Business Watch: February 11, 2003

The Greek Development Ministry nixed a joint bid by Russia's LUKoil and Greece's Latsis Group to purchase a 23.17 percent stake in Greek state-controlled refiner Hellenic Petroleum, RosBusinessConsulting (RBK) reported on 4 February. The news is the latest in a string of international setbacks for the Russian oil giant, which was most recently rebuffed by the Polish government in its bid to acquire a 75 percent stake in the Gdansk refinery. The Greek Development Ministry claimed that the LUKoil/Latsis offer "was not judged to be acceptable for the national interest," "Nefte Compass" reported on 5 February, noting that local competition concerns over homegrown Latsis were likely the primary factor in the decision. Citing Greek newspaper reports that LUKoil and Latsis bid $454 million for the stake, RBK wrote on 4 February that the Greek move was "no more than an attempt to jack up the price." "Vedomosti" reported on 5 February, however, that the final bid was substantially less than $454 million because of recent changes in Hellenic Petroleum's asset structure that made the acquisition less attractive to LUKoil. DK

Sibneft on 3 February became the first of Russia's oil majors to report preliminary 2003 financial results to U.S. Generally Accepted Accounting Principles. Revenue was up 40.2 percent year-on-year to $4.835 billion, net profit down 19.5 percent to $1.05 billion, and EBITDA (earnings before interest, taxes, depreciation, and amortization) up 3.3 percent to $1.775 billion. The company attributed the drop in profits to low prices on the domestic market, the purchase of the Moscow refinery, and higher taxes. United Financial Group analyst Pavel Kushnir told "Vremya novostei" on 4 February that the results are in line with expectations. Troika Dialog analyst Kakha Kiknavelidze told "Vedomosti" on 4 February that the increased revenues might have resulted from an upswing in business for Siboil, Sibneft's trading company, which handled a considerable amount of business for Slavneft in 2002. Together with Tyumen Oil Company, Sibneft acquired Slavneft in a December privatization; earlier, however, Sibneft managed to gain control of key management positions in the then-state-owned company. Sibneft's results also confirmed the company's ranking as Russia's most efficient, with an EBITDA/barrel ratio of $9.12, "Vedomosti" reported, besting competitors LUKoil ($6.85), Yukos ($8.34), and Surgutneftegaz ($7.46).

Sergei Grigorev, vice president of Russia's state-owned oil-transit monopolist Transneft, stirred up renewed controversy over Latvia's struggling Ventspils Nafta oil terminal with a 5 February interview in Riga's "Telegraph." Transneft has stopped pumping Russian oil to the terminal, claiming that other export routes make more economic sense. Critics charge that Transneft is trying to muscle its way into the terminal on the cheap by throttling its oil lifeline. Latvia plans to privatize its 42.68 percent stake by the end of 2003, "Vedomosti" reported on 6 February. Grigorev told "Telegraph" that Transneft is ready to invest $143 million in Ventspils Nafta in exchange for a share in the terminal. Confirming that Transneft is playing hardball, Grigorev reminded the Latvians that Ventspils Nafta "isn't worth anything now. There's no oil. It's a big question whether there are any buyers for an oil terminal without oil." "Kommersant" reported on 6 February that the drop-off in Russian exports through Ventspils Nafta has led to a 0.5 percent decrease in Latvia's GDP. The conflict has drawn international attention, and even sparked a letter from a group of Russian oil majors asking Transneft to ease export bottlenecks by renewing shipments through Latvia. For his part, Grigorev insisted on couching the dispute in economic terms, if not purely economic terms: "Why should we develop your ports? Because you're so blond and have blue eyes?" DK

State-owned Rosneft submitted an application to the Antimonopoly Ministry to obtain a stake in Andrei Vavilov's Severnaya Neft, "Vedomosti" reported on 4 February. The news showcases what appears to be an impressive demonstration of the art of the deal by former Finance Minister and current Federation Council member Vavilov, whose oil company has been mired in litigation over oil-field rights and share issues. Severnaya Neft's legal troubles seem likely to end, however, with the company's move to the bosom of state ownership. After confirming that Rosneft is indeed purchasing Severnaya Neft, Deputy Minister of Economic Development Mukhamed Tsikanov told a 7 February news conference that his ministry will recommend that Severnaya Neft keep its disputed license to develop the Val Gamburtsev oil field, "Kommersant" reported on 8 February. According to Tsikanov, Rosneft will compensate the state for the difference between the $7 million Severnaya Neft paid for the license and its $80 million market value. LUKoil, which is embroiled in a long-running dispute with Severnaya Neft over a share issue that watered down its take in the company, promised to keep fighting "in court for as long as it takes," "The Moscow Times" reported on 5 February. DK

The Ministry of Natural Resources intends to ask $900 million, 16 times the original asking price, for the rights to develop the Talakan oil field, "Izvestiya" reported on 3 February. Officials scratched a scheduled December auction after deciding that the $56 million starting price was too low. The new price had some scratching their heads, however. "Only a person with psychological problems could show up at an auction with conditions like that," a Yukos representative told "Izvestiya." Troika Dialog analyst Kakha Kiknavelidze concurred, commenting to "Vedomosti" on 4 February, "You can buy a complete oil company with a developed infrastructure for that kind of money." Authorities in Yakutia, where Talakan is located, suggested that the starting price should not exceed $150 million, "Vremya novostei" reported on 7 February. Aton analyst Timerbulat Karimov agreed with them, telling the newspaper that the average cost of development rights in Russia is $0.38/barrel. At $150 million, the per-barrel reserve price for Talakan would be $0.17. Karimov called this fair, citing the region's underdeveloped infrastructure, lack of a pipeline, and harsh climate. More haggling among officials over the starting price is likely before oil companies get their chance to haggle over the purchase price. DK

Duma Deputies Pavel Medvedev and Valerii Zubov are sponsoring legislation to create Russia's first full-fledged credit bureau, "Vedomosti" reported on 4 February. Their bill would charge the Russian Central Bank with setting up a structure to collect and provide credit histories. Banks would be obliged to offer clients the chance to submit information about themselves as they perform credit transactions, presumably because it would increase their chances of receiving credit in the future. The bureau would then make credit histories available, also with clients' permission, at a price of 100 rubles ($3.14) each. The idea found few supporters, however. "It's just absurd," Marina Medvedeva, adviser to the CEO of the Russian Bank of Development, told "Vedomosti." "The idea of commercial credit bureaus long ago gained the upper hand in the banking community." The Central Bank itself has reacted coolly to such proposals in the past, rejecting them in 1997 and 2002, "Kommersant" reported on 4 February. The Economic Development and Trade Ministry has developed its own credit-bureau plan, "Vedomosti" reported on 5 February, although "neither bankers nor existing credit bureaus like it." Meanwhile, Duma Deputy Vladimir Tarachev suggested the state should stop worrying about the question, since private financial institutions conduct their own "covert security-related information-gathering activities," "Vremya MN" reported on 4 February. DK

The Federal Securities Commission (FKTsB) gave the RTS Stock Exchange an additional three weeks to bring its method of calculating trading volume into line with new regulations, extending the deadline to 26 February, "Kommersant" reported on 6 February. The FKTsB threatened the RTS on 29 January with the loss of its license for failing to distinguish between directed and nondirected orders in calculating trading volume. It gave the exchange one week to fix the problem. (Directed orders are limited to a specific party, whereas nondirected orders are open to all market participants. The FKTsB argued that a failure to distinguish between them results in a distorted picture of the market.) RTS CEO Oleg Yachnik's 5 February report to the FKTsB was deemed "insufficient," "Vremya novostei" reported on 6 February, although regulators chose to extend the deadline rather than take extreme action against the exchange. Market watchers remain confident that the issue is more of a technical glitch than a serious violation. Renaissance Capital head trader Dmitrii Kulyashenets told "Vedomosti" on 6 February, "For now, the market is calm about the commission's objections to the exchange." DK

Fifty representatives of two unions are on a hunger strike at Norilsk Nickel's arctic division to protest management intransigence in a labor dispute, RBK reported on 7 February. The Trade Union Federation initiated the protest on 6 February; the Alliance of Trade Unions joined in the next day. The hunger strike comes after a conciliation commission failed to resolve differences over raises, vacations, and disclosures of managers' salaries and company financials. Management subsequently proposed a conference with employees in March to further direct discussion of sticking points, "Kommersant" reported on 7 February. Union representatives, however, fear that the conference is an attempt to freeze them out of the bargaining process. Arctic Division Director Vitalii Bobrov described the hunger strike as "blackmail," promising that "company management will spare no effort to guarantee the stable and uninterrupted work of all units in the arctic division," "The Moscow Times" reported on 6 February. The threat of a strike at the world's largest nickel and palladium producer has sent prices for the metals to record highs. DK

Financial group MDM and aluminum magnate Oleg Deripaska might have bought up as much as a 17 percent stake in state-run electricity giant Unified Energy Systems (EES), "Vedomosti" reported on 6 February. MDM-Group CEO Sergei Popov ended the aura of secrecy around the recent buy-up of EES shares, confirming to the newspaper that he and MDM-Bank head Andrei Melnichenko will be included in the list of candidates to the EES board to represent the "interests of a pool of Russian and Western investors." Official representatives of Deripaska's Basic Element denied reports that they were acquiring EES shares. Market sources insisted, however, on linking "structures close to [oil tycoon] Roman Abramovich and Oleg Deripaska" to the buy-up, "Izvestiya" reported on 7 February. Deripaska and MDM might have spent up to $600 million on the shares, "The Moscow Times" reported on 7 February. Legislation to reform the electrical-energy sector is currently moving through parliament, increasing the significance of any activity around EES. Persistent speculation holds that electricity-dependent industrial groups -- aluminum producers, for example -- might try to acquire generating assets from the utility giant on the cheap in order to protect themselves against the higher prices reforms are likely to bring. DK

New developments enlivened the ongoing conflict over Moscow-based confectioner Babaevskii last week without bringing about a resolution. On 3 February, Gosinkor-Holding, which has been fighting to gain control of Babaevskii for two years, announced that it has succeeded in consolidating a 74 percent stake in the enterprise, "Vedomosti" reported on 4 February. According to the newspaper, Gosinkor-Holding claims to have acquired a 38 percent stake in Babaevskii from bankrupt Inkombank for 750 million rubles ($23.57 million). Babaevskii, which has thus far successfully resisted Gosinkor-Holding's takeover attempts, hit back with some powerful new friends. Current President Sergei Nosenko convinced the city of Moscow and crisis-management firm Alliance to join in a new management company called Concern Babaevskii that will help the enterprise to pay off its debts and develop its business, RBK reported on 6 February. Moscow Mayor Yurii Luzhkov even promised to bring all the parties to the negotiating table for a final round of talks to end the conflict, so far without success. Gosinkor-Holding, which faces legal challenges in its share acquisition, was unimpressed by the new alliance. "We haven't seen a single resolution that the city of Moscow will take part in managing the concern," a Gosinkor-Holding representative told "Izvestiya" on 9 February, "which is why we're not inclined to change our position on Babaevskii." DK

Prof-Media General Director Vadim Goryainov announced on 6 February that the media holding will shift its subsidiaries to a single share to raise their aggregate value and pave the way for a public offering, RBK reported on 7 February. Prof-Media is itself part of Vladimir Potanin's Interros holding; it includes such well-known national newspapers as "Izvestiya," "Komsomolskaya pravda," "Sovetskii sport," and "Express-Gazeta," in addition to several FM radio stations, "The Moscow Times" reported on 7 February. Norwegian media group A-Pressen and Russian oil giant LUKoil also own stakes in some of Prof-Media's newspapers. According to Goryainov, A-Pressen wants a 25 percent-plus-one-share stake in the new holding, while LUKoil is gunning for 10 percent. Goryainov told journalists that a consolidated company would be worth "30 percent more than now, or $260 million," "Vedomosti" reported on 7 February. Sistema Mass-Media Director Sergei Klyuchenkov told the newspaper, however, "It's unclear how they calculated the company's value; the shares don't circulate and there haven't been any deals with them lately." Despite its oligarchic affiliation, Prof-Media differs markedly from the prominent post-Soviet media empires of now-exiled Vladimir Gusinskii and Boris Berezovskii. "Vremya MN" wrote on 7 February, "Prof-Media managers claim that they won't take part in agitation for the upcoming parliamentary and presidential elections, considering it economically unwise." DK

Finland's Fortum Power and Heat Oy announced on 31 January its acquisition of a 9.3 percent stake in St. Petersburg utility Lenenergo from Germany's E.ON Energie, "Kommersant" reported on 3 February. The deal brings Fortum's stake in Lenenergo to 15.7 percent, making it the largest investor in the company after state-run energy giant EES. Lenenergo representatives were quick to tie E.ON Energie's decision to Lenenergo's conflict with the city of St. Petersburg over the utility's partial privatization 10 years ago, Finmarket reported on 3 February. Market observers were inclined, however, to link the move to E.ON Energie's $10 billion merger with Ruhrgas. Nine European energy companies came out against the deal, and E.ON Energie has been involved in asset swaps with them to smooth ruffled feathers, "Vedomosti" reported on 3 February. Meanwhile, Lenenergo board member Aleksandr Branis told the newspaper that a strategic partner like Fortum will be a boon to the Petersburg utility as electrical energy reform kicks off in Russia. DK

Armenia will entrust the finances and economic activity of its sole nuclear-power plant to Russian management in exchange for a debt settlement, AP reported on February. The Medzamor plant, which supplies nearly half of Armenia's electricity, owes Russia $40 million for fuel supplies. Armenian President Robert Kocharian reached a tentative agreement on the debt-relief deal during a recent visit to Moscow, "Nezavisimaya gazeta" reported on 7 February. Russian Industry and Science Minister Ilya Klebanov was careful to stress that the Medzamor plant will remain Armenian property, "Vremya novostei" reported on 6 February. (International agreements prevent Russia from owning nuclear-power plants in other countries.) Klebanov explained to journalists at a 5 February press conference that the deal will be formalized within 15 days, "Parlamentskaya gazeta" reported on 8 February. The transfer of control continues, albeit in slightly altered form, a trend that has seen impoverished Armenia surrender assets for debt relief. DK

Exiled Russian financier Boris Berezovskii is involved in a complex deal to acquire one of the most famous surviving brands of the Soviet Union, the "Financial Times" reported on 3 February. Salford, a British Virgin Islands-based investment bank with ties to Berezovskii, allegedly paid $50 million for 50 percent of Georgian Glass and Mineral Water Company (GGMW), producer of Borjomi mineral water. The initial report in the "Financial Times" triggered a furious round of denials and clarifications. GGMW President Mamuka Khazaradze denied the reports, claiming that the report was serving the interests of ill-wishers who hoped to discredit Borjomi in Russia by linking it to the unpopular Berezovksii, "Kommersant" reported on 5 February. Khazaradze fingered British Petroleum, operator of the Baku-Tbilisi-Ceyhan pipeline project, as the culprit. The pipeline is to pass through the Borjomi Valley, and GGMW has objected strenuously on environmental grounds. In a 4 February interview with "Gazeta," Berezovskii would only confirm that Salford had approached him with an offer to invest in the Borjomi project. Salford owner Yevgenii Ioffe told "Kommersant" on 5 February that the deal involves a "larger-than-blocking stake" but is "not yet completed and could fall through at any moment." DK

The Tax Ministry's 29 June 2000 Directive No. 63 has a touch of grandeur, and lunacy, in its title: "On the Calculation and Payment of the Levy for the Use of 'Russia,' 'Russian Federation,' and Words and Phrases Formed Therefrom." The directive means just what it says. If the name of your business includes the word "Russia," you pay 0.5 percent of your revenues for the privilege (with qualifications and adjustments too complex to detail here). The law mercifully exempts the media, but not "advertising or erotic publications." "Rowdy Russia" is a tax-free tabloid; "Randy Russia" is not.

But tax reform is in the air, and Russia might soon regain free use of, well, Russia, or some part thereof. The Russia tax itself could end up on the scrap heap, along with taxes on securities transactions, parking, and owning dogs, "Vremya novostei" reported on 6 February.

The cabinet's 6 February meeting to discuss tax reform was hardly a celebration of tax-slashing fiscal liberalism, however. Deputy Finance Minister Sergei Shatalov presented a conservative blueprint for tax reform, putting off cuts in the all-important single social tax and value-added tax (VAT) until 2005-06. Prime Minister Mikhail Kasyanov responded by urging Finance Minister Aleksei Kudrin to pick up the pace, "Kommersant" reported on 7 February, telling him: "We can't allow any rigidity on this question. We can't lose a year. We need rapid, considered actions." The prime minister instructed the finance minister to prepare a more ambitious project with actual cuts beginning in 2004 by the 27 February cabinet meeting.

At issue are the taxes that businesses pay, and whether the current tax burden in Russia hinders investment and economic growth. Central to the discussion are the single social tax (ESN), VAT, and profit tax. The ESN, which goes to fund the social services that citizens receive from the state, now stands at 35.6 percent of the wage fund. The VAT is 20 percent. The profit tax was recently reduced from 35 percent to 24 percent, although the elimination of a 50 percent investment deduction increased the actual rate for most business from 17.5 percent to 24 percent.

Recent weeks have seen intensive negotiations between the Finance Ministry and Economic Development and Trade Ministry over the shape of tax reform. The standard view on the interministerial polemic pits Kudrin's Finance Ministry conservatives against German Gref's Economic Development and Trade Ministry liberals. The former are "weighed down by memories of the 1998 crisis," as "Finansovaya rossiya" wrote on 6 February, and hope to keep the tax press on until Russia pays off as much of its foreign debt as possible. The latter hope to spur economic growth and investment by easing the tax burden.

The Finance Ministry conservatives were widely viewed as having bested their liberal counterparts on the eve of the 6 February cabinet meeting. The Economic Development and Trade Ministry "completely surrendered its liberal positions in favor of the [Finance Ministry] tax goons," "Vremya novostei" wrote on 6 February. "Gazeta" dismissed the entire dispute as so much horse trading, writing on 4 February, "German Gref's ministry gives up its ambitious plans to lower taxes in exchange for a 'green light' from the Finance Ministry on the special economic zones bill that the Economic Development Ministry has unsuccessfully lobbied for the past year and a half."

As the prime minister's above-noted comment makes clear, the predictions were wrong. Tax reform now seems good to go.

(Connoisseurs of Russian political nuts and bolts might take note of a 5 February article in "Vedomosti" about an initiative from the Kremlin-controlled Unity party. Unity deputies expressed concern that timorous officials were exhibiting insufficient tax-cutting zeal. The deputies proposed lowering the VAT to 17 percent in 2004, dropping the ESN to 20 percent, and slashing the profit tax to 21 percent.)

The conception to be presented on 27 February will likely focus on gradual reductions across the board. The only innovation in the offing is the disguised return of the investment deduction that allowed businesses to cut the real rate of the profit tax in half, "Gazeta" reported on 7 February. The new catchphrase is "accelerated amortization" -- beginning in 2004, businesses will be able to write off 25 percent of the cost of newly purchased facilities and equipment with a life of more than five years. The effect will be similar to the old investment deduction. Meanwhile, an increase in the tax on resources extraction can force oil companies to keep the budget at current levels as other revenue sources are scaled back.

The renewed impetus for tax reform comes at a time when the government can well afford it. Sky-high prices for oil have left the state's coffers flush with tax revenues from the energy sector, minimizing the social risk of fiscal experimentation. Moreover, a widespread perception in Russia and abroad holds that the tax burden is throttling economic growth and blocking investment, making tax cuts a "liberal," "pro-reform" choice.

Tax reform is only one of a group of interconnected structural reforms that represent the next stage of development if Russia is to retain its status as a country "in transition" to something better, rather than that has arrived at whatever legacy past decades have wrought. The rest of the reforms involve the so-called natural monopolies: electrical energy, natural gas, the railways.

The issues are thorny, without easy options or forgiving circumstances. If real progress is to occur there, it will require more than the triumph of expediency evident in the wrangling over tax reform. DK