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Business Watch: May 28, 2002

28 May 2002, Volume 2, Number 21
Russia's LUKoil and Greece's Latsis Group jointly offered $418 million for a 23 percent stake in Greece's Hellenic Petroleum (HP). Theirs was the only binding offer, Reuters reported. Russia's Yukos Oil and Austrian energy group OMV had shown initial interest but withdrew from the tender some months ago. "Following the evaluation of the financial offer, it was decided to name the consortium LUKoil and Latsis Group as 'preferred bidder' and to start exclusive negotiations," the Greek Development Ministry announced. Giorgos Grigoriou, an analyst at Marfin Hellenic Securities, said, "We can say that the offer, taken at face value, is generous. But we will also have to look at all the fine details." HP owns the Aspropyrgos refinery with a throughput capacity of 125,000 barrels per day (bpd), the Thessaloniki refinery with 67,000 bpd capacity, and the Okta refinery in Macedonia with 66,000 bpd capacity. The Greek press reports that the Latsis Group is angling to merge its refining company, Petrola, with Hellenic if the joint bid with LUKoil is successful, "SKRIN Issuer" reported. This will add another 100 million bpd of processing capacity. Hellenic's profitability has been poor since its privatization in 1999, posting a return on capital of only 3 percent in 2001. A LUKoil representative said that, despite past financial weakness, he believes the acquisition, if successful, will be a positive for LUKoil. It could allow the company to increase its crude exports relative to other Russian oil companies, he stressed. (JMR/IAM)

Exxon Mobil announced it awarded a Russian plant a $140 million contract to refurbish a platform needed to start extraction at its Sakhalin oil offshore deposit in Russia's far east, Reuters reported. Exxon Mobil said in a statement the contract was awarded to Amur Shipbuilding Plant, which will modernize the Orlan platform, built by Exxon Mobil in 1984 to extract oil in the Beaufort Sea off Alaska. Exxon Mobil is the operator of the Sakhalin-1 project, with recoverable reserves of some 2.3 billion barrels of oil and 17 trillion cubic feet of natural gas. Sakhalin-1 is expected to produce its first oil at the end of 2005 and reach a daily rate of around 250,000 barrels. Work on the platform is expected to begin in June, with installation scheduled for 2004 on one of the three Sakhalin-1 fields, Chaivo, some 11 kilometers (7 miles) off the east coast of Sakhalin Island. (JMR)

First Deputy State Property Minister Aleksandr Braverman announced that the Russian government will sell a minority stake in state telecom holding Svyazinvest in 2003, when restructuring is finished. He said the government plans to sell 25 percent minus one share in the company. International financier George Soros led a coalition that won 25 percent plus one share in the holding in a 1997 auction with a bid of $1.9 million. Following Russia's financial meltdown in 1998 and the collapse of telecoms share prices, Svyazinvest officials estimate the stake is now worth about one-quarter of what the consortium paid. They hope a sweeping restructure will raise the price of the stake, Reuters reported. Svyazinvest is in the process of consolidating its dozens of regional fixed-line carriers into seven to give them critical mass necessary to attract investors and make their shares liquid. It also owns a controlling stake in Rostelekom, the national fixed-line carrier. Braverman also said the government will privatize stakes in the Magnitogorsk Metals Plant and some airlines in 2003. (JMR)

The State Statistics Committee reported that the amount of Russian investment abroad continues to exceed foreign investment into Russia. Statistics show that Russian outward investment reached nearly $4.4 billion in the first quarter of 2002, a 40.7 percent increase from the first quarter of 2001, Interfax reported. Foreign investment in Russia in the first three months totaled just $3.8 million. The committee pointed out that Russian capital abroad returns to Russia after a short period of time. For this reason, the amount of Russian capital accumulated abroad was just $3.6 billion in late March, which is less that what was invested in the first quarter of this year. Of Russian investments accumulated abroad, $2.4 billion represents direct investment, $155 million portfolio investment, and another $1.03 billion other investment. Russia's largest accumulated investment figures are in Belarus ($577 million), Iran ($554 million), Cyprus ($452 million), the Netherlands ($434 million), Liberia ($227 million), Moldova ($170 million), Armenia ($127 million), the British Virgin Islands ($118 million), the U.S. ($94 million), and Germany ($70 million). (JMR)

Russia's third-largest car manufacturer, the Sok Group Company, announced that it will launch a $200 million joint-venture factory in China to develop a car priced under 80,000 yuan (about $9,640), according to a company press release. Sok is the first Russian car manufacturer to enter the Chinese market and will conduct market testing in more than 20 Chinese cities. Founded in 1994, Sok is the holding company for 40 enterprises employing 80,000 people. (JMR)

Economic Development and Trade Ministry spokesman Konstantin Bogdanov told Reuters the Russian government expects consumer price inflation (CPI) to slow to 10-12 percent in 2003 from this year's projected 12-13 percent. The average ruble rate is expected to edge down to 33.7-34.0 versus the dollar compared with an average of 31.5 rubles to the dollar fixed in the 2002 budget. He said the ministry expects the ruble to weaken further, to 35.0-35.8 per dollar in 2004 and to 35.6-36.7 in 2005. In 2004, CPI will be a tighter 8-10 percent and 6-8 percent in 2005, he predicted. (JMR)

On 21 May, the World Bank praised Ukraine's 2002 economic growth along with government efforts to reform the economy, Reuters reported. Johannes Linn, World Bank vice president for Europe and Central Asia, told a news conference he expected Ukraine's gross domestic product (GDP) to grow between 4 and 6 percent in 2002. Ukraine's GDP grew a record 9.1 percent in 2001. The pace of growth has slowed this year, with GDP rising by 4.1 percent in the first four months of 2002, year-on-year. Linn said Ukraine's economic expansion was encouraging in the context of a global recession: "Given the last 10 years of economic decline, the kind of reversal which Ukraine has seen over the last two or three years is encouraging." Linn said talks over the next installment of a $750 million, three-year loan were successful. He noted that more steps are needed to reform the country's financial and energy sectors. The World Bank expects to see continued efforts to privatize electricity distributing companies and improve transparency and financial discipline. Linn said this fall he will most likely propose that the bank's board of directors release a $250 million loan to Ukraine in one installment instead of dividing it into tranches. (JMR)

Russian lawmakers and government ministers agreed to draft legislation that would cut taxes for small and medium-sized businesses -- a sector of the Russian economy that has been slow to develop. Russian Economic Development and Trade Minister German Gref said after the Kremlin meeting that the tax on sales will be cut from 8 percent to 6 percent, the Interfax news agency reported. Gref said that plans are also under way to reduce the tax on profits from 20 percent to 15 percent, according to the ITAR-TASS. The tax cuts would affect businesses with annual revenues of up to 15 million rubles ($469,000), a higher ceiling than the 10 million rubles ($312,000) proposed by the Kremlin earlier this year, AP reported. Russian President Vladimir Putin was quoted by ITAR-TASS as saying, "We must...create such conditions that will allow business to develop well and us to fulfill our obligations to the people." According to the Russian State Council, small businesses account for 10-11 percent of Russia's GDP and employ 12 million people. (JMR)

Talks on the legal status of the Caspian Sea appeared to fall apart between Azerbaijani President Heidar Aliyev and Iranian President Mohammad Khatami on 18 May in Tehran. The sides could not agree on what to call the sea. Khatami had said, "The leaders' summit in Ashgabat on the Mazandaran Sea was important." At that point Aliyev interrupted him, saying, "I do not understand. What is the Mazandaran Sea?" "You call it the Caspian Sea and we say the Mazandaran Sea," replied Khatami. He further explained, "Caspian comes from Qazvin," referring to a town in northern Iran. "Well, that's the first I've heard of it," Reuters reported Aliyev as saying. Of the five countries on the Caspian's shores, Iran and Azerbaijan are the furthest from agreement on the issue of oil rights and now they appear to disagree even on the sea's name. (JMR)

Kazakh Central Bank Chief Grigorii Marchenko announced on 19 May that the country's economy is growing faster than predicted. He said growth is now expected to reach 8-9 percent. "The [government] forecast -- of 7 percent -- was based on a $19-a-barrel [oil] price. So, with oil prices higher, we could get 8-9 percent growth," he told Reuters. First-quarter data showed Kazakhstan's GDP growth came largely from a rapid expansion of industrial output, which jumped by 12.1 percent from the same 2001 period. Marchenko said GDP was expected to rise 7-8 percent in 2003, with growth maintained by strong foreign direct investment, the financial sector's ability to mobilize savings, and continued macroeconomic stability. (JMR)

Effective 20 May, the Russian Central Bank cut its deposit rates by two to three percentage points to make it less attractive for commercial banks to park their loose rubles with the Central Bank. The bank said in a statement that it was lowering its one-week rate to 8 percent from 11 percent, the spot/week rate to 8.5 from 11.5 percent, the two-week rate to 10 from 12 percent, and the spot two-week rate to 10.5 from 12.5 percent. The cuts were also seen as sending a signal that the new central bank management, under Chairman Sergei Ignatiev, was making good on its promise to play a more active role on Russia's financial market. Vladimir Zavershinskii, head of the hard-currency department of Moskomprivatbank, told Reuters, "Traditionally, Russia's central bank had concentrated on exchange-rate policy and now they seem to have shifted the focus to monetary issues." (JMR)

Igor Makarov's and Itera's official relationship with Gazprom began in the mid-1990s as Itera, touting its experience in conducting barter-trade arrangements in Turkmenistan, became Gazprom's agent in sales of Turkmen gas. Itera eventually became a middleman for gas sales throughout the former Soviet Union. "Sovershenno sekretno" (No. 4, 1999) explained that Itera, acting as the "operator" that sold the gas, earned "huge amounts of money" off the difference between the Gazprom price and the market price in CIS states. Gazprom transported the gas through its pipeline system (Gazprom controls the pipeline system throughout the Commonwealth of Independent States, or CIS) at cut rates. Some sources subsequently claimed that Gazprom pressured the Turkmen authorities to sell gas directly to Makarov's company under terms that were highly profitable for Itera ("Nezavisimaya gazeta" 22 December 1999).

Later, Gazprom began selling production facilities and gas fields to Itera, also at nominal rates, fostering Itera's phenomenal success. Gazprom, for instance, sold its 51 percent stake in Rospan, a Siberian gas company that holds licenses to develop gas fields with reserves of some 230 billion cubic meters of natural gas, to two Itera-connected shell companies for $284, even though Gazprom's own securities department stated that the stake was worth $104 million ("The Wall Street Journal" 24 October 2000). According to "Moskovskii komsomolets" (7 June 2000), the sale of Rospan was preceded by its "looting" via Gazprom. This occurred after Gazprom bought the majority stake in Rospan and began using Itera as a gas-sales agent. Under the Itera scheme, according to the paper, Rospan was "paid" for its gas in "consumer goods" priced at "three or four times their actual value," driving the company into the ground financially. Makarov's Itera subsequently bought Rospan cheaply from Gazprom, which claimed it did not want to invest any money into the near-bankrupt enterprise.

Drawing Links To Criminal Activities

Makarov and Itera have also been linked to organized-crime activities and individuals by Russian journalists. "Moskovskii komsomolets" (7 June 2000), for instance, claimed that Itera put Chechen mob-connected managers on the Rospan payroll after the company's takeover. "Sovershenno sekretno" (No. 6, June 2000) further claimed that Itera used "enforcers" from "various crime gangs" in a dispute with Rospan's creditors over the company's management. Moreover, reputed Solntsevo mafia boss Sergei Mikhailov, according to "Sovershenno sekretno" (No. 4, 1999), acted as Itera's agent in its gas deals with Ukraine in the late 1990s. Stories have also appeared in the foreign press concerning Makarov and Itera. A scandal erupted in 2000 concerning Tractebel, the Belgian energy group, and the government of Kazakhstan over an alleged breach of contract concerning the heating distribution and utility in the capital, "The Financial Times" reported on 28 January 2000. Later, BBC reported on 2 March 2000 a story appearing in "Le Soir" on how a businessman named Grigorii Luchanskii, a representative of Itera, met with Pierre Baquet, crisis manager for Tractebel, claiming to have the authority to resolve any crisis concerning a breach of contract with Kazakhstan because he also represents the Kazakh government and Gazprom. Luchanskii is also known in connection with a company he established called Nordex. "[U.S. Central Intelligence Agency] Director John Deutch went on record in describing Nordex as an organization associated with Russian criminal activity" as found in "One Point Safe," written by Andrew and Leslie Cockburn (Doubleday, 1997). According to the "Le Soir" article cited in the BBC report, Baquet was offered a $7 million bribe by a representative of Itera. Baquet claims to have met with Luchanskii and Igor Makarov in Moscow in late 1999. This supposedly led to an investigation by the Swiss Prosecutor's Office of Itera for bribery and the questioning of Luchanskii by Swiss authorities. No results emerged. Tractebel remains partners with Itera in Kazakhstan, but as the BBC report concluded, "Itera's reputation now in the Belgian press is clear. The news that senior Russian officials are involved in talks at Itera's office brings a knowing smile to reporters in Brussels. It takes years to build a reputation. But only minutes to lose it."

Many sources have thus viewed Makarov as a shady front man for the Rem Vyakhirev Gazprom management team, which was at least partially dislodged last year with Russian President Vladimir Putin's appointment of Aleksei Miller as head of Gazprom's management board. Miller has reportedly made efforts to assert state control over the gas giant and clear up questions about Gazprom's relations with Itera.

According to the "front man" view of Makarov, Vyakhirev, who was Gazprom founder Viktor Chernomyrdin's deputy in the Soviet-era gas industry, and his allies created Itera and are the true, hidden owners of the company -- something Makarov has repeatedly denied. The founding of Itera and Vyakhirev's takeover of Gazprom management roughly coincided with Chernomyrdin's appointment as Russian prime minister. Gazprom subsequently complained repeatedly of cash shortages in the 1990s, and the company, which is the biggest source of tax revenue for the state, bargained constantly with the government on tax payments, while most press accounts reported it investing the minimum required to maintain its infrastructure. Meanwhile, as Gazprom's production fell, Itera's sales and production -- as well as profits, safely transported to offshore affiliates -- rose dramatically.

Critics of Gazprom -- especially minority shareholders who feel the former management bilked the company of huge amounts of cash, keeping its share prices low and cutting them out of profits -- have therefore claimed that Itera was set up as an "offshore zone" by Vyakhirev and his allies in the Gazprom management (and, possibly, Chernomyrdin) to siphon funds away from the Russian budget and Gazprom shareholders (see 18 March 2002 Carnegie Endowment report from William Browder, CEO of Hermitage Capital Management, a Gazprom shareholder that has attacked the firm's relations with Itera at www.

The dubious deals between Gazprom and its partners have been strengthened by revelations about Gazprom's relations with Stroitransgaz, a pipeline and construction firm that received $1 billion in contracts from Gazprom -- and boasted two sons of Chernomyrdin and Vyakhirev's daughter as major shareholders ("The Washington Post" 24 December 2000).

Makarov's And Itera's Future

Since last year, when Miller took over as Gazprom management chief, various press sources have speculated that Itera's potential business rivals and Kremlin operatives would see Makarov and his firm as vulnerable without his Gazprom "cover." Shortly after Vyakhirev's departure from his Gazprom post, for instance, "Kommersant" (6 June 2001) reported that the Tyumen Oil Company was buying up Rospan's debts, probably in preparation for an eventual attempted takeover of the gas firm. Moreover, the Russian Audit Chamber was auditing Gazprom's relations with Makarov's Itera.

There is some reason to believe, however, that Makarov and Itera may not only survive, but continue to prosper. Makarov has grown into a full-fledged economic player in his own right -- and Itera's business, as the primary gas supplier to many CIS states, may prove useful to the Kremlin, which, in view of the CIS states' energy needs, has used natural gas sales as a tool in strengthening Moscow's position within the "former Soviet space." Moreover, Itera has sold gas in the "near abroad" for much higher rates than Gazprom (for political reasons) has sold "blue fuel" domestically. Many Russian politicians both within and without the Kremlin might see the highly profitable Itera as a source of campaign funding and a potential ally in regions where Itera does business domestically.

Last summer, for instance, "Kommersant" (16 August 2001) saw Itera's threats to cut off gas supplies to Ukraine as yet another "trump card" in Moscow's relations with Kiev. Itera has also expanded into the electrical energy business, planning construction of power lines in, for example, Belarus, which would facilitate the export of Russian energy to the "near abroad" ("Kommersant" 30 May 2001) and give Moscow another lever to pressure its CIS partners with. Indeed, according to "Kompaniya" (23 July 2001), many of the journal's observers claimed Makarov (whom the magazine placed on its list of Russia's "business elite" last year) had already reached an "understanding" with the Kremlin last summer, strongly implying that Itera would be left alone in return for certain services to the authorities, much as Gazprom management had been in the past. "Business Week" (2 April, 2001) anticipated the "Kompaniya" claims last spring, writing that Makarov and Itera (a "power player" in the CIS) "fit in" with the Kremlin's overall design to "rebuild Russia's influence in key regions of its former empire."

The Russian Audit Chamber's issuing of a clean bill of health regarding Itera's past relations with Gazprom last summer ("Kommersant" 11 July 2001) may have been a sign of the "understanding" Makarov had allegedly reached with the Kremlin. According to the "Kommersant" report, even Audit Chamber officials admitted they were still not certain that many of the Gazprom-Itera transactions were "justified," even as they cleared Itera of any charges of impropriety. It is also possible, however, given the way business and the state have interacted since the early 1990s, that the auditors may have gathered enough kompromat ("compromising material") on Makarov to ensure his future cooperation with the authorities.

Doing business in the former Soviet Union is a challenging undertaking. Finding the right partner and knowing the local customs is a fundamental requirement. Stories have filled the media and films depicting Russian organized crime as a formidable force to be reckoned with, but the true cost and scope has often gone undefined. Corruption, while often mentioned, has not been exhaustively researched. The "Financial Times" on 23 May reported on the "brilliant presentation" of Georgii Satarov that provides some answers to the scope of the problem. Satarov, who runs the think tank INDEM (Information for Democracy), interviewed "700 businessmen and 2,000 people from other walks of life." The conclusions of the research were remarkable. According to his research, "private citizens pay at least $2.8 billion a year in bribes, and businessmen pay at least $33 billion." If these figures are accurate, bribes amount to a figure more than one-half of all taxes collected by the Russian government. Russian budget revenues in 2000 were $40 billion. Speculation is that the amount businesses paid in bribes are lower than reported, and, if so, bribes may equal or even exceed the level of taxes collected by the government.

The efficiency of bribery was also measured. A full 98 percent of those interviewed acknowledged satisfaction with the results of the bribe. In Satarov's words, bribery is a "very efficient and dependable market,... the most efficient services market in our country" according to the "Financial Times" story. Interfax reported on 21 May the breakdown of bribery as follows: "People spend the most money on admission to universities ($449 million), followed by bribes to traffic policemen ($368 million) and courts ($274 million). The total amount of bribes paid for various services relating to medical care reach some $600 million," Satarov said. The report also linked the payment of bribes for university admission as a means for obtaining deferment from the army. With the war in Chechnya still simmering and the high levels of injuries and suicides resulting from the alleged hazing of young military recruits, families appear increasingly inclined to do whatever is possible to avoid military service.

However, this trend is not only restricted to Russia itself. Corruption watchdog Transparency International (TI) for the first time recently listed Russian companies as the most likely to offer or pay bribes for contracts in emerging market countries, followed by firms from China and Taiwan (see "RFE/RL Business Watch," 21 May 2002).

Another point tracks the criticism Russian President Vladimir Putin has leveled at the Russian bureaucracy. Information obtained in Satarov's study claims that 99 percent of businessmen who paid bribes did so to Russian government employees. Government workers often delay approval of licenses and other permissions that are required for businesses to operate. As the efficiency figures indicate, once a bribe is paid the obstacles disappear and the problems are solved. Putin openly complained about this when he criticized the corrupt and inefficient Russian bureaucracy in his annual address in April.

When Satarov asked interviewees how they feel about the conditions surrounding living and working in Russia, the response surprised him, according to the "Financial Times" story. Rather than the cynical reaction to which Russians are accustomed, the most common response was very different, he said: "I hate our system of government which puts people in such situations."