burgeoning popularity. Lev Arshanskii, director of security for processing firm UCS, told "Vedomosti" on 28 November that fraudulent transactions account for 0.32 percent of total transaction volume in Russia, against a world average of 0.11 percent. According to Arshanskii, Russia's "second capital" of St. Petersburg is first in fraud, accounting for some 85 percent of bogus transactions. Experts attribute the northern capital's penchant for dubious debits to a financial infrastructure that has outpaced banks' and law enforcement's ability to monitor card use. (DK)

A planned merger of Tatarstan's Ak Bars and Zenit banks has encountered opposition from the Novolipetsk Metallurgical Plant (NLMK), which owns a 20 percent stake in Zenit, "Vremya i dengi" reported on 27 November. Oil company Tatneft, which owns a 50.05 percent stake in Zenit and a 29.09 percent stake in Ak Bars, wants to merge the banks, creating a new structure that will be one of Russia's 10 largest banks. The supervisory board of Ak Bars voted to approve the merger in a secret meeting on 23 November, "Vedomosti" reported on 26 November, while Zenit's board, inspired by NLMK dissenters, decided on 25 November to call an extraordinary shareholders meeting within 45 days to vote on the merger. Richard Hainsworth, the head of rating agency RusRating, told "Vedomosti" on 25 November that a large Western investor could take an interest in Zenit. For its part, NLMK management told "Vedomosti" on 26 November that they see little economic justification for the merger. RusRating analyst Sergei Tubin told the newspaper: "These banks are too different, and it's impossible to merge them without doing a lot of harm. What shareholder would support a decision that is obviously unfounded economically?" (DK)

The Russian Union of Industrialists and Entrepreneurs (RSPP) allowed some of the Russian business world's heavy hitters to have their final say on currency regulation at a 27 November conference, a day before the government approved its near-final version of the draft bill "On currency regulation and control" for submission to parliament, "Kommersant" reported on 28 November. The draft has been the subject of animated debate over the past month between control-minded officials and a business world increasingly vocal about its distaste for stringent currency regulations. Kakha Bedukidze, general director of Unified Machine-Building Plants and head of the RSPP's Tax and Budget Committee, confirmed his reputation as a staunch opponent of regulation, publicly betting $75,000 (the maximum sum that Russian citizens can move abroad to purchase securities) against $7,500 that no one could prove in an open debate the effectiveness of currency regulation. Alfa Bank president Petr Aven, who pioneered currency controls during his tenure in government in the early 1990s before switching to the private sector and seeing the error of his ways, huffed that "all arguments in favor of maintaining currency limitations are false" and promised to fight the pernicious limitations up to the Constitutional Court. For its part, the government seems ready to submit a compromise draft bill that will reduce the amount of hard-currency revenues exporters are required to convert to rubles from 50 to 30 percent, make it easier for Russian citizens to open accounts abroad, and compel the Central Bank to coordinate emergency restrictions with the cabinet. Hard lobbying by business moguls has whittled away many restrictive measures initially included in the draft; they are likely to keep at it as the bill makes its way through the Duma. (DK)

Six traders and analysts sought refuge in anonymity to tell Reuters on 28 November that aluminum magnate Oleg Deripaska and politically connected oil tycoon Roman Abramovich may have bought up 20 percent of shares in Unified Energy Systems (EES). The sources speculated that the moguls might be snapping up shares to ensure that the enterprises they control have a steady supply of cheap power. "Vedomosti" queried representatives of Deripaska and Abramovich on 29 November, garnering a "no comment" from the press secretary of an Abramovich-affiliated company and a denial from the public-relations department of Deripaska's Base Element investment company. Nevertheless, EES board member Andrei Trapeznikov told "Vedomosti" that the company's increased capitalization indicates that a buy-up is in progress. Zenit bank analyst Sergei Suverov expressed similar sentiments, commenting to the newspaper that, "We can't rule out that more than $500 million has been spent on this buy-up...and the buyers are Russian investors, since the share of ADR [American depositary receipts] owners is going down." (DK)

Ulyanovsk-based aircraft manufacturer Aviastar and Egypt's Sirocco Aerospace International officially inked a pre-export finance deal on 29 November for the production of 25 Tu-204 planes, reported the same day. According to the website, Sirocco Aerospace, which has had exclusive marketing and sale rights for the Tu-204-120 with Rolls-Royce engines since 1996, will provide $150 million in financing in exchange for 25 percent-minus-one-share stakes in Aviastar and Tupolev. RIA-Novosti reported on 29 November that Sirocco Aerospace owner Ibrahim Kamil will invest $280 million over a two-year period for the two stakes. "Vedomosti" also reported the $280 million investment amount on 27 November. Another player in the deal is the European Bank for Reconstruction and Development (EBRD). "The Moscow Times" reported on 28 November that the EBRD's board is expected to extend its approval next month of a $50 million loan to Sirocco Aerospace Russia, a specially created Russian affiliate of the Egyptian parent company. EBRD press secretary Richard Wallis told "Vedomosti" that: "The money will be used to construct Tu-204-120 aircraft that Sirocco plans to sell for export. We consider this a promising project." If the loan goes through, it will be the EBRD's first foray into the Russian aerospace industry. (DK)

With increased funding for the Electronic Russia program approved for 2003, the Communications Ministry evaluated the project's progress thus far and discussed future development prospects during a 29 November meeting, "Vremya MN" reported on 30 November. Parliament voted on 22 November to raise E-Russia's 2003 funding to 1.43 billion rubles ($44.9 million) from 1.23 billion rubles, "Vedomosti" reported on 27 November. The program aims to increase Internet use and awareness, especially as a means of bringing government closer to citizens. Participants in the Communications Ministry colloquium stressed that E-Russia will focus in 2003 on regional consciousness raising and the Cyberpost project, which will provide Internet access at local post offices. Higher School of Economics rector Yaroslav Kuzminov emphasized the need to augment equipment purchases with appropriate training, noting that while state institutions direct 70 percent of information-technology expenditures toward acquiring new equipment, they spend only 1 percent on training staff. (DK)

Russian national long-distance operator Rostelecom plans to consolidate its networks and expand fiber-optic connections abroad, "Vremya novostei" reported on 26 November. Rostelecom launched a 456-kilometer Russia-Kazakhstan fiber-optic cable in May, improving its access to Central Asia. The company announced on 25 November that it has begun to construct a Russia-Azerbaijan fiber-optic link that will eventually encompass Georgia and Armenia, "Vedomosti" reported on 26 November. Transtelecom's public-relations manager, Andrei Polyakov, called the Azerbaijan project a "dependable entrance to the Caucasus region." Nikoil analyst Konstantin Chernyshev told "Vedomosti" that Rostelecom's Caucasian expansion will bring the company increased profits, but Troika Dialog analyst Yevgenii Golosnoi felt that while the company needs to upgrade to digital lines, the initial effect on profits will be slight. "Vremya novostei" noted that even analysts who are bullish on Rostelecom's expansion plans feel that the operator will have difficulty wresting its share of international traffic from foreign companies that already have more transit capacity than callers to fill the ether. (DK)

Mobile Telesystems (MTS) President Mikhail Smirnov announced on 27 November at the Belarusian Investment Forum in Minsk that MTS will invest $60 million in 2003 to develop a cellular network in Belarus, RIA-Oreanda reported on 28 November. Belarusian-Russian joint venture Mobile Telesystems, in which Belarusian unitary enterprise Intercity Communications holds a 51 percent stake, will implement the project, which envisions increasing the number of base stations in Belarus from 123 to 140. Industry watchers reacted coolly to the idea. Nikoil analyst Vladimir Bogdanov offered "Vedomosti" an uncharitable description of Belarus on 28 November, calling it a "poor country with serious political risks." Deutsche Bank analyst Yuliya Matevosova seconded him, telling the newspaper that while "the market is quite large...working conditions there are just awful." (DK)

America's AES Corporation intends to divest itself of its controlling stakes in Ukrainian utilities Kyivoblenerho and Rivneoblenerho, "Vedomosti" reported on 26 November. AES paid $70 million for 75 percent-plus-one-share stakes in the two utilities in a May 2001 privatization deal and has since invested $15 million in the enterprises. AES representatives refused to confirm or deny the news to "Vedomosti," but Ukrainian Fuel and Energy Ministry spokesman Vitaliy Hayduk told the newspaper that officials are aware of the plan. He named Russia's Unified Energy Systems and Slovakia's VES, which already owns three Ukrainian utilities, as potential buyers. With a $300 million-plus-interest bond payment due on 16 December, AES has ample need to raise funds, "The Washington Post" reported on 18 November. Debt-fueled growth made Arlington-based AES the world's largest producer of electricity, but economic turmoil in South America and losses from its $3 billion acquisition of England's Drax Power Station have hurt the company's financial profile. According to "The Washington Post," cash-strapped AES hopes to raise $800 million in asset sales to cope with 2003 debt-repayment deadlines. (DK)

The Russian equivalent of "still waters run deep" is the slightly menacing "devils lurk in the stagnant depth," a proverb that tidily summarizes the messy straits of the country's largest company. Gazprom holds sway over more natural-gas reserves -- one quarter of what our planet is known to contain -- than any other company in the world, and the taxes it pays on its export earnings account for nearly one-fifth of Russia's tax revenues. Yet the gas giant's latest financial results, which chronicled a mysterious drop in profits and a worrisome weight of debt, are only one small part of the problems that continue to bedevil a company that could potentially rise to take its place among the mightiest transnational energy titans.

Gazprom announced its results for the first half of 2002 on 26 November to a chorus of concerned sighs from industry analysts. The bottom line, calculated to U.S. GAAP (Generally Accepted Accounting Principles) with certain omissions, featured a 15 percent drop in net profit to 9.8 billion rubles ($310 million) from 11.5 billion rubles in the first half of 2001. Revenues sank to $9.2 billion from $11.1 billion in the first half of 2001. The company's debt increased by $700 million in 2002 to some $15 billion, with short-term obligations rising from 51 percent to 53 percent of the total. Rounding out the dreary picture, negative cash flow reared its head for the first time since 1999.

Analysts had nary a kind word for the company, as the lower-than-expected results came on the watch of a new management team that had been charged with restoring order after years of asset-stripping mismanagement. "We've seen only sketchy results...but they're looking bad, very bad," Brunswick UBS Warburg analyst Paul Collison told "The Moscow Times" on 27 November. Though Gazprom representatives blamed the results on lower prices for gas in Western Europe, where the company earns 70 percent of its revenue and makes most of its profit, observers found this explanation unconvincing. "Finansovaya Rossiya" wrote on 28 November that Perm Securities Company analysts commented, "It is difficult to attribute the drop in revenue solely to lower prices for gas on export contracts." "Vremya novostei" concurred on 27 November, juggling various figures before concluding that only a posited drop of $28 in the price of 1,000 cubic meters of natural gas could explain Gazprom's slack revenues. "Vedomosti" was less diplomatic, grumbling in a 29 November editorial: "Where's the money? One can only guess."

Not everyone was quite so downbeat. Stephen Dashevskii sounded a strong contrarian note, telling "The Moscow Times" on 28 November that, with gas prices on the rise in Europe, "this is yesterday's news." He seconded himself to "Vedomosti" the same day with a strong vote of confidence for Gazprom CEO Aleksei Miller's team. Hermitage Capital Management director William Browder implied that Gazprom management could be using the grim financials as a bargaining chip in Russia's ongoing debate over the differential between cheap domestic natural-gas tariffs and market-driven rates abroad. He told "The Moscow Times" that, "They used every provision they could to lower their numbers so they could push for higher tariffs."

Browder, whose Hermitage Capital is believed to control up to 2 percent of Gazprom stock, detailed his own vested interest in those higher tariffs and the broader relevance for Gazprom in a 23 June article in "The Washington Post." Gazprom does business with the West at market prices. At home, it cuts domestic purchasers a big break, charging them 89 percent less than German customers. According to Browder, the discounts translate into $43 billion a year in subsidies to Russian companies. Even if the government follows the 2001 domestic tariff hike of 37.5 percent with similar, and similarly unpopular, measures, it will take Russian gas prices six years to catch up to Western levels. "Vedomosti" reported on 28 November, however, that the Economic Development and Trade Ministry's most recent proposal for reforming the domestic gas market posits more modest tariff increases of 20, 24, and 23 percent over the next three years. (DK)

It is, of course, no accident that the tariffs that so influence Gazprom's balance sheet should issue forth from a government office. Producer of 93 percent of Russia's gas, Gazprom is a state-run affair led by Putin-appointed CEO Aleksei Miller, described by Browder as a "loyal technocrat." The state owns a 38.4 percent stake in Gazprom and retains voting rights on a 14 percent stake held in trust. According to "Kompaniya" No. 45, Gazprom's management has succeeded in gaining control over 20 percent of the company's shares, giving the state a de facto 58 percent stake. The numbers are important to proponents of tariff reform. Economic Development and Trade Minister German Gref has said that full price liberalization will take place only when the state has a de jure controlling stake. But the additional 12 percent of Gazprom's shares that would give the state an official controlling stake have a market value of more than $2 billion, more money than even the most inventive, or heartless, accountant can squeeze out of the Russian budget.

None of the preceding can obscure the basic fact that, when push comes to shove, Gazprom has got the goods: 26 trillion cubic meters of them. Even here, however, one key qualification is in order. As a 9 September article in "Petroleum Economist" put it, "most of [Gazprom's] 100%-owned 26 trillion cubic metres of gas lie in daunting locations in remote Siberia or beneath the frozen waters of the Arctic oceans." The galling handiwork of geology and natural history translates into astronomical development costs. According to "Petroleum Economist," Gazprom plans to invest $69.7 billion to extract the estimated 10.4 trillion cubic meters of gas locked in Siberia's Yamal Peninsula.

In the end, Gazprom fascinates not because of its size and significance, but because it encapsulates so many of the pivotal contradictions in Russia's transition from a hobbled planned economy to a hobbling hybrid one. Partially owned and effectively (if not always efficiently) run by the state, Gazprom's shares are traded, albeit with restrictions, and even foreign investors own $1 billion of its stock. Nominally concerned with profit like any other company and expected to yield tax revenues like no other company, Gazprom is locked into a system of dual foreign-domestic pricing that skews its balance sheet, makes proponents of laissez-faire see red, and enshrines it at the center of a decade-long, politically charged Russian debate over the promise and peril of the free market. Blessed beyond measure with natural riches, Gazprom's progress toward commensurate profitability has been stymied by both the avarice of mercenary management and the cruel collusion of geography and climate.

Russian business has both its bellwethers and its behemoths. For better or worse, Gazprom has perhaps the strongest claim to being both. (DK)