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Business Watch: August 16, 2001

16 August 2001, Volume 1, Number 6
The Russian oil company LUKoil confirmed plans to purchase a 85.36 percent block of shares in NORSI-oil at an auction that will be held on 19 October, LUKoil's first vice president, Leonid Fedun, announced. The Russian Federal Property Fund started accepting applications for participation in the auction on 15 August. As reported, shares in NORSI-oil will be sold in two blocks: 40 percent and 45.36 percent. The initial price of these blocks amounts to $22 million. LUKoil, however, will not participate in the privatization of a 19.6 percent block of shares in the Russian-Belarusian oil company Slavneft in the second half of 2002. Fedun also announced that LUKoil will publish a report for the first half of 2001 according to the GAAP (Generally Accepted Accounting Principles) standards. This report is expected to be published at the beginning of the fourth quarter of 2001.

The Russian-Belarusian oil company Slavneft is preparing a lawsuit against the Russian foreign bank Ost-West Handelsbank, a structural branch of the Russian Central Bank, for defamation. RosBusiness Consulting reported that a representative of Ost-West Handelsbank announced several days ago that a German court seized $2.6 million of Slavneft's assets after it refused to repay the above sum as a guarantee on a credit to the Finnish Uni-Baltic Oy Ltd. The Slavneft leadership stated that there are no official documents proving this court decision. In addition, they announced that the participation of Slavneft in the transaction between Ost-West Handelsbank and Uni-Baltic Oy Ltd would be illegal. Slavneft officials believe this campaign defames the reputation of the Rus-Belarus oil company and Ost-West Handelsbank itself.

Boeing Co. and the Russian aerospace company Ilyushin Aviation plan to open a Moscow-based training center to develop computer skills for engineers. The center will train Russian aerospace engineers in CATIA, the computer software Boeing uses to design its aircraft. The center, which can train up to 50 engineers at a time, will teach some English. Engineers will be trained to work at the Moscow-based Boeing Design Center, which does work for the aerospace giant's Commercial Airplanes division. Sergei Kravchenko, Boeing's vice president for cooperative programs and business development in Russia, said the company also plans a major investment in upgrading technology at the training center, the "Russia Journal" wrote.

The Moscow city government Audit Chamber finished auditing Mosenergo, Moscow's major energy supplier, Mosenergo Director-General Aleksandr Remezov declared at a briefing on 14 August. The Audit Chamber concluded that municipal companies were working inefficiently with Mosenergo, which led to excess profits of the energy company. In addition, officials declared all of Mosenergo's promissory note transactions efficient and gave their positive estimations to its leasing activities as well, RosBusiness Consulting reported. The volume of excess profits of the energy company amounted to 1.8 billion rubles (about $61.4 million). The Audit Chamber didn't reconsider the results of an audit conducted by Mosenergo's own audit commission. The latter revealed a $16 million to $20 million loss over 2000 and the first five months of 2001.

Lockheed Martin Air Traffic Management (LMATM) announced the opening of a representative office in Moscow to address a broad spectrum of civil aviation infrastructure needs in Russia and other Commonwealth of Independent States (CIS). At a press conference, LMATM said that the company will propose the deployment of new technology to provide air traffic control for major segments of Russian airspace currently uncontrolled by radar. LMATM President Don Antonucci said, "We look forward to establishing technology partnerships with Russia and neighboring countries to improve the CIS region's aviation infrastructure. These improvements can open airspace, generate revenues via overflight and landing fees, and thus contribute to economic development and progress in the region." He added that the system proposed to be deployed, "relies on advanced satellite position reporting and data communications to improve situational awareness." The company is also working with transportation authorities in Russia and surrounding states to plan other airspace modernization projects. In December 2000, LMATM signed a 15-year agreement to modernize the Republic of Georgia's aviation infrastructure. Under the agreement, the company is evaluating a wide range of aviation-related projects, such as the establishment of a regional airline. LMATM has also worked with Ukraine and plans to conclude an agreement within the next few months with Kazakhstan.

A Russian court has rejected a lawsuit launched by a Norilsk Nickel shareholder against the metals giant, which led to the suspension of trade in the shares of one of its units, Norilsk said on 13 August. Trade in shares in Norilsk subsidiary Mining and Metals Company (MMC) Norilsk Nickel was suspended on 9 August on the Moscow International Currency Exchange (MICEX), in line with a court order from the Siberian town of Kemerovo. Norilsk said in a statement that the order, launched after a suit by an individual shareholder, had been overturned as groundless. A ban on the use of Norilsk's brand name to advertise its goods and services was also overturned. MICEX could not immediately say when trade in MMC would resume. The RTS electronic exchange, which also received the court order last week, had declined to obey it, having found loopholes in the order, Reuters reported. Norilsk is the world's largest producer of nickel and palladium, a platinum group metal used in the car industry. The company is currently undergoing a restructuring in which shares in MMC will be swapped for shares in Norilsk and will eventually become the company's only traded stock.

The Moscow International Currency Exchange (MICEX) said on 10 August that it had halted share trade in a unit of metals giant Norilsk Nickel after an order from a regional court. Yelena Kovaleva, a spokeswoman for Norilsk, said a private shareholder in the town of Norilsk had launched a suit against the company in a court in the Siberian industrial town Kemerovo, although Norilsk had not yet received the court orders. "But from what we heard, MICEX and the Russian Trading System (RTS) have received court orders not to undertake any actions with the shares of Metals and Mining Company (MMC) Norilsk Nickel and with Norilsk shares themselves." The RTS electronic exchange declined to obey the court order, as it had found some legal holes in it, a spokeswoman for the RTS told Reuters. Both MMC and Norilsk shares are traded on RTS, while only MMC shares are listed on MICEX. The court order also bans Norilsk from using the name Norilsk Nickel to advertise its goods and services. Kovaleva said the order was unlikely to hit Norilsk's metals trade and had no comment on the aim and instigators of the suit. Analysts doubted the court decision could cause serious damage to Norilsk. "These rulings normally have a short life," said Mikhail Seleznev of United Financial Group.

Yonhap News Agency reported that North Korea is considering plans to establish a permanent trade office in St. Petersburg. This is in line with the aim of increasing bilateral trade between North Korea and Russia's second largest city. A source close to the planning said that a drastic increase in bilateral trade between North Korea and St. Petersburg is not anticipated even if such an office is established, considering North Korea's meager trade volume with the Russian city. Kyodo News reported that North Korea's exports to St. Petersburg stood at about $640,000 while imports from the Russian city stood at about $570,000 this year. While visiting, North Koran leader Kim Jong Il showed interest in the beer brewing industry, frigates, equipment for drilling petroleum and natural gas, road construction, and logging equipment.

Russia may pool resources with China or India to build a new-generation fighter jet to re-equip its air force and help secure a competitive edge over prospective U.S. and European designs, a top cabinet official said on 9 August. China and India are the top customers for Russia's beleaguered aircraft makers, who have received almost no orders from their own government in the decade since the Soviet collapse. Both countries have recently bought large batches of Russia's Sukhoi fighter, and purchased licenses to manufacture more. But Russian Aerospace Agency Director Yuri Koptev warned that Russia risks being edged away from lucrative export markets unless it urgently starts work on a new fighter. "Such planes as the Su-27 and the MiG-29 and their modifications can stay competitive only for another seven or eight years, as the United States is developing new-generation planes," Koptev told a Moscow news conference. The largest portion of the new fighter's development costs involve building a new engine. It's expected that the new aircraft would first upgrade the AL-31 engine that equips the Su-27 and its derivatives. It would cost between $1.2 billion and $1.5 billion to modify the engine for the new fighter and another $600 million to $800 million to then turn it into a completely new engine. Koptev said the Sukhoi and MiG companies are competing to meet an end-of-the year deadline to present their proposals for the new generation fighter to a government commission, which will determine the winner during the first quarter of 2002. The winning company is to present a prototype by early 2006 and make the plane ready for serial production by 2010.

Russian Finance Minister Aleksei Kudrin has announced that he expects no sharp changes in the ruble to dollar exchange rate after a cut in obligatory hard-currency sales by exporters, ITAR-TASS reported. Effective on 10 August, Russia has cut the volume of revenue exporters must to sell inside the country from 75 percent to 50 percent. Kudrin said the move would be good for the economy and that the Central Bank had enough currency instruments at its disposal to keep the ruble stable. Obligatory hard currency sales for exporters were introduced following the 1998 economic crisis and ruble devaluation to prop up the currency and increase Central Bank reserves to help the government service foreign debts, Reuters reported. "It [the cut in required sales] is a necessary economic measure which is overdue," Kudrin said.

Russia's Finance Ministry has predicted, based on the 2002 draft budget, that the country will seek up to $1.19 billion in foreign loans. The government would also borrow up to 652.1 billion rubles ($22.25 billion) on the domestic market. Interfax quoted the source as saying that under the 2002 budget parameters the government has the right to undertake foreign borrowing to restructure the country's foreign debt, lower the cost of servicing it, or pay it off. The government had earlier said it planned to issue up to $1 billion in eurobonds in 2002.

St. Petersburg has opened a vodka museum to mark the importance of the drink in more than five centuries of Russian life. Sergei Chentsov, one of the museum's directors, said that "Vodka is a part of Russian culture and national history, and people should not only drink it but also know and understand it." Included in the exhibition is a history of vodka's first appearance in a Russian monastery between 1438 and 1478, antique vodka bottles, glasses, advertising posters, jokes, and comics surrounding the beverage, and, of course, a tasting. Chentsov notes that the proper daily portion of vodka should not exceed 1 and three-quarter ounces. Visitors can drink more than three times that amount if they try all seven types of top-notch vodka. A "dry" museum visit cost $.86, while a tour with the tasting costs from $13 to $15.

Russia's population continues to decline. If this trend does not change by 2050, there will only be some 85 million people living in Russia. To prevent this decline from occurring, at least 700,000 people should annually immigrate to Russia. Since 1991, 8 million people, mostly from the neighboring former Soviet republics, came to Russia seeking permanent residence. Unfortunately, the flow of migrants has decreased in recent years and "red tape" is to blame, "Izvestiya" reported. Due to bureaucratic complications, it is nearly impossible to become a legal refugee in Russia today. A "propiska" (registration) is still required but cannot be easily obtained. As a result, more than a million immigrants stay in Russia illegally. Another problem is a lack of funds needed to direct the immigrants to the most deserted territories. Generally, the government is unwilling to spend money on attracting immigrants. Some public organizations, however, provide financial aid for immigrants, but this is reportedly insufficient to attract millions of ethnic Russians, between 3 and 20 million, who are willing to go back to Russia but do not have funds to do so.

The net profit of Tyumen Oil Company (TNK) plummeted 49 percent in the first half of 2001, compared to the corresponding period in 2000. Profits reached 1.18 billion rubles (about $40.2 million). The volume of pretax profit amounted to 2.77 billion rubles (about $94.21 million), compared to 3.41 billion rubles ($116 million) in the first six months of 2000, according to the TNK press service. The volume of sales revenues reached 7.17 billion rubles ($244 million) in the first half of 2001 as compared to 4.73 billion rubles ($161 million) in the corresponding period in 2000.

Top Russian cellular firm Mobile TeleSystems beat expectations as it reported a rise in profits and core earnings in the second quarter. The higher profits were achieved despite a $28 million write-off of previously capitalized costs. The operator posted a net income of $35.04 million on net revenues of $205.89 million. The company's first quarter income was $31.22 million on net revenues of $166.3 million and its second quarter 2000 income was $28 million on revenues of $120 million, Reuters reported. Earnings before interest, taxes, depreciation, and amortization rose to $81.54 million in the second quarter from $58.44 million in the same period last year. Analysts had expected lower profits due to an influx of mass market subscribers, that nearly tripled its subscriber base year-on-year, on top of the effects of the write-off of $28 million in previously capitalized subscriber-acquisition costs. Average revenue per user for the quarter was $38 compared with $67 in the second quarter of 2000.

Until recently, Aleksei Mordashov, director of the Severstal Metallurgical Plant, was one of the few Russian oligarchs not involved in a major scandal. This is no longer the case, and his days out of the media spotlight are over. In late July, Mordashov's first wife, Elena, filed a lawsuit against him alleging failure to pay alimony. Elena claimed that she receives $650 per month in alimony for their 16-year-old son, Ilya. For the sake of comparison, "Moskovsky Komsomolets" reported on 20 August that Mordashov's annual income is $80 million. Under a court decision, 32 percent of Severstal shares, which are controlled by Mordashov, have been seized. Until this week, Mordashov did not publicly comment on the lawsuit. In his first interview with "Vedomosti," on 21 August, Mordashov denied all the allegations. He stated that his income has never been $80 million, but refused to specify the exact amount. Mordashov claims that he pays $1,500 in alimony per month excluding the expenses for his son's education, health care, and traveling. He believes Elena is being manipulated by some outside forces which use the pretext of alimony to distract Mordashov from his business affairs. "I cannot blame anybody. I do not hold evidence in my hands," he said. However, Mordashov openly pointed his finger at Iskander Mahmudov and Oleg Deripaska, powerful oligarchs and Mordashov's business competitors.

Mordashov specified the exact deals where his and Mahmudov-Deripaska's business interests clashed. First, Mordashov says, Severstal has been seriously negotiating a merger with Magnitogorsky Metallurgical Plant (Magnitka). This merger would create a new powerful player on a world metallurgical market. At the same time, this would be a business failure for Mahmudov, who repeatedly made clear that he will "devour" Magnitka. According to "Novaya Gazeta," an alliance of Mordashov and Vladimir Kogan, another oligarch close to President Putin, was playing the role of "white knight" by saving Magnitka from a predatory Mahmudov. Secondly, Mordashov is engaged in a huge project to manufacture large-diameter pipelines. Mahmudov happens to be lobbing for a similar project in Nizhny Tagil. Thirdly, Mordashov openly states that he will participate in the Kuzbasugol (Kuzbas coal plant) privatization tender. If he wins, Severstal will have its own coal supplier ensuring stability of its operation. Finally, Mordashov and Mahmudov-Deripaska business interests collided in the automobile industry. Media reports that Mordashov took over the Zavolzhsky Motor Plant from Deripaska, thus igniting the conflict. However, Mordashov, who likes to compare himself with a tank pushing its way through dirt to get things done, is not afraid of the clash of interests. "We will do what we want to achieve. They will not stop us, and they will not break me," he said.

"Vedomosti" concluded that behind Mordashov's alimony scandal is a lucrative place in the metallurgical market, sought by Mahmudov and other business tycoons. "Novaya Gazeta" goes further with its conclusions, stating these new "iron" oligarchs are throwing into a garbage can with their iron fists the "sentimental and romantic Yeltsin team." Mordashov displays deep loyalty to Putin, and expects the same in return. "Novaya Gazeta" explained how the "trust and support" between Putin and Mordashov works in reality. Yuri Spiridonov, the governor of the coal-rich Komi Republic, is running for his second term this fall. The best guarantee for his victory would be the personal support of Putin. The newspaper claims Mordashov guaranteed Spiridonov that Putin would visit his region in return for his help in gaining control of Vorkutaugol (Vorkuta coal plant) shares. If Putin goes to Komi to support Spiridonov, the far-reaching influence of Mordashov will be proven. According to media, Mordashov's ambitions extend much further. The Russian press reported Mordashov is actively lobbying himself for a deputy premier position. He hopes to eventually use such a position as a springboard to the highest governmental position, as it is reported that Mordashov plans to run in the 2004 presidential election. Such a perspective, however, might cause Putin to reconsider his "friendship" with Mordashov.

On 14 August, the Moscow International Air Show opened at Zhukovsky Base, part of the Gromov Flight Research Institute, which is responsible for testing new military aircraft. Domestic aircraft producers Sukhoi, MiG, and Ilyushin, along with foreign companies Antonov, Boeing, and Airbus exhibited the latest in civilian and military aircraft. Russian President Vladimir Putin addressed the air show, which was attended by thousands. He said, "Economic difficulties have taken their toll on the aviation industry, but despite that, our aircraft makers have found their niche in the global market," the AP reported.

The Russia aviation industry once accounted for 60 percent of world output during the Soviet-era, making 2,500 planes and helicopters a year under the names of Tupolev, Ilyushin, and Antonov. Heavy government orders dried up after the collapse of the Soviet Union. In 2000, Russia delivered just four planes, compared with 489 produced by Boeing alone. The Russian Air Force received a few experimental aircraft, and only 49 of 115 bases have fuel for aircraft and training pilots. General Anatolii Kornukov, commander in chief of the Russian Air Force, described the situation in bleak terms in "Kranaya Zvezda" on 18 August. He described the air defense system as being in disarray and that not a single new aircraft was added to the front line air groups in the last decade. "Our air resources and the condition of our aircraft are falling. To buy equipment, spare parts and engines, we estimate we will need almost 11 billion rubles ($375 million)." Modernization of existing aircraft has been financed through the sale of its older fleet, which produced four billion rubles ($136 million). Only 5 percent of the military fleet today can be described as modern.

The Russian aviation industry is producing about 30 percent of all defense-sector production and is responsible for 60 percent of Russia's weapon exports, Deputy Prime Minister Ilya Klebanov noted during a speech at the air show. Sukhoi has been virtually the only Russian aircraft manufacturer, winning contracts for large batches of Su-27 and Su-30 fighters to China and India with deals worth billions of dollars. But these figures do not represent a solution to the military aviation problem. Today, the average age of experienced military pilots is approximately 40 years.

Despite limited successes, Russia's aircraft industry is torn between protectionism and cooperation with Western companies. While the Russian aviation industry specialists call for increased restrictions on the acquisition of foreign planes by domestic airlines, those firms are seeking cooperation and investment abroad. One aircraft manufacturer official said that protectionism was vital for manufacturers, who will need at least another decade to recover and might not otherwise survive to see better years. He said, "Companies like Boeing or Airbus can talk about wanting to help Russia's aviation industry, but they are not charities. They are here to make money," Reuters reported. He believes that pressuring domestic airlines to buy domestically produced aircraft or face heavy tariffs on the import of foreign ones was a necessary evil. He said, "[Russian] Airlines and [the] aviation industry must band together because the demise of one would devastate the other." Aviation lobbyists have criticized Boeing and Airbus, stressing that they have an unfair advantage in the country. Boeing Vice President Craig Jones does not doubt the capability of Russian engineers, but said they needed many years before they would recover fully from the Soviet collapse. He said, "They need to find the money to build themselves up, modernize, and finally produce the plane clients want, not just the ones they themselves want to build." He argued that industry protectionism hurts Russia by making it harder for airlines to acquire the hundreds of quality aircraft they will need over the next 10 years.

Meanwhile, aviation manufactures have been forming necessary partnerships with Western companies. Boeing, which has invested $1 billion in Russia, has started a feasibility study with Ilyushin and Sukhoi to consider the joint creation of a regional jet, seating up to 100 passengers. Airlines in Russia are seeking a reliable, cost-efficient regional jet. Aeroflot has already said it would be interested in purchasing 30 regional jets. Boeing's vice president for cooperative programs and business development, Sergei Kravchenko, said: "Despite everything that has happened in Russia in the last decade, engineers and technicians in Russia's aviation industry remain among the best in the world," Reuters reported. He explained that Sukhoi will lead the venture; Boeing will help market the plane in Russia and abroad; and Ilyushin will deal with domestic and foreign certification. Test flights on the regional jet could begin in 2004. In addition, Airbus has offered Russia a program of cooperation in the production of civil aircraft. Airbus Director Havier Ternier explained that the program will focus on certification, research and technologies, purchasing of materials, designing, and participating in batch production. Kyiv-based Antonov and the Chkalov aircraft manufacturing plant in Novosibirsk have decided to begin designing a version of the An-38 aircraft for carrying airborne troops, with a payload of 3 tons. This cooperation noted the new plane had three potential buyers, but did not disclose their names. Russia and Ukraine have agreed to pool their efforts to market the jointly developed An-70 transport plane internationally.

The Irkutsk aircraft production amalgamation is taking a different approach: self reliance. According to Aleksei Fedorov, the company is restructuring itself to increase production, as reported by ITAR-TASS on 17 August. The ambitious plan is to create a company that can do it all from design, to production, marketing, and maintenance. Military aircraft will be marketed by the Russian military export agency while they will concentrate on civilian sales. The company plans to reinvest its profits to achieve its goals internally. These plans include investing $200 million or 10 percent of its profits into new projects and modernizing existing aircraft. Another 5 percent or $100 million will be used to enhance its technical capabilities. This comes at a time when more than 20 civilian aircraft and 80 flight crew members in Siberia have been grounded for safety violations. However, all is not lost: Ulyanovsk Aviation Production Complex (Aviastar) has announced its intention to resume assembling aircraft after a six-year hiatus. In 1999, Tupolev Design Bureau announced a merger with its production partner Aviastar. This was the first commercial merger of Tupolev with a production company. After 10 years without investment, the challenges for Russia's aviation industry remain formidable.