Business Watch: December 17, 2002

State-owned oil-transport company Transneft jolted an industry accustomed to rate hikes with a rate freeze for 2003. The official announcement came in a 10 December press release on the company's website (http://www.transneft.ru). Transneft stressed that its decision to ask the Federal Energy Commission not to raise rates was taken independently: "Oil industry representatives did not make such a request." Transneft Vice President Sergei Grigorev gave advance notice to "Vremya novostei" on 8 December, telling the newspaper simply that "the company now has enough money." Some of that money came from two rate hikes in 2002 -- of 13 percent in February and of 9.3 percent in October -- as well as a 9 percent increase in pipeline traffic. Some found news of the freeze almost too good to be true. "We're shocked," an anonymous oil-industry source told "Vedomosti" on 9 December. "It makes you wonder whether they have any dirty tricks up their sleeve." Troika Dialog analyst Valerii Nesterov dubbed the rate freeze a "politically winning move," explaining to "Vedomosti" that Transneft President Semen Vainshtok has "demonstratively slipped off into the shadows while other monopolies are fighting for higher tariffs." DK

The cabinet hewed to recommendations from German Gref's Economic Development Ministry, approving middle-of-the-road 2003 rate increases for "natural monopolies" Gazprom, Unified Energy Systems (EES), and the Railway Ministry (MPS) at an 11 December meeting, Interfax reported the same day. Gazprom's rates will rise in 2003 by 20 percent instead of the 37 percent the gas monopolist had wanted. EES rates will rise 13-14 percent on average, with customer rates increasing by 12 percent and electrical energy supplied from the Federal Wholesale Market (FOREM) costing 17-19 percent more. EES had asked for across-the-board hikes of approximately 22 percent. MPS freight and passenger rates will go up 12 percent instead of 18 percent. The Russian government announced in an 11 December press release that the same cabinet meeting also approved 2003 investment budgets for the monopolies. Gazprom will get 179.7 billion rubles ($5.64 billion), EES 23.55 billion rubles, and the railways 122.6 billion rubles. The three monopolists had initially hoped for 188 billion rubles, 31.5 billion rubles, and 126 billion rubles, respectively, "Izvestia" reported on 11 December. DK

The Russian Union of Industrialists and Entrepreneurs (RSPP), the brain trust and lobbying arm of the powerhouse groups that control the lion's share of Russia's cash-generating enterprises, presented its vision of a fitting industrial policy for the nation at a conference in Moscow's upscale President Hotel on 10 December, "Vremya novostei" reported on 11 December. The program, developed by the RSPP's Industrial Policy Committee under the guidance of AFK Sistema Director Vladimir Evtushenkov, calls on the state to support individual companies that have proven their effectiveness and dependability, rather than entire branches of industry. As the RSPP sees it, the state should encourage consolidation by privatizing what it still owns and making it easier to bankrupt unsuccessful enterprises for subsequent acquisition by successful ones. State support should also take the form of helping out successful enterprises with tax breaks and customs preferences. Reaction to the program was largely negative. "Vedomosti" titled a 10 December editorial "A Project For Chaebols" in a sarcastic nod to South Korea's vast and powerful business conglomerates, describing the document as "reflecting the mores of the era" in its relentless intent to further a final gobbling up of Russia's remaining unconsolidated profitable enterprises. DK

Visa Russia's board decided on 10 December to spurn Visa International's recommendation to lower the interchange fee -- the commission a bank imposes when cards issued by another bank are used in one of its ATMs -- within Russia from $1.50 to $1.00, "Kommersant" reported on 11 December. Board members felt that reducing the fee could hinder the growth of ATM networks in Russia. Despite transaction fees, plastic is gaining ground in Russia. Gazeta.ru reported on 10 December that Russian banks issued 3.6 million cards in 2002, more than twice as many as in the preceding year, and that Visa transactions in Russia reached $5.7 billion this year. Still, the vast majority of those transactions are cash withdrawals on debit cards. Retail- and service-sector transactions accounted for only 14 percent of total volume. In an attempt to encourage consumers to reach for the plastic when making purchases, Russian lawmakers are considering exempting card purchases from the 5 percent sales tax, "Vedomosti" reported on 11 December. A group of legislators hopes to introduce the required amendment into the chapter of the Tax Code that deals with the taxation of small business. Although Deputy Finance Minister Sergei Shatalov called the idea "discrimination against cash purchases" and voiced his ministry's opposition, the 10 December meeting of the Taxation Subcommittee voted to move ahead with the amendment. DK

Mikhail Sukhov, head of the Russian Central Bank's department for licensing credit organizations, announced on 9 December that the Central Bank and cabinet are discussing changes to Russian law that would prevent offshore companies from owning more than 10 percent of any bank's shares, "Kommersant" reported on 10 December. Sukhov stated that the aim is to "make it a legal necessity to provide open, public, accessible information about who really owns, controls, and is responsible for what happens in banks." Standard & Poor's analyst Ekaterina Trofimova told "Vedomosti" on 10 December that she considers accurate information about ownership "a necessary condition for effectively monitoring the banking system." Mikhail Matovnikov, head of the Interfax Rating Agency's bank division, explained to "Vedomosti" that the Central Bank needs to keep the pressure on banks to come out into the open: "Banks will get sick of reshuffling their ownership structure three times a year. It's annoying and expensive. At some point, they'll come out of the shadows." Many of Russia's privately owned banks are controlled through offshore companies. According to "Kommersant," 89.5 percent of the shares in Alfa-Bank, Russia's largest private bank, are controlled by Alfa Bank Holdings Ltd., an offshore company registered on Tortola in the British Virgin Islands. Offshore ties extend beyond the private banking sector. "Gazeta" reported on 10 December that the Central Bank used the Cyprus-based offshore Batildor Holding Ltd. to purchase shares in its foreign affiliates Eurobank and Moscow Narodny Bank in February 2002. DK

Steel producer Severstal's automotive branch and world-famous heavy truck maker Kamaz are "becoming strategic partners with an intention to develop production, sales, and resource cooperation for maximum economic efficiency," according to a 6 December press release on the Kamaz website (http://www.kamaz.net). Severstal CEO Aleksei Mordashev and Industry and Science Minister and Kamaz CEO Ilya Klebanov presided over the signing of the partnership agreement on 6 December, "The Moscow Times" reported on 9 December. Severstal-Auto General Director Vadim Shvetsov said the new alliance, which pairs Severstal-Auto's Ulyanovsk Automobile Factory (UAZ) and Zavolzhskii Engine Plant with Kamaz, hopes to conquer 50 percent of the Russian commercial vehicle market, "Vedomosti" reported on 9 December. Kamaz currently controls 43 percent of the Russian heavy truck market; UAZ controls roughly one-third each of Russia's off-road, light-truck, and minibus markets. United Financial Group analyst Elena Sakhnova told "Vedomosti" that while the alliance could lower costs through joint design efforts and procurements, this will at first require an expensive integration process. The initial alliance will be general. According to Kamaz General Director Sergei Kogogin, the question of actually uniting the companies' production facilities into a single enterprise "will be decided in mid-2003," "Kommersant" reported on 9 December. DK

Telco Overseas Ltd., an offshore firm with St. Petersburg ties, has acquired a 20 percent stake in Moscow Cellular Communications (MSS) from Swedish holding company Tele2, "Vedomosti" reported on 10 December. Yurii Dombrovskii, a representative of Tele2, confirmed the sale, which has not yet been officially announced, to "Vedomosti." Sources told the newspaper that the stake cost Telco approximately $5 million. "Kommersant" reported on 7 December that the 20 percent stake was acquired from a firm called Millicom International Cellular S.A. Aleksandr Goncharuk, an MSS shareholder and the president of Sistema Telecom holding company, told "Vedomosti" that Telco now has a controlling stake in MSS. According to "Kommersant," the acquisition is part of an effort by Moscow-based "Petersburgers," led by Communications Minister Leonid Reiman, to gain control of cellular operators ready to switch to CDMA digital technology. Petersburg-based Delta Telecom is currently poised to launch a CDMA network. Telco was embroiled in a scandal in early 2002 when its attempt to acquire a 43.5 percent stake in Delta Telecom from North-West Telecom led Standard & Poor's to lower the latter's corporate-governance rating because of irregularities in the deal, which was eventually called off. "Delovoi Peterburg" reported on 11 December that the MSS deal is part of a renewed effort by the "Petersburg team" to unite all CDMA operators into a single holding. DK

National fixed-line operator Rostelecom announced its IAS (International Accounting Standards) financial results for the first nine months of 2002 in a 9 December press release. Consolidated earnings came to $622.8 million, a 3.5 percent increase over results for the first nine months of 2001; net earnings rose 10.7 percent to $464.2 million; and net profit was $94.9 million, a 3.2 percent year-on-year increase. Third-quarter net profit soared to $67.51 million, a whopping 493 percent rise over third-quarter 2001 results occasioned by Rostelecom's sale of a 50 percent stake in Sovintel. Renaissance Capital analyst told "Vedomosti" on 10 December that subtracting proceeds from the deal reduces third-quarter net profit to $24 million. The current financial statement differed from last year's in its inclusion of six affiliates: RTK-Leasing, RosTelecomLeasing C.A. (Switzerland), RTDK Holdings Inc. (U.S.), Russian Industrial Bank, Vestelcom, and RTKomm.RU. NIKoil expert Vladimir Bogdanov told "Vremya novostei" on 10 December that the report highlights continuing negative tendencies, as Rostelecom losing market share in Moscow and earning less from international operators. DK

Despite Kazakh Energy Minister Vladimir Shkolnik's assurances that Kazakhstan and ChevronTexaco subsidiary TengizChevroil (TCO) have resolved a funding dispute over the Tengiz oil-field project, a final resolution appears elusive. The dispute broke out over the next stage of the $3 billion joint venture, the oldest and largest in the CIS, which was to boost production from 250,000 barrels per day (bpd) to 440,000 bpd. TCO wanted to fund the expansion with export profits, while the Kazakh government preferred to have TCO pay taxes on exports and borrow for further development. TCO suspended work on the project in November. Shkolnik announced to the Kazakh parliament on 9 December that an amicable compromise was reached that would reanimate the project and guarantee the national budget $200 million a year from TCO. Major wire services and leading newspapers dutifully carried the story. TCO, however, never confirmed any agreement, "Nefte Compass" reported on 11 December. ChevronTexaco spokesman Fred Gorell told RFE/RL on 13 December that "discussions between TCO partners are ongoing." Resourcefully sidestepping Shkolnik's announcement, Gorell commended Kazakh officials for their "positive remarks." Multimillion-dollar contractual discord between Western firms and local governments over multibillion-dollar joint ventures is eye-catching enough; the confusion over this particular conflict can only increase the number of observers now looking toward its eventual resolution. DK

Through all the storms that have gathered over Baghdad, Russia and Iraq have succeeded in maintaining cordially oil-inflected relations, in no small part thanks to the magic of diplomatic language. The salving balm of principled declarations can wash away much of the grime that adheres to the advancement of real national interests as expressed in the earthbound quantities of money and power. But when nerves fray, the truth will out. Such a moment came on 13 December, when a "source in the Russian government" told RIA-Novosti that, "In and of himself, Saddam Hussein is not such a sweetheart that he should be defended just because."

The comment came in response to news that Iraq's Oil Ministry terminated its $3.7 billion contract with LUKoil to develop the West Qurna oil field. Energy Intelligence Group's "Eye on Iraq" broke the news in the West on 11 December, citing a copy it obtained of a letter from the Iraqi Oil Ministry to LUKoil President Vagit Alekperov. The letter charged LUKoil with a failure to fulfill its contractual obligations and pronounced the contract null and void as of 9 December.

Noting that Iraq has threatened to cancel the contract on several occasions over the past two years, "Eye on Iraq" ascribed the real motivation behind the contract cancellation to Iraqi suspicions that LUKoil conducted "behind-the-scenes negotiations with U.S. Secretary of Energy Spencer Abraham on oil activities in a post-Saddam Iraq...during the U.S.-Russia energy summit in Houston last October." Energy Intelligence Group's analysts referred also to an interview that Nikolai Tokarev, general director of state-owned oil company Zarubezhneft, gave to "Vremya novostei" on 10 December. In the interview, Tokarev claims that Zarubezhneft was approached by U.S. firms with offers to fund the Iraqi opposition in exchange for the right to continue working in Iraq (presumably post Saddam). According to Tokarev, he rejected such schemes as unprincipled and unreliable, since "the Americans have no reason to guarantee us anything." He hints, however, that other Russian companies may be involved in such discussions with the Americans.

Analytical agency Stratfor was more specific, citing on 12 December "sources within the Russian Energy Ministry [who] have confirmed that LUKoil contacted the INC [Iraqi National Congress] at Washington's behest." According to Stratfor, "Bagdad apparently learned about the meeting from antiwar elements in Russia -- probably from Russian intelligence services." "The Wall Street Journal" gave further credence to this theory in a 13 December article titled "Possible Retaliation Amid Speculation."

In the Arab world, where all eyes are on Iraq and all thoughts on the possibility of war, the Russian government source's blunt comment about legitimate reasons for defending Saddam Hussein quickly made the rounds. Two Gulf newspapers -- Qatar's "Al-Raya" and the United Arab Emirates' "Al-Ittihad" -- sharpened the phrase in translation, rendering the Russian "prosto tak" (just because) as "min dun muqabil" (without compensation, gratis) to remove any ambiguity about possible motives for defending Saddam Hussein.

Arab observers also seized on Tokarev's insinuations of backroom dealings with the Americans. London-based "Al-Hayat" wrote on 13 December: "Tokarev stated that other Russian companies are conducting active negotiations [with the Americans], although he did not say whether LUKoil is one of them." Others harbored darker suspicions. In a 15 December editorial in Jordan's "Al-Dustur," George Haddad saw hostile Russian reactions to the contract cancellation as tantamount to support for Iraq's enemies. "What is Russia's interest in joining the ranks of these enemies," he wondered, "or is Jewish influence so powerful among Russian decision makers?" A 13 December article in Saudi Arabia's "Al-Watan" even quoted "informed Russian sources" claiming: "Israel is behind the Russian oil lobby's drive to adopt a position hostile to oil from Middle Eastern countries, and especially Saudi Arabia and Iraq...reorienting Russian oil companies toward American and European markets." The article went on to describe the contract cancellation as an "Iraqi slap in the face against Moscow that comes in the wake of recent reports that Washington is exerting pressure to prevent Russian oil companies from cooperating with the Iraqi government."

Russian editorials took a dim view of the Iraqi decision. "Izvestiya" wrote on 13 December: "In choosing to speak with Russia in the language of ultimatums, Hussein has made a fateful error." Surveying the possible damage to Russian-Iraqi relations without particular regrets, the newspaper concluded, "Russia has remembered 'realpolitik.'" "Kommersant" noted on 16 December that while Baghdad was likely reacting to "certain reports of Russian-U.S. contacts over the future of post-Saddam Iraq," the Iraqis nevertheless hedged their bets, "choosing as a whipping boy a large, but not state-run, company." "Vedomosti" suggested in a 16 December editorial that Moscow should use the opportunity afforded by Baghdad to realign its foreign policy priorities. Finally, a 16 December analysis by RosBusinessConsulting cited "unofficial channels from Baghdad" and claimed that Iraq was already offering West Qurna to British Petroleum.

Iraqi officials, it should be noted, were careful to make their case as blandly as possible. Al-Jazeera reported on 12 December that, according to LUKoil spokesman Aleksandr Vasilenko, the letter the company received bore the signature of Iraq's deputy oil minister, hardly the top dog in Baghdad. Abbas Khalaf Kunfudh, Iraq's ambassador to Russia, announced on 15 December that Iraq awarded the West Qurna contract "to Russia" in 1997, and he was sure another Russian company will take LUKoil's place. Iraq's official press downplayed the story, burying news of the contract cancellation in the fourth paragraph of a 16 December article in "Al-Thawra" cheerily titled "Oil Minister Says Iraq Approves Two Contracts With Two Russian Companies To Develop Oil Fields."

On 16 December, Russian Foreign Minister Igor Ivanov entered the fray with a restrained official position, telling journalists in the course of his visit to Manila that he had sent a letter to the Iraqi authorities asking them to review their decision, Interfax reported the same day. For his part, LUKoil President Vagit Alekperov made it clear to the press in the days following the Iraqi announcement that his company intends to take its case to international arbitration.

The key to the LUKoil tiff, above and beyond the intriguing vagaries of Iraqi decision making, is what it tells us about the real nature of Russian-Iraqi relations. Despite the visibility of Russian oil companies in Iraq, especially in the oil-for-food program, and the mutual warmth that Moscow and Baghdad periodically exude, relations between the two countries are best described as a virtual partnership. Iraq dangles the possibility of repaying its debts to Russia -- estimated by "The New York Times" at $7.6 billion and by "The Wall Street Journal" at $9.5 billion -- and securing Russian companies huge profits from megadeals -- one day. Russia eschews Washington's incendiary rhetoric and urges caution in the international community's dealings with Iraq but not so insistently as to spoil its newfound role as a broadly conceived U.S. ally in George W. Bush's war on terror.

The flap over LUKoil lays bare the promises-for-rhetoric program that forms the ethereal core of this virtual partnership. Baghdad extends promises; Moscow proffers pleasantries. Baghdad revokes its promise; Moscow growls about reality. Baghdad hints at another promise; Moscow softens its tone. Only such an absence of substance can transform the cancellation of a contract frozen for years by international sanctions into an event. DK

On Wednesday, 18 December at 11 a.m., the Russian state will auction off its 74.95 percent stake in oil company Slavneft with a starting price of $1.7 billion and a bidding increment of $20 million. Beyond that, things get complicated.

Despite initial expectations of an industrywide free-for-all that would gather all of Russia's oil majors for a ferocious bidding frenzy, some of the country's largest companies have chosen to sit out the competition. Yukos and LUKoil dropped out of the race in the last two weeks. Surgutneftegaz demurred on 11 December. "Kommersant" reported on 17 December that China National Petroleum Corporation (CNPC) decided to withdraw from the proceedings, averting a mounting scandal after Russian lawmakers voted on 15 December to recommend that CNPC be barred from the privatization auction as a state-run company.

By all accounts, the leading contender is Sibneft. Controlled by Chukotka Governor Roman Abramovich, an oligarch's oligarch who combines financial muscle and political influence, Sibneft recently acquired a 10.83 percent stake in Slavneft from Belarus for $207 million. Sibneft also has partial control of a trust company that holds a 13.17 percent stake in Slavneft. Rounding out the insider advantage, Slavneft President Yurii Sukhanov is a former Sibneft executive.

Tyumen Oil Company (TNK) shares with Sibneft the trust company that controls a 13.17 percent stake in Slavneft, and it also plans to participate in the auction. The two companies could compete, but they could also act in concert.

A dark horse is Sergei Pugachev's Mezhprombank. Just as Abramovich and Sibneft represent "the Yeltsin-era 'family,'" Yulya Latynina wrote in "The Moscow Times" on 11 December, Mezhprombank represents the St. Petersburg KGB veterans who now haunt the halls of power. Their only problem, Latynina notes, is that they "don't have much money."

In a seemingly paradoxical development, "Kommersant" reported on 17 December that Rosneft is a potential player. Rosneft, of course, is 100 percent state-owned, rendering its participation in what is ostensibly a privatization auction somewhat counterintuitive. (To avoid a conflict with Russian law, which prevents companies in which the state holds more than a 25 percent stake from participating in privatization tenders, Rosneft would act through an affiliate.) "Kommersant" writes that "one can only guess" at the aims Rosneft seeks to pursue with its initiative.

The story does not end there, of course. The preliminary list of bidders who submitted applications to the Antimonopoly Ministry consisted largely of entities created especially for the auction. "Nefte Compass" reported on 11 December that Thriftiness Investments, Optifor, Investoil, and Promspect are all on the list. Whom do they represent? In theory, we might find out only after the gavel comes down on 18 December. DK