Business Watch: May 29, 2001

Russia's Aeroflot Airline has hired Sweden's Bovis Lend Lease International Ltd. to design and build a new international air terminal in Moscow. Aeroflot signed a contract with Bovis, one of the world's largest construction management firms, after the company won a tender for the job in February. The $300 million terminal will be able to handle 8 million passengers a year and will take two years to build as part of Aeroflot's efforts to remake its image as a Soviet-era airline by improving customer service and investing in new aircraft. Aeroflot will be able to use the new terminal for both domestic and international flights, offering connections to passengers who now must travel for as long as two hours between Sheremetyevo's domestic and international terminals. Aeroflot and Moscow's Sheremetyevo Airport have said they plan to contribute about 10 percent to 30 percent of the cost of the project, with the rest to come from outside investors.

Finnish telecom-equipment maker Nokia has won an order to supply GSM (global system for mobile communication) wireless network equipment for Telecominvest's MegaFon network in the North Caucasus region. No financial details were provided. Nokia said it would be the sole supplier of MegaFon's GSM 900/1800-band network, including core network infrastructure equipment and a radio-access network. Deliveries would start immediately, with the first phase of commercial launch targeted for the second half of this year, the company said in a statement.

Surgutneftegaz has replaced rival LUKoil as Russia's largest company by market capitalization, but it is still 65 times smaller than U.S. General Electric, according to the "Financial Times'" new rankings of the world's top companies. No Russian company cracked the annual global FT500, but five -- Surgutneftegaz, LUKoil, Gazprom, Yukos, and Unified Energy Systems -- made the top 500 in Europe and 26 counted among the top 100 for Eastern Europe, up from four and 20, respectively. The rankings show that although 2000 was not the most successful year for the Russian economy since the collapse of the Soviet Union, Russian companies to a small degree strengthened their positions in the ratings, "The St. Petersburg Times" reported.

Rosneft, Russia's state-owned oil company, plans to build a pipeline to ship natural gas from Far East oil projects involving Exxon Mobil Corp. and Royal Dutch/Shell Group to mainland Russia and possibly then sell some of the fuel to China. DalTransGaz, co-owned by Rosneft, its Sakhalinmorneftegaz unit, and the Khabarovsk region government will invest $250 million to build the 400-kilometer (250-mile) link by 2005 from Komsomolsk-on-Amur to the Russian city of Khabarovsk, near the Chinese border, Bloomberg News reported. There is already a gas pipeline from Sakhalin Island to Komsomolsk-on-Amur. Rosneft plans to ship as much as 3 billion cubic meters a year of gas to Khabarovsk through the pipeline, partly from the Sakhalin-1 project, in which Exxon Mobil and Japan's Sodeco each own 30 percent. It is also hoping that Shell will ship some of the gas it extracts along with crude oil being pumped from its Sakhalin-2 offshore field. Rosneft President Sergei Bogdanchikov said, "If gas is now burned off (at Sakhalin-2's) oil platform maybe they will be willing to sell the gas for $15 per 1,000 cubic meters. Especially as we are building the infrastructure."

Tyumen Oil Co. (TNK) plans to consolidate control of its main refinery and retail units in 2002, after completing share swaps to acquire stakes it doesn't already own in four producing units. Tyumen said it will pay 1.18 billion shares to take over four privately held Siberian companies that produce about 65 percent of Tyumen's 40 million tons a year (800,000 barrels a day) of oil. That will leave minority investors owning 5 percent of Tyumen Oil, with the rest split between Alfa Group and U.S.-Russian company Access/Renova, Bloomberg News reported. The consolidation will give potential investors a clearer picture of its operations ahead of a planned $450 million Eurobond sale this year and a possible initial public offering. The company also will move its oil-producing unit's headquarters to Siberia from Moscow. "This will increase the authority of the regional directors and allow them to increase control of production," said Tyumen Chief Executive Office Simon Kukes. "This process was agreed with the regional directors and will allow Moscow to supervise production operators" and work on strategic development plans.

The Armenian government is holding negotiations with the International Group of Companies Itera to reschedule Armenia's debt for natural gas. Prime news agency reported that due to the negotiations, Itera did not suspended supplies of gas to Armenia on 15 May as announced earlier by Itera. The deputy head of Itera's press service, Yevgenii Aleksandrov, said that Armenia has proposed rescheduling the debt for 18 months, by the 18 percent annual interest rate. He stressed that Armenia's total debt for consumed gas is approximately $10 million.

In the last four years, Itera has grown from a new natural gas trading firm to one of the world's largest repositories of gas reserves due to transfers from Gazprom. Itera, which has been accused of secret links and deals with Gazprom executives, earlier this year released an incomplete ownership list in an attempt to become more transparent. The list did little to clear up questions as to who controls the companies because most company shares are held in trusts.

Sibneft's proven oil reserves rose 1 percent in 2000 as drilling increased at its fields, which were audited by international oil and gas consultant Miller and Lents. The company said its proven oil reserves rose to 4.64 billion barrels last year, from 4.6 billion barrels in 1999. Sibneft's total crude reserves fell 11.1 percent to 8.28 billion barrels last year, while its proven reserves of natural gas stood at 43 billion cubic meters in January, Sibneft said in a statement. Sibneft drilled 249 new wells last year, more than double the wells drilled in 1999, while reserves rose because of "enhanced recovery methods," the company said. Sibneft plans to drill 361 new wells this year, Bloomberg News reported. The company earlier said it would almost triple investments to $595 million, up from $219 million in 2000. The company, which produces about 370,000 barrels a day of crude, is increasing output and investment as oil prices stay high for a third year. The reserves do not include oil held by the company's joint venture with Britain's Sibir Energy, or its 40 percent stake in Orenburgneft, a major producer of Onaco.

LUKoil-Garant, a pension fund owned by Russian oil giant LUKoil, is seeking to liquidate TV-6, the channel that absorbed journalists who left NTV last month, following its takeover by gas company Gazprom. LUKoil-Garant, which holds a stake in the television station, is asking a court to order its liquidation, citing no reasons behind the request. A hearing at the Moscow Arbitration Court has been set for 31 May. On 14 May, TV-6 shareholders appointed ousted NTV General Director and top news presenter Yevgenii Kiselev to run the channel. Self-exiled business tycoon Boris Berezovsky, who intends to form an opposition political party based on liberalism, controls TV-6. Some NTV journalists fear that Berezovsky will use TV-6 as a political tool against Russian President Vladimir Putin, thereby jeopardizing the journalists' independent editorial style. Critics of NTV claim that Media-MOST Chairman Vladimir Gusinsky used NTV in a similar fashion to promote his own political beliefs. Berezovsky and Gusinsky both accuse the Kremlin of trying to stifle criticism by cracking down on their media. Putin has accused the two financiers of abusing their positions by using their media to settle business scores, Reuters reported. This move by LUKoil will no doubt be viewed as part of the Kremlin's strategy of stifling and eliminating critical and independent news coverage from major TV outlets.

The Russian government on 19 May approved a sweeping electrical utility restructuring aimed at breaking up national power monopoly Unified Energy Systems (EES), despite protests from foreign investors. The plan, approved at a cabinet meeting, will split off regional electricity generating companies within three years and turn EES into the country's nationwide electrical grid operator. Economy Minister German Gref said that the state would take control over the transmission system and oversee the creation of five to seven competing electricity-generating companies. He believes that a federal body to oversee electricity tariffs will be established by October. Proponents, led by company chairman Anatolii Chubais, say selling stakes in the regional generators will attract badly needed investment to refurbish worn-out facilities and equipment, and spark competition. But many of the foreign investors, who own 34.3 percent of the company, fear valuable assets will be unfairly transferred away from the company, reducing the value of their holdings. Gref told reporters after the government meeting: "No seizing of property is being proposed. Everything will be compensated." The government adopted the plan put forward by Gref in conjunction with EES, rather than the proposal presented by the mediating Kress Commission. Special economic adviser to the president, Andrei Illarionov, said: "This is a very clear sign of the continuation of the privatization of the state with decisions from government bodies taken not in the interests of society, but in the interests of particular companies. It is very sad to see," the "Financial Times" reported. Aleksandr Lebedev, a EES board member and shareholder, said that Illarionov's criticisms were "overdramatic."

Alfa Bank President Petr Aven was elected as Golden Telecom Inc.'s new supervisory board chairman after Russia's largest private bank bought a 43.6 percent stake in the country's top Internet service provider. Alfa, which bought the stake on 11 May, received three seats on Golden Telecom's nine-member board of directors. Andrei Kosogov, Alfa's first deputy chief executive, and Tigran Agadjanov, a senior vice president at the bank, were also elected to the board, Bloomberg News reported. Golden Telecom Chief Executive Officer Stewart Reich said in the statement: "Mr. Aven will make an ideal chairman. He is experienced, extremely articulate, and has a great command of the economic and business issues we face in Russia." Golden Telecom offers local, international, and mobile data and telecommunications services in cities in Russia and the former Soviet Union. Earlier this month Global TeleSystems Inc., an Arlington, Virginia-based telephone company, completed the sale of most of its stake in Golden Telecom.

Meanwhile, Aven's Alfa Group announced that it is in final talks for a $250 million stake in Vimpelcom-Region, a subsidiary of Vimpelcom, Russia's second wireless company. The purchase is to be announced on 24 May. According to "Kommersant Daily," Alfa, which runs Russia's largest privately owned bank, will take its stake in Vimpelcom to 30 percent and will buy more than 50 percent of Vimpelcom-Region. Vimpelcom said in January it was negotiating with Alfa Eco Group, part of Alfa, to finance expansion outside the Russian capital. Alfa, which has been buying stakes in other telecommunications companies, including Golden Telecom, Russia's largest Internet service provider, is seen as an ideal partner because of its local knowledge and connections, Bloomberg News reported.

The "Nikkei English News" reported that Russia has proposed jointly developing rocket engines with Japan. It seeks to obtain modern engine technology. In recent talks under a bilateral treaty on space development, the deputy of the Russian Aviation and Space Agency suggested the two countries conduct research on Russian engines. Japan, expected to make a decision within three months, has suffered a series of accidents with its H-II rocket and plans to buy a Russian engine, it reported. The two countries already hold joint training sessions for astronauts.

Yukos Oil Co. agreed to acquire Siberia's largest refinery, in a move to expand its market in the Far East and sell oil to China. Yukos did not release figures on how much it will pay for a controlling stake in Angarskaya Neftekhimicheskaya Kompaniya. The refinery can process 24 million tons a year, with Yukos supplying it with a quarter of that amount. A company statement said, "The acquisition will be completed by 20 June, if all agreed conditions are met." Yukos is building a $1.7 billion pipeline with China National Petroleum Corp. to ship 20 million tons of crude a year (400,000 barrels a day) to China, starting in 2005. Yukos also is talking with NNGK Sakhaneftegaz to acquire 25 percent of the Yakutia-based exploration company, which holds an estimated 2 trillion cubic meters of natural gas and 300 million tons of oil reserves, Bloomberg News reported.

The Russian Energomashexport company is planning to participate in some power projects in Kenya and Tanzania. Director-General Aleksandr Zhigalov, a deputy in the Russian State Duma, said the Russian side was primarily interested in building power transmission lines and geothermal electric stations in those two African countries. "Power transmission lines are to link Kenya with some other countries of the region within the coming three or four years, especially with Uganda, Tanzania, and Zambia. We are able to offer all the necessary materials and equipment that are needed to transmit and distribute electric power. Russian companies are doing successful business abroad in such areas. Therefore, I see good prospects for such work," Zhigalov noted. A tender for the project in Kenya will not happen until 2007. Zhigalov said that, "as soon as a tender for this job is declared, we shall definitely take part in it." In Tanzania, Energomashexport will construct power transmission lines. The director-general noted that financing for the projects will come from German sources. The tender deadline for the Tanzania project is early June.

Rostelecom reported that in 2000 its profit fell 28 percent, as expenses increased and as Russia's national telephone company lost market share in its growing competition with other long-distance providers. Net income fell to 1.03 billion rubles ($35.4 million) in 2000 from 1.43 billion in 1999, based on Russian accounting standards. Revenue rose to 16.87 billion rubles from 15.21 bullion rubles in 1999, while the cost of selling goods rose 33.8 percent to 10.41 billion rubles. Konstantin Chernyshev, director of research at Nikoil Capital Markets in Moscow, said: "These are in line with our expectations. The first reason is the change in accounting standards, which cut net profit, and expenses are growing faster than their revenue." Rostelecom, which provides long-distance and international telecommunications services to regional and foreign telephone companies across Russia, is the second-worst performing stock on Russia's benchmark RTS index over the past 12 months, falling 61.7 percent. Rostelecom has said it aims to increase profit by boosting international traffic and expanding its Internet business, Bloomberg News reported.

Tatneft, Russia's fifth oil company, said first-quarter profit fell 17 percent from last year, as world crude oil prices declined and the government charged higher export duties on oil and fuel to as much as triple the level a year ago. First-quarter net income fell from 5.3 billion rubles last year to 4.4 billion rubles ($151 million). Revenue fell 18 percent to 20.1 billion rubles, based on Russian accounting standards. Oil prices stayed a third lower in the first quarter of this year, after reaching $34.59 a barrel, a 10-year high, last October. Russian oil companies expect revenue to decline by as much as 30 percent, depending on crude prices this year, according to industry experts' estimates. Tatneft was able to maintain operating margins of 34 percent, compared with 35 percent a year ago, by cutting operating costs, administrative expenses and interest payments on loans, said Steven Dashevsky, an analyst at Aton brokerage. Tatneft's four-month output rose by 5.2 percent to 8.1 million tons (494,000 barrels a day) from the past year's period.

Surgutneftegaz, which produces an eighth of Russia's oil, said first-quarter net income fell 21 percent. The company's first-quarter net income fell to 13.3 billion rubles ($457 million), from 16.9 billion rubles for the year-ago period. Revenue fell 7 percent to 33.6 billion rubles, based on Russian accounting standards. Dashevsky said: "This is in line with the broad trends in the sector we envisioned. We are going to see lower revenues and lower earnings because of lower export prices for oil products, while domestic costs are continuing to advance and the ruble remains stable." Surgut, Russia's third oil producer, also said capital expenditures rose 32.8 percent in the first quarter to 7.7 billion rubles. Its oil production rose 6.1 percent to 10.4 million tons (847,000 barrels a day), while natural gas production fell by 3.4 percent to 2.8 billion cubic meters of gas. "This profit is after tax deductions but before capital expenditure," Surgut spokesman Dmitrii Zhdanovich said. The company refined 4.2 million tons of oil in the first quarter, up by 2.4 percent from the first quarter of 2000. Dashevsky predicted, "Surgut management is in a very good position to control cost inflation."

An international conference called the "Caspian Sea of the 21st Century: from Politics to Business," will be held in Astrakhan on 24 and 25 May. The chief of the Astrakhan regional administration, Anatolii Guzhvin, said the conference "will be an efficient prologue to a meeting of Russia, Iran, Kazakhstan, Azerbaijan, and Turkmenistan planned for fall to define the Caspian Sea status." He said the forum will concentrate on the coordination of efforts of politicians and businessmen for the efficient use of Caspian natural resources, the sea status, and the environmental protection. They will also analyze the policy on investments, the development of oil and gas fields, and transportation and selling of fuel. Representatives of the Caspian leaders, ministries, departments, oil and gas companies, as well as of international consortiums of the U.S., Canada, Great Britain, Germany, France, Turkey, Ukraine, Armenia, and Georgia will participate in the conference.

Yuri Komarov, the deputy head of Russia's Gazprom, recently announced that the completion of the $3.3 billion natural gas pipeline from Russia to Turkey under the Black Sea, known as Blue Stream, would be delayed until Spring 2002. This seemingly minor delay, from the projected October 2001 completion, may have even bigger implications. Company officials stressed that they would not breach their commitments. "Gazprom has never failed its commitments. Neither will this happen in the case with the Blue Stream pipeline," Komarov declared. He blamed the Turkish parliament's late approval of laws supporting the project and the Turkish government's delay in ratifying it on environmental grounds for slowing down the work, AP reported.

According to the 1997 Russia-Turkey intergovernmental agreement, Russia is to deliver 360 billion cubic meters (bcm) of gas over 25 years between 2000 and 2025. Russia hopes to retain its role as Turkey's primary gas supplier. Turkey's gas demand is expected to more than double its current annual gas consumption to 45 bcm by 2006, according to estimated projections. This may, in fact, be reduced due to the current Turkish economic crisis. Gazprom annually exports up to 16 bcm of gas to Turkey. The 1,200-kilometer pipeline, laid at a depth of 2,100 meters under the Black Sea, would run from Russia's Izobilnoye compressor station, located 100 kilometers east of Krasnodar, to the Turkish capital Ankara, with 400 kilometers under the Black Sea. The final capacity of 16 bcm per year will eventually be supplied by two 8 bcm pipelines. The first pipeline will be completed in early 2002. At that time, an assessment will be conducted to determine if the second 8 bcm pipeline will be built based on consumer value to the Turkish citizen and viability for the companies and investors involved.

Stroitransgaz, a subsidiary of Gazprom, is building the overall pipeline and gas delivery project. On 12 May 1999, Intercon reported that Gazprom and the Italian gas-oil group ENI formed a 50-50 joint venture called Trustco to build, own, and operate the subsea section. Both companies planned to invest $200 million in Trustco, in addition to the $800 million loan from Italian banks Banca Commerciale Italiana and Mediocredito Centrale as well as Germany's Westdeutsche Landesbank. On 24 November 1999, Intercon reported that a $1.7 billion contract to build the offshore sections of the Blue Stream pipeline was signed. The joint venture, Blue Stream Pipeline Company, contracted Italian-based Saipem SpA, French-owned Bouygues Offshore, and a Japanese consortium comprising Mitsui Co. Ltd., Sumitomo Corp., and Itochu Corp. to design, engineer, and construct two threads of an underwater section of the pipeline and a compressor station, Beregovaya, on the Black Sea coast. Mitsui, Sumitomo, and Itochu planned to supply $500 million worth of pipeline. According to Intercon, on 28 February 2001, Gazprom borrowed 250 million euro ($231 million) to finance the pipeline from European banks led by HypoVereinsbank. Banks which participated in the loan included Germany's second-largest bank Credit Agricole, France's second-biggest bank, and Westdeutsche Landesbank Girozentrale, Germany's largest state-owned bank.

The delay of the Blue Stream pipeline will not significantly enhance development of the rival $2 billion trans-Caspian 16 bcm gas pipeline from Turkmenistan. It does, however, leave open the possibility for the smaller 6.6 bcm gas pipeline from Azerbaijani wells in the Caspian at Shakh Deniz through Georgia. This smaller pipeline may, in fact, fill a need in the Turkish market if Gazprom chooses not to build a second 8 bcm pipeline due to lack of profitability and the failure of the Turkish economy to expand and increase gas energy demand.

The trans-Caspian pipeline was one of the pillars of the Clinton administration's energy policy in the Central Asian/Caucasus region. Its purpose was to provide alternative energy routes out of the Caspian region bypassing Iran and Russia, thus reducing both countries ability to influence the region and effect international events by depriving energy supplies through their territories. The accord on the construction of the trans-Caspian pipeline was reached on the sidelines of the OSCE Istanbul Summit in November 1999. Little of substance was realized. An interstate agreement on implementation of the Istanbul accords between the governments of Georgia, Turkmenistan, Azerbaijan, and Turkey was scheduled to be signed in early April 2000. The Trans-Caspian Gas Pipeline group, which includes Royal/Dutch Shell and PSG International Ltd., jointly owned by Bechtel Enterprises Inc. and General Electric Co. of the U.S., set a target to deliver Turkmen gas to Turkey by the end of 2002, at a rate of 16 bcm of gas annually. U.S. influence and support accomplished little, but aggravated the Russian government and motivated Gazprom to move quickly with Blue Stream.

With the discovery of a new large natural gas field in Azerbaijan, the government of Azerbaijan demanded that it be allowed to use at least half of the trans-Caspian pipeline to transport its own gas reserves from the Shakh Deniz field. The resulting tensions between Azerbaijan and Turkmenistan prevented the signing of the accords. In late May 2000, State Oil Company of Azerbaijan (SOCAR) officials admitted that the pipeline would not be completed before 2006. According to SOCAR's chief of foreign investment Valekh Aleskerov, "The trans-Caspian gas pipeline cannot physically be ready before 2006 and that will only be if all the agreements are reached this year." In June 2000, PSG shareholder General Electric Capital threatened to withdraw its offer to build a gas pipeline from Turkmenistan to Turkey, if it was not approved. Ken Koprowski, vice president of communications for General Electric Capital Structured Finance, said: "We continue to have an offer outstanding with the Turkmen government. If we don't receive an answer in the near term we may withdraw the offer." On 18 September 2000, PSG consortium, which comprises General Electric Capital Services and Bechtel Enterprises, announced its intentions to close its offices in Ashgabat because of the uncertain future of the trans Caspian pipeline. PSG said it was handing over the lead on the $2 billion project to partner Royal-Dutch Shell.

Turkish government officials have tried to encourage both Russian and non-Russian governments to provide natural gas for Turkey's growing energy needs. This has produced competition between Russia and the former Soviet republics supported by U.S. State Department policy. This natural gas pipeline competition has clearly been an intersection point where politics and business have become almost indistinguishable. The recent parliamentary investigation into Botas and the Blue Stream project underlines the high-stakes political jockeying which is occurring in Turkey now. It has forced one Turkish energy minister from office and others may follow.

Clearly, whoever controls the lion's share of the natural gas market in Turkey will be able to assert tremendous influence on Turkish internal and external affairs. The degree of influence, however, will be measured not only by which pipeline gets there first, but also how quickly the demand for additional gas supplies will be expanded. Until this becomes clear, the first pipeline will continue to be the focus of great competition. Turkish Prime Minister Bulent Ecevit's comments during his 1999 visit to Moscow to discuss the Blue Stream project illustrated how Turkey has attempted to balance or manage this competition. Ecevit said: "We need gas, from wherever it may come from. These projects [Blue Stream and trans-Caspian] are not alternatives, they are complementary to one another."

Gazprom turned up the heat in Turkey on 18 May by blaming the resulting delays of the project with Botas and Blue Stream parliamentary investigation. Gazprom threatened to cease gas supplies to Turkish companies with late payment histories and find solvent companies to maintain its export volumes. Gazprom Chief Executive Officer Rem Vyakhirev said of Turkish companies struggling with the economic downturn: "The ones who do not have money, will not get gas. They will quickly be replaced by other consumers." A week before, Botas said it could not pay its bills for gas imports from Russia, Algeria, and Nigeria, Reuters reported. Gazprom has announced it is expanding transit capacity via Romania and Bulgaria to boost gas supplies to Turkey and meet its contracts. Vyakhirev added, "All the gas which will be supplied to Turkey will be used for gas-fired power utilities which are built by foreign companies, so Turkey's gas demand will be increasing."

It is unclear if Turkey's energy demand will require the second Blue Stream pipeline to be constructed in summer of 2002 or the Azerbaijan-Georgia one. It will be important to monitor both Turkey's economic health and the effectiveness of the Azerbaijani Caspian pipeline project. But with the expected participation of the ENI president at the annual CERA (Cambridge Energy Research Associates) conference in Istanbul in June, observers anticipate an "all systems go" announcement for Blue Stream. Until then, the competition will continue while politicians seek advantage either to internally remove political opponents or advance national interests. Politics will no doubt play a large role in determining the ultimate business and economic outcomes.