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Business Watch: July 27, 2001

27 July 2001, Volume 1, Number 4
The trip of Russian Prime Minister Mikhail Kasyanov to Finland on 24 July for meetings with his counterpart Paavo Lipponen, introduces a new political dimension into Russian foreign policy and its repertoire of energy pipeline projects. ITAR-TASS reported that "the discussion on energy cooperation would focus on constructing a northern European gas pipeline" under the Baltic Sea. Construction of such a pipeline would attempt to counterbalance and erase the uncertainties over proposals to construct a new pipeline through Poland to Europe. This has been interpreted as a political move to circumvent Ukraine and the pipelines that manage Russian gas distribution to Europe. The newly proposed Baltic Sea pipeline would enable Russia to use Finland to reach Western Europe, allowing regular deliveries of Russian-produced gas to EU countries. The northern European route could seriously compete with Russian gas deliveries through Ukraine or the plan of constructing a new gas pipeline through Poland to Europe that many doubt is realizable.

Finland has always been an important country for Russia. It is also a technologically advanced neighbor that plays a dominating role in the world's telecommunication market. Russia, meanwhile, intends to use its vast energy wealth to its advantage. Finland is already Russia's fourth-largest trading partner. The $5.2 billion in trade that was achieved in 2000 is a 30 percent increase over the previous year. This is largely energy related. In 2000, Russia and Finland trade surged, led by the energy sector with 42 percent of Russia's exports in oil products and 17.5 percent in natural gas. It is little wonder that a joint gas company between Russia's Gazprom and Finland's Fortrum is also under discussion. This is a further indication of the close, if not symbiotic, relationship that exists between the Russian government and Gazprom, especially after the appointment of Putin's confidante, Aleksei Miller, as Gazprom's new CEO. While many other transportation, railroad development, and oil exploration projects will be discussed, the project with the real international impact is clearly the North European gas pipeline that would transverse Finland to feed other European countries. But construction of any gas pipeline from Helsinki to the western parts of Finland and beyond is unlikely to be initiated much before mid-2006 at best. Much can happen between now and then.

A Japanese consortium including Itochu Corp. and Exxon Mobil Corp. are considering a gas pipeline connecting Russia's eastern island of Sakhalin to Japan. The pipeline, if built, would be the first connecting Japan to an overseas gas field. An Itochu spokesman said: "The final decision has not been made yet, but we are making a study along those lines." Construction of the pipeline between the Sakhalin 1 gas field and Japan's northernmost island of Hokkaido would begin in 2005, the report said. The pipeline, which the "Nihon Keizai Shimbun" business daily estimated would cost several hundred-billion yen to build, would eventually extend to the main Japanese island of Honshu. Exxon Mobil leads an international consortium to develop Sakhalin 1. It and Japan's Sakhalin Oil and Gas Development Co. Ltd. (SODECO) each have a 30 percent stake in the project. SODECO is owned by Itochu, Japanese trading company Marubeni, and other firms. Russian oil firm Rosneft and its affiliate owned the remaining 40 percent stake in the field. In February, India's ONGC Videsh Ltd. and Rosneft finalized a deal in which ONGC would buy half of the Russian firm's stake in the oil field.

Russian oil company Sibneft intends to place Eurobonds worth $250 million at the end of October. The term of repayment of the securities is three years. The final terms and the date of placement will be determined later depending on the situation on the market. ABN-AMRO and Schroeder Salomon Smith Barney have been hired as underwriters to coordinate the arrangements and book running of the issue. Sibneft collaborates with Moody's rating agency to examine the market and decide on the best time to place Eurobonds. Proceeds from the issue will be used to help finance Sibneft's investment program. The oil company plans to invest $595 million this year in exploration and production activities, plus $100 million in refining and retailing, the "Financial Times" reported. In June, Sibneft reported net profits for 2000 of $674.8 million. In 1999, it earned only $315.1 million. Sibneft has made two previous international issues: a $150 million international bond issue in 1997 and a $200 million zero-coupon note in 1998. In 2000, these securities were successfully repaid.

At a meeting between Russian President Vladimir Putin and officials from major auto producers held in Moscow on 6 June, a decision was taken to increase production of domestic cars by some 300,000 by the year 2006. It is also planned to raise the quality of the cars and to update existing models. According to Interfax, Russia plans to ban the production of ecologically harmful gasoline with a high-lead content starting on 1 January 2003.

The National Investment Council (NIC) worked out a scheme of returning legally earned capital back to Russia through the system of authorized banks, ITAR-TASS reported. On the sidelines of the 5th economic forum in St. Petersburg, NIC Chairman Aleksandr Lebedev said that these authorized banks "will be named by the president or the government from [among] the major Russian banks." These banks will open accounts for Russian businessmen who want to return their capital to the Russian economy. The businessmen will be guaranteed anonymity. The banks will inform the government of the amount of money returned to the economy and on further allocation of this money. Primarily, the money will go into investment projects, prioritized by the government, such as civil aircraft construction, Lebedev stressed. Within the first six months, the new program will bring "hundreds of million dollars" back to Russia, he said.

Canadian-Australian miner Argosy Minerals Ltd. said on 26 July that it would end up with a 30 percent stake in a proposed $800 million nickel project in New Caledonia under an agreement with Russia's Norilsk Nickel. Norilsk, the world's largest producer of nickel from its mines in Siberia, has agreed to proceed with the completion of a bankable feasibility study leading to the joint development with Argosy and its New Caledonian partner Societe des Mines de la Tontouta (SMT) of the Nakety/Bogota project. "We will end up with something in the order of 30 percent, with Norilsk holding the majority and SMT having a minority stake," David Russell, Argosy's manager of corporate strategy, told Reuters. He said the project was expected to receive a 15-year tax break from the New Caledonia government plus a further five years with tax at half the normal rate, in line with other mine projects planned for the island. Argosy had been seeking financial help to develop its Nakety and Bogota nickel deposits in the Northern Province and to build a processing plant to turn ore into nickel metal at a rate of 50,000 tons a year. An earlier plan to ship ore from New Caledonia to eastern Australia for refinement was abandoned after being deemed too expensive. Under the agreement, Norilsk will fund a $20 million feasibility study required before construction of the mine and plant can commence, Russell said. Norilsk also will reimburse Argosy for part of the $14 million it has already spent preparing the site.

Russia's minister for antimonopoly policies and entrepreneurial support, Ilya Yuzhanov, called on Russian entrepreneurs to get ready for severe competition on the international market after Russia enters the World Trade Organization (WTO). The minister, participating in a roundtable discussion on government and business interaction held in St. Petersburg, stated that current Russian antimonopoly legislation is not only fully in line with European and world standards, but even exceeds the latter in the aspect of interaction with the regions. Commenting on St. Petersburg's businesses, Yuzhanov said that the city can be fully competitive on the world market in shipbuilding, military equipment, and beer production, reported.

The Russian Union of Industrialists and Entrepreneurs on 16 July presented a proposal for the reform of Russia's weak banking system to a joint government-business council chaired by Prime Minister Mikhail Kasyanov. The proposal, drawn up by a working group under MDM Bank Chairman Aleksandr Mamut, calls for a sharp rise in capital requirements for fully licensed banks from $4.3 million to $100 million to be phased in over three years. This rise could cut the number of banks with full general licenses in Russia from 250 to 40 or less. Mamut said, "Russian industry needs stable banks it can trust. The government is doing a lot of serious reform, but in the banking sector little is happening." He said that in the past two to three years nothing has changed, noting that many banks remain undercapitalized, not properly regulated, and inept in serving the industry's needs. Mamut also proposed changing Russia's tax rules so that banks can build up adequate reserves out of untaxed income. He also wants specialized state-owned banks to have licenses explicitly preventing them from crossing over into areas of ordinary commercial banking, the "Financial Times" reported. "If you are going to have a development bank, it doesn't need to run foreign-exchange offices all across Russia."

On the first day of June, the Russian State Duma and the government agreed on a proposed reform which would reduce the burden of the profit tax. The government, which has made tax reform a priority, aims to get the Duma's approval for parts of the Tax Code relating to profit tax and abolishing turnover tax this year, making them effective at the start of 2002. It says its profit-tax reforms would reduce the overall tax burden by around 100 billion rubles ($3.43 billion) a year due to various deductions from the tax base, but the tax rate itself would be kept unchanged at 35 percent. Aleksandr Zhukov, chairman of the Budget Committee, said that in broad terms there is one main difference between the new and the old profit tax. The new law would allow businesses to fully deduct all their ordinary business expenses, with limited exceptions. The Duma's Budget Committee backed a compromise to let banks and professional securities market players create provisions for the depreciation of securities and agreed to limit the deductibility of bad debt provisions by a percentage of sales. The two sides agreed on changes to amortization terms, aimed at saving the government up to 80 billion rubles. The sticking point of a 50 percent deductibility of capital expenses remained unresolved. The committee backed Duma proposals to extend this privilege to all firms, whereas the government wanted to confine it to production industries. The first reading of the profit tax legislation concluded on 1 June. The second reading is set for 20 June. A final reading could come in July before the Duma goes on summer holiday.

Russia's Constitutional Court on 25 July, ruled that government authorities cannot reverse privatizations of state property without court approval. The ruling followed probes into disputed sales, prompting fears that major companies could be renationalized. The court also said that if buyers of state property are found to have violated investment requirements, they must forfeit the property to the state without being compensated. Government officials praised the decision, saying it clarified and tightened control over the murky privatization process, the AP reported. Under former President Boris Yeltsin, state assets were sold for bargain prices to a group of oligarchs, who then supported Yeltsin's reelection campaign in 1996 with their profits. First Deputy Property Minister Aleksandr Braverman said, "Unfortunately the 1991 Law on Privatization gave a lot of loopholes and turned the privatization process into a competition of promises, which as a rule were broken." The government's representative to the Constitutional Court, Mikhail Barshevsky, said, "This decision is totally right and follows all requirements of the constitution and the civil code." No renationalizations have taken place to date under Yeltsin's successor, Vladimir Putin. Last year, Russian prosecutors sought to cancel the privatization of the Norilsk Nickel mining complex, claiming that the $620 million paid for the state's stake was far below its actual value. The lawsuit was thrown out by a Moscow court.

Some of Russia's big liquor-vodka plants, including Moscow's Kristall and Topaz, resumed operations on 12 June after almost a two-week break. On 1 June, Russian vodka plants were shut down after a new excise tax mechanism was introduced. Currently, only 10 percent of the closed plants have obtained a status of excise storage facilities in line with the new legislation. According to Pavel Shapkin, head of the National Alcohol Association, vodka production in Tula, Ryazan, Tver, Vladimir, Sverdlovsk, and some other regions is still under suspension.

On 9 June, Sidanco subsidiary Varyoganneftegaz elected Sidanco's financial planning department head Khariton Kesov to chair its board. Previously, Kesov was also the general director of Varyoganneftegaz. The board of directors appointed Yevgenii Bulgakov the company's general director. He worked for Brown & Root Energy Services from 1994 to 1996 and headed Halliburton Arkhangelsk Ltd. in 1997.

A poll conducted by GazetaSNG and the Fund of Newly Independent States named the most influential representatives of the CIS business elite. The list included LUKoil President Vagit Alekperov, leader of all-Ukraine Batkyvshchina movement Yuliya Tymoshenko, and United Energy Systems Chairman Anatolii Chubais. The poll was conducted among 321 business experts from 12 CIS states. "The Golden 20" of leading CIS businessmen also includes Rem Vyakhirev, Mikhail Fridman, Lev Chernoi, and Ilkam Aliev. They scored five out of 10 "influential points." Boris Berezovsky, Oleg Deripaska, Vadim Rabinovich, and Igor Makarov follow them on the list, reported.

Russia's leading steelmaker, Severstal, has abandoned a plan to build a large-diameter pipe plant with Europipe in St. Petersburg and has agreed to work with a domestic partner instead. The firm is creating a joint venture with the United Metallurgical Company (OMK), which controls the Vyxunsky and Chelyabinsk pipe plants. Severstal will supply strips for large-diameter 1,420-mm pipes to both Vyxunsky and Chelyabinsk. Vyxunsky will then produce thick pipes and Chelyabinsk thin pipes. The project calls for an investment of between $200 million and $220 million at the wide-sheet facility known as Mill-5000 at Severstal's Izhora works. The money must also be spent on equipping the two pipe plants with production facilities for the 1,420-mm pipes. Roughly half the planned investment will go into Severstal's mill and half into the OMK units. Annual output will be 300,000 tons of large-diameter pipes. Payback of the investment is estimated to take two-and-a-half years. After the first stage of the project is up and running, the Severstal-OMK venture plans to expand into production of other large-diameter sized pipes, "Russia Journal" reported.

Troika Dialog has given the rating of "strong buy" to AvtoVAZ and assigned the stock an estimated fair value of $16.52 per share, Reuters reported. According to Troika market analysis, "AvtoVAZ is an attractive speculative bet on a possible improvement in the corporate governance image, which should unlock value in the largest manufacturing company in Russia." Troika said AvtoVAZ's joint venture with General Motors, which was signed last month after years of delay, would improve the Russian carmaker's corporate governance and hence, market sentiment towards it. The brokerage said AvtoVAZ's fundamentals were strongly undervalued, despite the fact it had a 43-percent market share and was among the 10 largest corporations in Russia with a market capitalization of $211 million. AvtoVAZ has been outperforming the local market since mid-February. It closed on 16 July at $7.90. Preferred shares were last traded on 11 July at $2.70. Troika based its recommendation on a $7.25 price per ordinary share and $2.73 per preferred share.

The appointment of Deputy Energy Minister Aleksei Miller to the position of Gazprom Chief Executive Officer (CEO) in late May was a complete surprise and had a shocking effect on the management of the company. As Intercon's "Daily Report on Russia and the Former Soviet Republics" reported on 30 May, President Vladimir Putin convened Gazprom's board of directors in a special Kremlin meeting and introduced his candidate, Aleksei Miller, for the position of CEO. Half an hour later, all 11 board members, including then-CEO Rem Vyakhirev, in a unanimous vote accepted Vyakhirev's resignation and approved Putin's appointee. Rumors over who would lead Gazprom were widely speculated by the Russian press and industry analysts. Among the potential candidates were the names of practically all top managers of the company including Vyakhirev's children -- Yuri Vyakhirev, head of Gazexport, and Tatyana Dedikova. This is why the appointment of Miller was a "fantastic nomination" by President Putin, as described by "Nezavisimaya Gazeta" on 31 May.

Miller's biography has one small, but revealing detail -- for five years, from 1991 to 1996, he worked under Putin at the Committee of External Relations of the St. Petersburg Administration. Apparently, he demonstrated loyalty to Putin, which is now being rewarded. Putin earlier lobbied Miller's appointment as a head of the Baltic Pipeline System, one of the major transport and investment projects of the Russian Northwest. Last year, Miller was promoted by a personal presidential order to the post of deputy energy minister. According to "Kommersant-Vlast," Miller was offered the energy minister position. Most likely Miller rejected this because Putin had promised him the Gazprom position as early as last winter. According to the biographical note issued by the External Relations Committee of the St. Petersburg Administration, Miller was deputy chairman of the committee and head of external economic relations. In the early 1990s, he was involved in the first regional investment projects of U.S. companies Coca-Cola, Wrigley, and Gillette. He participated in the development of the customs infrastructure and foreign investment support projects. Miller was the deputy director of investments in the joint-stock company Sea Port of St. Petersburg.

"Kommersant" believes that from his very first steps as Gazprom CEO Miller took a right political direction. He promised the president and the prime minister to increase gas production by 10-15 percent by 2010. This move will be appreciated by Vyakhirev's opponent, Anatolii Chubais, who has been trying for years to make Gazprom increase production. Miller also pledged to increase gas exports. "Expert" speculates that Miller's appointment could have a positive effect on developing a competitive gas market in Russia. Traditionally, a head of Gazprom would go through all the stages of the "gas business" before taking the leading position. As a result, the company developed a "specialty" style of centralized management for its leaders who knew every detail of this business and were capable of controlling "all entrances and exits." Miller is not that type of manager and he is not well versed in gas extraction. It is likely that Miller will only control the "central policy" implementation. He will have to allocate power over professional decisions to each of the top managers responsible for extraction, transportation, exports, and domestic sales. This will cause each division to become more independent, contributing to decentralization and the break up of Gazprom into smaller companies "under the same roof." Analysts believe this will make the company more transparent and will attract foreign investment into the Russian gas industry. "Profile" forwards another theory on Miller's activities as a Gazprom CEO. The magazine believes that being an "outsider" in the gas industry, Miller will not be able to rely on his personal or professional ties within the company, because he does not have them. Thus, he will be a puppet in the Kremlin's hands, and play his traditional role, the one of a loyal and punctual bureaucrat.

In early June, "Novaya Gazeta" reported that the criminal tax evasion case was reopened against Sibneft's Roman Abramovich and that Russian President Vladimir Putin was tired of Abramovich's political pretensions. So the president, in the heat of the moment, decided to break up the three-way tango, a term used in the political circles to refer to the close alliance of Roman Abramovich, Tatyana Dyachenko, and Valentin Yumashev. The current investigation concerns allegations that Sibneft failed to pay $12 million to $14 million in value-added taxes (VAT) and obtained tax privileges it was not entitled to. Bloomberg reports that the investigation is against Sibneft President Eugene Shvidler and involves 14 million rubles ($480,000) in unpaid taxes. He noted that prosecutors had previously investigated the company and resolved the case in Sibneft's favor.

Summoned for questioning, Abramovich had to report on the tax case and on the state's sale of Sibneft in 1995 to 1996, "Kommersant Daily" reported. Sibneft First Vice President Aleksandr Korsik stated at a press conference, "We do not understand why the issues, which were already resolved in Sibneft's favor, appear again on the agenda. I do not know what the accusations are. If there were reasons to be worried, I would know this."

The question remains, however: Why is President Putin getting rid of his loyal financier and political manager? After all, Abramovich had taken Sibneft away from Boris Berezovsky, whom Putin recently called "a traitor." Abramovich also brought the ORT network under state control. Finally, he departed to remote Chukotka peninsula so as not to wreck Putin's image as an "oligarch-free" politician. Is this government investigation directed at Abramovich himself or will Abramovich use it for his own purposes? Some Russian commentators have speculated that the case may be cleverly used by Abramovich to implicate specific individuals who he is interested in removing from Sibneft.

Abramovich continues to influence the cabinet and Prime Minister Mikhail Kasyanov. According to sources in the Russian State Duma, officials close to Kasyanov worked via Abramovich and his resources in order to encourage a number of Duma deputies to endorse Kasyanov as prime minister and support his projects at critical moments. Apparently, the Kremlin, which holds control over the Duma and its voting behavior, did not like it. Moreover, the rumors on reshuffling the cabinet, including Kasyanov, have been in the air for months now. On 29 May, Intercon reported that Putin criticized Kasyanov over the budget, saying that although he [Kasyanov] was "working intensively every day...there are no results. There is no light at the end of the tunnel." Putin comments came two days after Kasyanov asked the president to postpone the reshuffle.

The charges against Sibneft have been unleashed under Article 199 (tax evasion) of the Criminal Code. Everything was done according to tradition, tested in the cases of Media-MOST, Transneft, and other companies -- raids by masked security police and the sweeping confiscation of documents. An intelligent man, Governor Abramovich understands that the Kremlin is ordering him to scale back his activities. This is not yet a matter of jailing him, this just a warning sign. But what happens if Abramovich disobeys and continues to interfere with the government? Then the Federal Tax Police Service archives will provide certain lethal documents, which will be handed over to the General Prosecutor's office, and which will be included in the criminal case against Sibneft. According to the tax police, Sibneft managed to understate VAT alone by 52.13 million rubles within just five months. Abramovich and his team also concealed revenues of 55.67 million rubles from the sale of fuel and lubricants. These two figures added and exchanged at a pre-crisis rate total of $21.58 million. Accusations against Abramovich get even more serious: "During inspections, Sibneft presents customs declarations with stamps confirming that CIS borders have been crossed -- but these are clear signs of forgery," the tax police said. According to the preliminary data from the Omsk regional police, the total sum which Sibneft has failed to pay to the state is 500 million rubles, which is around $100 million at a precrisis rate. All these documents were safely filed away. Now, there is a chance that they may be used in the tax-evasion case. This means Abramovich's fate is sealed.

The question, however, remains: Is this Putin's next move in an anti-oligarch war which he launched over a year ago? Is it really getting rid of an oligarch structure, or is this just the replacement of one oligarch for another? If the investigation is directed at Abramovich himself it will be the first high-profile move against an oligarch who has not openly criticized Putin or his policies, as Vladimir Gusinsky or Boris Berezovsky did through their media outlets.