Business Watch: June 3, 2003

Russian oil major Yukos and China National Petroleum Corp. (CNPC) signed a general agreement on 28 May paving the way for the construction of an oil pipeline from Angarsk in Eastern Siberia to Daqing in China, "International Oil Daily" reported the same day. The final 25-year contract, set to be signed in the fall, will have China buy 400,000 barrels per day (bpd) of crude starting in 2005, and 600,000 bpd by 2010, making for a grand total purchase of $150 billion. The agreement appears to mark a de facto victory for the Angarsk-Daqing pipeline project, which had vied with a plan to link Angarsk and Nakhodka on the Pacific Ocean. The costlier second option would open the door to Japanese and North American markets. "Despite the Japanese attempts to turn the pipeline their way, it became obvious to the market some time ago that the Angarsk-Daqing pipeline is the one the government supports," Alfa-Bank analyst Konstantin Reznik told "Vedomosti" on 28 May. When Japanese Prime Minister Junichiro Koizumi broached the topic with Russian President Vladimir Putin on 30 May, Putin would only agree to give the matter "serious consideration," "Oil & Gas Journal" reported the same day. An analyst for the Aton brokerage told "Izvestiya" of 29 May, "The government supports the Angarsk-Daqing project. This is good news for Yukos and YukosSibneft, which clearly could use an additional market for their oil." According to Semyon Vaynshtok, president of state-owned pipeline monopolist Transneft, the government will make a final decision on the pipeline project within two weeks, "Vremya novostei" reported on 28 May. DK

Turkish Energy Minister Hilmi Guler said on 27 May that his country would consider international arbitration if it fails to resolve its differences with Russia's Gazprom over the price of natural-gas shipments to Turkey via the Blue Stream pipeline, AFP reported the same day. Russian Deputy Foreign Minister Viktor Kalyuzhnii shot back that "Turkey...is constantly demanding price cuts," Anatolia news agency reported. The $3.2 billion, 1,213-kilometer pipeline beneath the Black Sea became operational in February. Turkey halted deliveries through the pipeline on 12 March after Botas, Turkey's state-run gas company, failed to extract a price reduction from Gazprom, "Kommersant" reported on 28 May. On 1 July, the contract between Botas and Gazprom enters its "take or pay" phase, and Botas will be obligated to pay for scheduled deliveries, whether it accepts them or not, or face stiff fines. Ali Tigrel, a leading Turkish economist, predicts that Turkey will face an energy surplus by 2005, partly as a result of the needlessly ambitious Blue Stream project, "Ekspert" (No. 018) reported on 19 May. Troika Dialog analyst Valerii Nesterov told "Vedomosti" on 28 May that Gazprom should "show toughness" in negotiations because "the precedent of changing a 'take or pay' contract would shake the European gas market." The two sides will get another chance to hammer out a mutually acceptable solution at a 15 June meeting of the Turkish-Russian Intergovernmental Economic Commission. DK

Russia's Economic Development and Trade Ministry and the World Bank have independently raised their GDP growth forecasts for Russia. In revised forecasts presented to the cabinet, the ministry predicted average annual growth of 5.6 percent over the next three years, "Gazeta" reported on 29 May. The figures, which presume that oil will cost $22-23 per barrel, mark an increase over the ministry's April forecasts. Meanwhile, Christof Ruhl, the World Bank's chief economist for Russia, announced on 28 May that the World Bank has raised its 2003 growth prognosis from 5 percent to 5.5 percent, RBC reported the same day. As officials and experts polished their crystal balls, Russia's State Statistics Committee brightened the backdrop with news that in the first four months of 2003 the country's economy posted a better-than-expected 6.6 percent year-on-year increase, "Vremya novostei" reported on 28 May. Economic analyst Leonid Grigorev was quick to caution the newspaper's readers that the month-to-month comparison can be misleading, as growth was sluggish in early 2002. Growth forecasts have been the focus of heightened interest in Russian official circles since President Putin set the task of doubling the nation's GDP by 2010 in his 16 May annual address to the Federation Council. DK

Russia's state-owned Vneshtorgbank (VTB) signed a mandate letter on 27 May for the European Bank for Reconstruction and Development (EBRD) to invest $150 million-300 million in VTB, Prime-TASS reported the same day. The EBRD will acquire a 10 percent -- 20 percent stake in VTB through an additional share issue. The amount of the actual investment will depend on "a market assessment of the value of VTB shares," VTB Vice President Vasilii Titov told "Kommersant" on 28 May. With J.P. Morgan and Ernst & Young currently wrapping up an audit, VTB management is touting the value of the bank's assets, "Vremya MN" reported on 28 May. VTB managers point to the brand recognition the bank has gained over eight decades of financial activity. On the legal front, VTB filed suit for $100 million against Russia's Central Bank and the state-owned, London-based Moscow Narodny Bank, "Gazeta" reported on 27 May. The suit revolves around a 1992 loan that originated with the Central Bank, passed through VTB, and vanished somewhere in the Fisheries Committee. The bad loan continues to darken VTB's books. Development Center specialist Dmitrii Lepetikov told "Gazeta" that while the actual sum, a mere 2 percent-3 percent of the bank's assets, is hardly critical, the public airing of the issue underscores VTB's commitment to openness as the EBRD prepares to buy its way into a key vantage point on the bank's impending privatization. DK

Aleksandr Korsak, head of Moscow's economic security administration, announced on 29 May that the city is taking decisive steps to end a spate of hostile takeovers, utro.ru reported the same day. Korsak cited as evidence the case of Rosbuilding, a murky real-estate firm that was profiled in a 7 March article in "The Moscow Times." One expert told the newspaper on condition of anonymity, "Their methods are barbarian, and many takeover targets have to choose between their lives and their assets." Threatened with criminal proceedings by city officials, Rosbuilding has not only agreed to halt its ongoing hostile takeover of the Petr Alekseev Mill, but is apparently considering investments into businesses it had until recently been trying to bankrupt, "Vremya novostei" reported on 30 May. In a 29 May op-ed in "Izvestiya," Georgii Satarov, director of the Indem (Information for Democracy) Foundation, wrote that "takeovers rely entirely on corruption-based schemes" and "nullify all the good economic intentions of the president and government." According to Korsak, 100 firms in Moscow specialize in hostile takeovers. A 26 May report in "Vedomosti" raised questions about city officials' efforts to combat the trend, however, revealing that Sistema, a powerful company with close ties to City Hall, is the force behind the Moscow City Duma's recently created Consultative Center to Defend Industrial Enterprises from Hostile Takeovers. Center Director Yevgenii Belov, who is also a Sistema employee, told the newspaper that "the center works thanks to Sistema." The director of a firm, who chose to remain anonymous, told "Vedomosti" that he would never go for help to a company that could easily choose to initiative a hostile takeover. DK

Four Russian IT companies -- Aquarius, AND Project, Landata, and OCS -- announced in a joint 29 May press release that they are banding together to form an IT holding called National Computer Corporation (NKK). (Aquarius is a computer and server producer, AND Project is a consulting firm, and Landata and OCS are distributors.) According to the press release, the four companies' total 2002 revenues of $324.7 million would make NKK Russia's second largest IT holding. Aquarius President Leonid Goldenberg, who will head NKK, explained that the companies will unite their capital, but not their businesses, preferring to retain independent brand names and cash flows, "Vedomosti" reported on 30 May. Robert Farish, regional manager for Russia at research firm IDC, told "Kommersant" of 30 May, "Consolidation will help the companies to concentrate in the future on more profitable business projects." Anatolii Karachinskii, president of competitor IBS, was unimpressed, telling "Vedomosti" that the move is "pure PR.... I don't see any point to this merger." OCS President Maksim Sorokin hinted that strength in numbers might have provided some incentive, telling "Izvestiya" of 30 May, "The authorities only listen to large companies." DK

Cellular operator Vimpelcom announced financial results for the first quarter of 2003 in a 29 May press release. Revenues rose 68.5 percent year-on-year to $244.44 million, net profits 47.6 percent year-on-year to $41.4 million, and EBITDA (earnings before interest, tax, depreciation, and amortization) 70.6 percent to $107.9 million. Average revenue per user (ARPU) sank to $13.50 from $19.40 in the first quarter of 2002. For the first time, Vimpelcom's regional business turned a profit, bringing in a modest $40,000. NIKoil analyst Vladimir Bogdanov told "Vremya novostei" of 30 May, "Analysts' forecasts matched revenues and net profit, but the net profit in the regions wasn't expected until the second quarter, which definitely makes it a positive factor." Dmitrii Vinogradov, director of Brunswick UBS for Russia, told "Vedomosti" of 30 May, "The market was somewhat disappointed by the drop in ARPU, but Vimpelcom's high profitability is impressive." Vimpelcom lost $80 million in the regions in 1999-2002 before finally breaking into the black, "The Moscow Times" reported on 30 May. DK

Telecommunications holding Svyazinvest announced in a 28 May press release that it has chosen California-based Oracle to supply the company with Enterprise Resource Planning (ERP) system software. The company did not disclose the amount of the deal, but "Vedomosti" reported on 28 May that Svyazinvest will pay $153 million for the software, making it the biggest IT deal in Russian history. Robert Farish, regional manager for Russia at research firm IDC, cautioned on 29 May: "For Oracle, the question is how much is going to be spent on software. Until someone from Oracle comments, we just don't know," IDG News Service reported the same day. The decision to go with Oracle was made solely on the recommendation of a Moscow consulting firm, without any competitive bids, "Vremya novostei" reported on 29 May. According to "Vedomosti," minority shareholders were sufficiently disturbed by the price tag and the lack of competitive bidding to write to Svyazinvest Director Valerii Yashin asking him to postpone the deal. A representative of Germany's SAP, Oracle's main competitor, said that his company "sent a proactive commercial proposal to Svyazinvest management," but to no avail, "The Moscow Times" reported on 29 May. At least one analyst told the newspaper that "such a major transaction should be conducted with a tender and with the approval of other shareholders." The boards of directors of the seven regional telecoms that make up Svyazinvest need to approve the deal. Five of them had done so by 29 May, IDG News Service reported, and the approval of the remaining two is expected shortly. DK

Gazprom CEO Aleksei Miller and Georgian President Eduard Shevardnadze agreed on 28 May to sign a strategic cooperation agreement, the company announced in a press release the same day. The press release speaks in general terms about collaboration on gas transport and supplies to Georgia. News of the agreement prompted U.S. Ambassador to Georgia Richard Miles to pay a visit to Georgian State Minister Avtandil Jorbenadze on 30 May to ask that the United States be kept apprised of all joint projects with Russian companies, RBC reported the same day. Miles noted that the United States is concerned about the eventual economic viability of the Baku-Tbilisi-Erzerum gas pipeline, a project with significant U.S. involvement. Another concerned party was Itera, which currently supplies Georgia with natural gas and fears that Gazprom might be trying to muscle in on its territory. The company stated on 29 May that if Gazprom squeezes it out of the Georgian market, it will seek swift repayment of the $60 million Georgia owes it, "Kommersant" reported on 30 May. In a 30 May article, Georgian newspaper "Tbilisi Rezonansi" characterized Gazprom's attempts to increase cooperation with Georgia as "Russia...trying its best to impede Georgia's economic independence." DK

World punditry's sound bite of the moment is "Punish France, ignore Germany, forgive Russia." Attributed to U.S. national security adviser Condoleezza Rice, the phrase is said to be the blueprint for the United States' postwar policy toward its three most prominent prewar critics. The current brouhaha over the contract to develop Iraq's vast West Qurna oil field indicates that, at least as far as Russia is concerned, forgiveness is a tricky business.

West Qurna is one of Iraq's tastier morsels. According to data published in "Vedomosti" on 2 June, the field contains reserves of 8 billion-10 billion barrels of oil. A 1997 production-sharing agreement gave Russia's LUKoil a 68.5 percent stake in the field (with 3.25 percent stakes each for compatriots Mashinoimport and Zarubezhneft). The agreement, which ran through 2020, envisaged investments of $6 billion into the field's development. According to a report in "Kommersant" on 27 May, the contract would have brought the three Russian companies $70 billion worth of oil. UN sanctions rendered the contract stillborn.

Iraq canceled the contract with LUKoil in December, initially alleging that the company had failed to meet its obligations. LUKoil pointed indignantly to UN sanctions that prohibited work on the project. Subsequent reports indicated that Saddam Hussein's regime really intended to punish LUKoil for behind-the-scenes talks with the United States aimed at securing the company a role in a post-Saddam Iraq. Throughout, LUKoil insisted that unilateral termination represented a violation of the contract's terms and promised to pursue the matter through international arbitration. War temporarily quelled the controversy.

The issue resurfaced on 26 May, when Thamir al-Ghadban, Iraq's U.S.-appointed oil minister, told the BBC that LUKoil had "already lost" its contract to develop West Qurna. With their company suddenly in the unenviable position of a suitor spurned by both Hussein and his successors, LUKoil representatives went on an enviable verbal offensive. "Kommersant" reported spokesman Dmitrii Dolgov's official reaction the next day: "We do not consider the remarks by Thamir al-Ghadban the official position of the legitimate government of Iraq. We will conduct negotiations about the future of the oil field only with lawfully elected authorities." LUKoil Vice President Leonid Fedun went farther, threatening legal action in the event of the contract's cancellation: "We'll arrest tankers with Iraqi oil through the arbitration court in Geneva. LUKoil will present claims for $20 billion in lost profits."

Coming on the heels of Russia's 22 May vote for a U.S.-backed UN resolution to end sanctions against Iraq, al-Ghadban's comments prompted a gloomy 27 May editorial in "Vedomosti." "Russia has lost the diplomatic Iraqi campaign once and for all," the editors began. They went on to conclude: "The bargaining failed: the resolution passed, and the U.S. position has hardly changed. The fate of the debt, it's true, may still be decided within the Paris Club of creditors, but the contracts will be canceled."

LUKoil kept pressing its case. On 30 May, Interfax reported an anonymous source in the company as saying that the lifting of sanctions on 22 May had kicked off a 100-day period in which LUKoil would begin fulfilling the terms of its West Qurna contract.

On 1 June, a U.S. State Department representative told a briefing in St. Petersburg, temporarily at the center of world attention for its 300th anniversary bash, that al-Ghadban's comments had been "incorrectly cited," Prime-TASS reported the same day. The official explained that a decision on West Qurna would have to wait for a government to emerge in Baghdad. Until then, all contracts would be frozen.

By 2 June, LUKoil Vice President Leonid Fedun had switched from litigation to negotiation. "We are in consultation with the occupying power," he told journalists at an investment conference, "The Moscow Times" reported the next day. According to Fedun, Russian Foreign Minister Igor Ivanov was making LUKoil's case to U.S. officials in the course of high-level contacts in St. Petersburg and Evian, France.

The two highest levels of contact were coy when queried about Qurna. According to the White House transcript (http://www.whitehouse.gov), U.S. President George W. Bush responded to a question about Iraqi oil and Russian companies at a 1 June joint press conference in St. Petersburg as follows: "And as to the energy sector, the Iraqi people will make the decision which is in their best interest." Not to be outdone, Russian President Vladimir Putin parried: "We don't rule out that our companies will work there. That will depend on the situation that emerges in Iraq."

West Qurna is not the only Russian oil contract in Iraq, just the biggest and best known. "Nefte Compass" reported on 28 May that other contracts include: Mashinoimport ($77 million), Slavneft ($21.2 million), Zarubezhneft ($8.3 million), Tatneft ($4.8 million), and Stroitransgaz ($33.5 million and $150 million). According to "Nefte Compass," representatives of LUKoil, Zarubezhneft, and Stroitransgaz plan to accompany a group of Russian diplomats to Baghdad in early June to discuss the fate of the contracts.

Under Saddam Hussein, Baghdad made lavish promises to Russian companies; Moscow responded with occasionally sympathetic rhetoric. With UN sanctions preventing real movement on the juiciest contracts, the billions remained shimmering on the horizon as the two capitals bartered promises for rhetoric in a verbal tit-for-tat that did not, in the end, amount to much.

With Hussein gone and UN sanctions a thing of the past, the development of West Qurna is now a real possibility. That said, LUKoil's future in Iraq remains shrouded in uncertainty. What seems clearer in the back-and-forth of the past week is that even if the pundits are right about postwar forgiveness for prewar obstreperousness, forgiveness might not come easy. DK

Elections to the Unified Energy Systems (EES) board of directors were supposed to usher in change. They did not disappoint. After months of speculation that coal barons and aluminum tycoons were buying into EES to gain seats on the board, the 30 May annual shareholders' meeting came off with a whiff of coal and a glint of aluminum. (The sectors are hardly happenstance -- EES is a major consumer of coal, and the production of aluminum requires vast amounts of electricity.) MDM Group, which controls 70 percent of Russia's coal production, garnered two seats; Basic Element, linked through Oleg Deripaska to leading aluminum producer Russian Aluminum, won one seat.

Also noted was Alexander Branis's failure to gain re-election. A representative of portfolio investors, Branis was a gadfly to EES management and a watchdog on reform plans. He continued his tradition of vocal criticism at the shareholders' meeting, charging that "there is vote buying going on right here, right now," "The Moscow Times" reported on 2 June. David Hern and Aleksandr Lebedev, who represented portfolio investors on the previous board, were two more also-rans.

The 15-member board includes 10 representatives of the state, which owns 52 percent of EES: Aleksandr Voloshin, head of the presidential administration; Viktor Khristenko, deputy prime minister; German Gref, minister of economic development and trade; Ilya Yuzhanov, minister of antimonopoly policy; Igor Yusufov, minister of energy; Sergei Kosarev, deputy minister of property relations; Yurii Sakharnov, deputy chairman of the Federal Energy Commission; Anatolii Chubais, head of EES; and Valentin Zavadnikov and Aleksandr Kazakov, both members of the Federation Council. Leonid Melamid, first deputy chairman of EES, represents management. Three board members form the "oligarchic" block: MDM Group head Andrei Melnichenko, MDM Bank head Sergei Popov, and Basic Element Director David Geovanis. The job of representing portfolio investors falls to Seppo Remes, executive director of the Vostok Energo investment fund.

As "Izvestiya" noted in a 2 June article, the new board differs from the old not only in its composition but in the tasks it will be expected to perform. The old board tended to the legislative framework for reform. With that framework largely in place, the new board will oversee the breakup and privatization of the utility, including its most coveted assets -- the companies that actually generate the power. As the reform of EES proceeds through that critical stage, observers will keep their eyes on the board and their noses to the wind -- looking to catch a glint of aluminum, or perhaps a whiff of coal. DK