Business Watch: January 14, 2003

Prime Minister Mikhail Kasyanov told oil and gas prospectors in Murmansk on 10 January that current and future oil and gas pipelines in Russia will remain the property of the state, gazeta.ru reported the same day. The statement has serious implications for the $3.5 billion-$4.5 billion western Siberia-Murmansk pipeline that Yukos, Tyumen Oil Company, LUKoil, and Sibneft hope to build. The oil majors announced the project, slated for construction beginning in 2004, under the assumption that they would themselves control access and tariffs. (In the current system, state-owned Transneft has a monopoly on oil pipelines within Russia.) Kasyanov proposed that investors be compensated for their troubles with reduced transport tariffs, while the pipelines they build remain state property. Although industry reaction was not immediately forthcoming because of Russia's extended New Year's holidays, an oil company source told "Izvestiya" on 10 January that the state will have to offer some guarantee of return on investment beyond transportation discounts if it hopes to see oil companies shell out to build pipelines they cannot legally own. DK

A group of disgruntled oil tycoons vented their displeasure over a lack of access to Latvian oil terminal Ventspils Nafta in a letter to Prime Minister Kasyanov, "Kommersant" reported on 10 January. LUKoil President Vagit Alekperov, Yukos CEO Mikhail Khodorkovskii, Rosneft President Sergei Bogdanchikov, Surgutneftegaz Director Vladimir Bogdanov, and Tyumen Oil Company First Vice President German Khan protested a December decision by a government commission to close off pipeline access to Ventspils Nafta for the first quarter of 2003 in favor of Russia's Primorsk port. With the Latvian government gearing up to privatize part of its 43.6 percent stake in Ventspils Nafta, the Russian boycott "is pressure to encourage the sale of Ventspils Nafta to a Russian offshore company," Boris Epsteins, deputy editor of "Kommersant Baltic," told AFP on 10 January. With prices high, however, Russian oil majors are likely to keep lobbying for access to Ventspils Nafta as they seek to maximize exports and profits. DK

Japanese Prime Minister Junichiro Koizumi and Russian President Vladimir Putin agreed during the former's visit to Russia last week to examine a proposed 4,000-kilometer pipeline from Angarsk in eastern Siberia to Nakhodka on the Pacific coast, AFP reported on 12 January. The $5 billion pipeline would not only reduce Japan's dependence on oil from the Middle East, but would broaden Russian oil producers' access to world markets. Alfa-Bank strategist Chris Weafer told the "Financial Times" on 11 January that the project is moving "from possibility to probability." Complicating the picture, however, is a rival pipeline plan by Russian oil major Yukos to span the 2,400 kilometers from Angarsk to Manchuria and open doors to the Chinese market. A researcher at a Moscow-based brokerage told the "Financial Times," "No one thinks that there is room for both [projects]." "Vremya novostei" cautioned on 10 January that supply concerns could stymie the Angarsk-Nakhodka project, commenting, "No one knows where to get enough oil to cover the costs of such an expensive project." DK

Gazprom is taking active measures to reassert control over subsidiary Mezhregiongaz, stripping the company of its sales functions and taking over its assets, "Vremya novostei" reported on 10 January. As of 1 January, only Gazprom has the right to distribute gas to Russian customers. Moreover, an order from Gazprom CEO Aleksei Miller stipulates that Mezhregiongaz must transfer its controlling stake in Regiongasholding (a subsidiary that controls gas distribution to end customers) to Gazprom by 1 July, "Izvestiya" reported on 10 January. While Gazprom explained the moves as preparation for the upcoming liberalization of the domestic gas market, Troika Dialog analyst Valerii Nesterov told "Izvestiya" that Gazprom is simply trying to establish full control over a subsidiary that has acquired too much independence. "Vremya novostei" wrote on 9 January that political reasons may also play a role in Gazprom's campaign to bring Mezhregiongaz to heel -- 2003 is a pre-election year, and Mezhregiongaz is an instrument of regional political influence that Gazprom is expected to wield with full control when elections begin. DK

British Petroleum (BP) will call a $420 million bond next month, divesting itself of its holdings in LUKoil, "The Moscow Times" reported on 9 January. BP inherited a 7 percent stake in LUKoil when it acquired ARCO in 2000. The company sold a 3 percent stake in LUKoil in February 2001, issuing five-year bonds worth $420 million for its remaining 4 percent stake. Beginning on 10 February, BP will redeem the bonds at their face value of $1,000. Bondholders can also opt to convert each bond into 20 American Depositary Receipts (ADRs). With ADRs trading roughly 15 percent higher on the market, bondholders are expected to choose the conversion. News of the call on 8 January sent LUKoil shares down more than 5 percent on Russia's RTS Stock Exchange. Still, Alfa-Bank strategist Christopher Weafer told "The Moscow Times," "Once the current uncertainty is out of the way, the share price should actually do better." "Kommersant" noted on 9 January that with the release of BP's shares, 52 percent of LUKoil shares will be in free float, making it the first major Russian oil company with a controlling stake out on the open market. DK

Former Sheremetevo Airport Director Sergei Belyaev was reinstated on 9 January by court order only to be dismissed again the next morning by an emergency board meeting, "Izvestiya" reported on 10 January. Belyaev had originally received his walking papers on 2 November after coming into conflict with Economic Development and Trade Minister and Sheremetevo CEO German Gref over construction plans for the Sheremetevo-3 terminal. Formally, Belyaev was dismissed for failing to prepare the airport for winter, bungling its technical refurbishment, and handing out 14 million rubles ($439,837) in dubious loans to airport employees. The former director successfully disputed his dismissal on procedural grounds, arguing that he was on sick leave at the time. Sheremetevo Board Secretary Andrei Bubnov explained to "Gazeta" of 10 January that the latest sacking, which took place minutes after the board reinstated Belyaev in compliance with the court order, stemmed from criminal charges filed against Belyaev on 4 January. The charges focus on abuses he is alleged to have committed during his tenure as director. Observers were unanimous in forecasting further strife over the director's position at Russia's largest airport. DK

An extraordinary shareholders' meeting on 5 January gave Moscow's strife-plagued Kristall vodka factory a new board of directors, "Kommersant" reported on 9 January. Held in conditions of secrecy, the meeting also transformed Kristall acting Director Aleksandr Romanov into the factory's full-fledged general director, bringing formal resolution to a struggle for control of the enterprise, the nation's largest, that grabbed headlines last summer. Rosspirtprom, a state unitary enterprise created two years ago to control alcohol production, came under new management in July and began to make changes in the enterprises it oversees. A bitter dispute broke out when the revamped Rosspirtprom attempted to replace Aleksandr Timofeev, director of Kristall and ally of Rosspirtprom's old management team, with Romanov. The two sides came to an unofficial understanding, "Izvestiya" wrote on 5 January, in which Timofeev and his team ceded Romanov the director's chair in return for control of Kristall's sales network. The 5 January shakeup formalized Romanov's status and removed remnants of the old team from the board of directors, making it completely loyal to current Rosspirtprom Director Petr Myasoedov. DK

A study by ACM Consulting showed that for the first time since September 2001 Mobile TeleSystems (MTS) attracted more new users in the Moscow region than competitor Vimpelcom, "Kommersant" reported on 10 January. MTS drew 220,000 new subscribers in December, while Vimpelcom signed up an additional 165,000. Vimpelcom remains the largest operator in the Moscow area with 3.75 million subscribers. Overall, 2002 was a banner year for cellular communications in Russia. A study by market-research agency J'son & Partners showed that cellular penetration in 2002 rose from 5.6 percent to 12.4 percent, while the number of cellular subscribers jumped 121 percent to 17.8 million people. With Moscow and St. Petersburg boasting penetration rates of 48 percent and 33 percent, respectively, regional growth is the name of the game. A 5 January article on the gazeta.ru website noted that the poor state of fixed-line communications in the Russian provinces is stimulating the rapid growth of cellular networks. DK

If you absolutely must stock the most delicious hooch, look great, smell better, always be on time, and spend as much money as possible in the process, LVMH Moet Hennessy-Louis Vuitton is ready to pamper you. LVMH retails the best of the best, specializing in goods that the common folk usually associate with the duty-free shop at the airport: spirits, clothes, fashion accessories, watches, and jewelry (not to mention something mysterious the company calls "selective retailing").

Business is good at the top. According to its website (http://www.lvmh.com), the "world leader in luxury" employs 56,000 people and had turnover of 12.229 billion euros ($12.948 billion at the current exchange rate) last year. In December, LVMH celebrated the good times by opening its first store in Moscow.

"Finansovye izvestiya" interviewed Bernardo Sanchez Incera, the president of the French conglomerate's European division, on 24 December, prefacing the encounter with a logical-enough rhetorical question: "Why is a country where the average salary is $100 [a month] so attractive to producers of luxury goods?" In the actual interview, the question assumed a more theoretical form: "Is there a correlation between the economic indicators of countries and the turnover of your stores?" Sanchez Incera was unequivocal: "There is no such correlation.... Russian customers will come to buy our products whether or not the country goes through another crisis."

The point is not that Russia enters 2003 as a terrible place where millions scrape by on $100 a month while a select few emit bored sighs amid shelves heaped high with thousand-dollar cognacs and cardigans. Fixating on the mere fact of material inequality guarantees neither critical insight nor insightful criticism. But in taking stock and evaluating the perspectives of business and the economy in Russia as 2003 gets under way, what stands out is the immense difficulty of reconciling the extremes and deducing a meaningful synthesis -- some reasonable interpretation that takes into account both LVMH and an average salary of $100 a month.

1. Tellingly perhaps, most of the gushing about Russia's progress in 2002 and prospects in 2003 (Russian officialdom excepted) took place abroad. Peering through the prism of macroeconomic indicators and geopolitical sound bites, observers found ample cause for celebration. "Jane's Foreign Report" covers all the positive bases in its 9 January "Russia in 2003" -- a soaring stock market, impressive growth, comparatively low inflation, a reduced debt burden, progress on reform, and an improved credit rating, not to mention the acceptance of NATO expansion "with dignity" and a surprisingly positive attitude toward a "new, unlikely status as a de facto ally of the United States." "Jane's" forecasts workmanlike progress with key structural reforms, especially after President Vladimir Putin secures himself a second term in 2004, and the eventual likelihood that Russia will become "a normal, western-style democracy."

Compensatory gloom abounds in unofficial Russian sources. "Kommersant-Vlast" titled its end-of-the-year summary the "Year of Missed Opportunities," primarily in reference to absent or stuttering reforms. The editors begin their survey with the economy, focusing on the much-ballyhooed next wave of reforms involving the natural-gas sector, railroads, housing and utilities, and electricity. On all counts they note either a total lack of progress or stymied good intentions. Only in the electricity sector has an actual bill reached parliament, where it is currently mired in delays and postponements.

Yevgenii Yasin, former economics minister and doyen of Russian economists, provides more structurally grounded pessimism in a 27 December paper titled "Growth and Development of the Russian Economy" and available (in Russian) on the site of the Liberal Mission Foundation (http://www.liberal.ru). Yasin focuses less on the statistics of the moment and more on the institutional development and values needed for a functioning liberal, democratic society. He asks, and answers, the key question: "Do we have the institutions and culture that will allow Russia to become a flourishing country in the twenty-first century? No, we do not."

2. A lengthy, passionately argued 15 December article in "Izvestiya" by Svetlana Babaeva and Georgii Bovt reviews a wealth of economic statistics and poll results in an attempt to make sense of the current state of reform and atmosphere in society. "Two Countries of One President" is important not only for the breadth of the material it surveys, but because it grapples with the essential dilemma of a reform process that has succeeded in producing an elite that can shop at LVMH boutiques yet failed to increase the well-being of a majority that continues to inhabit a dreary, decaying, post-Soviet landscape the article's authors bitterly term "the Bantustans."

Babaeva and Bovt depict two parallel societies in a single country -- an elite that inhabits a brave new near-West of plentiful money and options, and a majority mired in near-Soviet Bantustans. The former are occupied with "houses and credit cards, offshore business and holidays 'on the islands,' antiques and nightclubs." Those "unencumbered by $4,500 a month" slog through a morass of everyday institutions -- the militia, the courts, the public-housing authorities -- that remain resolutely unreformed and relentlessly Soviet in their disregard for the individual.

Separate and unequal, the two countries hold different views on virtually all of the questions that face their single nation -- yet with a curious lack of consequence. The authors analyze poll results, noting the paradoxical fact that "the same population that trusts Putin entirely, when asked about the details, reacts with total rejection to the very political and economic initiatives that top the authorities' current agenda, from closer relations with the West to reforms of the energy sector and housing." Even so, "this dislike and mistrust in the end produce nothing -- no mass protests, no latent support for an opposition, not even grumbling in the kitchen."

And so they coexist.

3. These parallel social worlds would not exist without the peculiar economy that creates the material conditions for their existence. That economy finds itself at the outset of 2003 poised between stability and fluidity, showing signs of macroeconomic health even as it remains in flux. The key sectors that serve as barometers of change, and the potential lines of development in those sectors are somewhat clearer today than they have been in the past.

Clearest of all is the importance of oil. According to "Petroleum Intelligence Weekly," Russian oil production jumped 9 percent in 2002 to reach 7.62 million barrels per day (bpd). This year could see a 10 percent increase to 8.3 million bpd. Only Saudi Arabia produces more oil. Half of Russia's roughly 4 percent increase in GDP in 2002 came as a result of high oil prices. The international deck is stacked with too many wild cards -- from war in Iraq to political turmoil in Venezuela -- to make predictions about prices, but prices are not the only thing to watch in the critical oil sector.

Production increases are outpacing export capacity, moving pipeline and port projects to the top of the agenda. The oil majors have put two major pipeline projects on the table, one to a deepwater port in Murmansk and another to Manchuria and the thirsty Chinese market. Both are promising, if expensive. For now, however, the state retains a monopoly on oil transport within Russia through pipeline-watchdog Transneft. The privately owned oil companies are wealthy, influential, and will not want the state setting tariffs and controlling access to pipelines they pay to construct. Oil transport promises to be an area where private business could take a concerted stand, backed by substantial muscle, to defend its interests against the state's age-old impulse to control and oversee.

In the longer term, "Petroleum Intelligence Weekly" noted on 7 January that "current production is outstripping reserve replacement." Industry observers are paying more attention to corporate governance issues in the Russian oil sector, and companies' policies on reserve replacement could prove to be a decisive element in the race for a leading position in the years to come.

Gazprom, the state-run natural gas monopoly and Russia's biggest company, remains a perennial source of fascination and frustration. Even as debate continues on how to reform the behemoth and create a competitive market for natural gas within the country without unleashing social unrest over skyrocketing prices, Gazprom's financial health is raising questions. The company's debt stands at $14.7 billion, and 97 percent of its revenue from exports to Western Europe in 2002 went to servicing that debt, "Kommersant-Vlast," No. 50, reported. Reform and financial fundamentals will be the hot-button issues for Gazprom in 2003.

Tied in with reforms in the natural gas sector are the interconnected reforms of electricity, the railways, and housing. In all three areas, state monopolies in essence dole out subsidies, mucking up market mechanisms yet keeping life within the realm of the affordable for much of the population. Elections make any movement on reforms unlikely in the housing and transportation sectors. Unified Electrical Systems, however, could well be the focus of intense activity, as captains of industry in energy-intensive sectors like aluminum look to maintain access to cheap power by snapping up generating assets for themselves.

On the financial front, consumer credit is on the rise. Buyers are financing durable-goods purchases and cars, for now mainly in Moscow and St. Petersburg. With banks developing mechanisms to limit risks and increase profits and consumers getting to know the increased purchasing power that credit makes possible, consumer credit could be on its way to becoming a part of everyday life in Russia long before anyone expected it.

The beleaguered auto industry will shine a light on how the less fortunate sectors of the economy are coping with competition and change. AvtoVAZ, the nation's largest carmaker, had a grim year marred by an overproduction crisis, scaling down output through work stoppages from a planned 770,000 to 702,000 cars. Offering Soviet quality at prices that cannot compete with used imports, automakers face a crisis. Government intervention in the form of protective tariffs may buy them time, but only innovation and adaptation will save them. Needless to say, the lessons apply to more than the auto industry.

No overview, no matter how schematic, can overlook the financial-industrial groups that dominate the Russian business world. Built on a union of cash, contacts, and control of vital moneymaking industries (oil and aluminum, for example), the conglomerates continue to develop and adapt. Institutionalization is the trend to watch, with major groups slowly acquiring structural substance above and beyond individual tycoons and group representatives, be they founding oligarchs or lesser beings, increasingly eager to establish formal channels of influence and control.

4. Should anyone without a vested interest in business or Russia care about Russian business in 2003? Yes, they should. They should care because of the LVMH boutique in Moscow, because of the $100-a-month salaries, and because the state of business and the economy in Russia poses vital questions about how society's priorities can and should be arranged in a world of limited material resources.

On the surface, the question is one of emphasis and focus. Those who write about Russian business confront the issue of what is really important: the LVMH boutique or the $100-a-month salary? Does a recently privatized multibillion-dollar oil company's transition to international accounting standards outweigh the skullduggery that accompanied its acquisition? Is cell-phone penetration more pertinent or less pertinent than a living wage? How important is the bottom line? What exactly is the bottom line?

More deeply, the question is one of vision and values. The vexed issues of private property, profit, and public weal that the post-Soviet experience brings so starkly to the fore lay at the heart of the ideological and philosophical confrontation that was a vital part of the Cold War. That war ended in a clear victory for one side, and with it a certain vision of society and a set of values to support it.

All of which sounds very neat and noble. The reality leading up to 2003 has been far messier. Yet in evaluating the contradictory things we write about Russian business in 2003, readers have a unique opportunity to reexamine without foregone conclusions what it has always been about -- the vision, the values, and the messy reality. DK