Business Watch: July 29, 2003

Audit Chamber representatives announced at a 22 July press conference that choice chunks of Bashkortostan's oil industry were privatized on the sly in a process that amounted to theft, "Vremya MN" reported the next day. Auditor Vladislav Ignatov told reporters that a recent investigation in Bashkortostan turned up "gross violations of Russian law...[in the form of] the theft of federally owned shares in oil refineries." As detailed in "Izvestiya" on 23 July, the basic scheme ran as follows: Beginning in 1995-97, shares in Bashkortostan's chief oil-producing and refining companies were moved through a series of increasingly obscure ownership arrangements to end up in the hands of private individuals. According to Ignatov, the face value of the "privatized" stakes was $118 million. Aton analyst Timerbulat Karimov told "Vedomosti" on 23 July that the total worth of the Bashkir energy sector is more than $2 billion. Journalists appeared to encounter insurmountable difficulties in finding Bashkir officials to comment on the situation. With the Russian business world currently transfixed by an investigation of a 1994 privatization that has billionaire and core Yukos shareholder Platon Lebedev behind bars, news of the Bashkortostan probe provided much grist for the rumor mill. But with Bashkortostan President Murtaza Rakhimov facing elections before year's end, some observers pointed to local politics. Dmitrii Orlov, deputy director of the Center for Political Technologies, told "Vedomosti," "No one had any doubts that Rakhimov created privatization schemes that benefited him. The question of these schemes' legality was bound to arise sooner or later." The Prosecutor-General's Office will now review the Audit Chamber's findings before deciding whether or not to move ahead with charges. DK

State-owned savings behemoth Sberbank announced in a 18 July press release the publication of 2002 financial results to international accounting standards. Net profit fell 3.4 percent year-on-year to 30.5 billion rubles ($1 billion), assets rose 22.4 percent to 1.1 trillion rubles, and capital increased 31.4 percent to 123.1 billion rubles. The results drew mixed reactions. Analysts at the Troika Dialog brokerage found the combination of rising assets and falling profits less than inspiring, "Nezavisimaya gazeta" reported on 22 July. Meanwhile, Brunswick UBS banking analyst Vladimir Savov noted that, without adjustment for inflation, Sberbank's net profit actually increased from $875 million in 2001 to $1.15 billion in 2002, "The Moscow Times" reported on 21 July. Savov concluded that "the bank has worked much better" in 2002. Aton analyst Aleksandr Kantarovich told "Vedomosti" on 21 July that the overall reaction to Sberbank's results is "neutral with a slight degree of concern." Sberbank is Russia's largest bank in terms of capital and assets. DK

The warring parties in the fight for control of the Korshnunovskii Mining and Enrichment Plant (GOK) pleaded their cases before the court of public opinion last week in no fewer than five press conferences. The plant is at the center of an acrimonious bankruptcy dispute (see "RFE/RL Business Watch," 15 July 2003). The Federal Financial Recovery Service (FSFO) has made several unsuccessful attempts to take control of the plant, which it claims owes the state budget 1 billion ($33 million) rubles. The Mechel Steel Group, which currently controls the plant, claims that the plant is on the road to recovery and that the FSFO is trying to bankrupt it to benefit Mechel competitor Evrazholding, which has its own designs on the plant. Evrazholding President Aleksandr Abramov told journalists at a 22 July press conference that while the conflict is between the state and Mechel, Evrazholding would enter a bid of the plant went up for sale, "Nezavisimaya gazeta" reported the next day. (Korshunovskii was constructed as the primary raw-material supplier for the nearby West Siberian Steel Corp., currently owned by Evrazholding, and would fit neatly into Evrazholding's production cycle.) With all sides trading accusations, a 24 July editorial in "Vedomosti" mulled over the scandal's eventual impact: "Sooner or later, this story will end and the GOK will be divvied up. But we shouldn't be surprised if in five years the mountain of compromising material that is rising today comes crashing down on everyone's heads at the most inopportune moment -- for example, during talks with a foreign investor or a promising partner." DK

Britain's Financial Services Authority (FSA) announced on 24 July that it will investigate the disclosure of shareholdings in Chelsea Village PLC, AP reported the same day. The inquiry concerns the period before Chukotka Governor Roman Abramovich's acquisition of Chelsea Village, which in turn owns the Chelsea Football Club. The FSA decided to look into Chelsea Village after learning that some shareholders may not have disclosed their positions accurately, "The Telegraph" reported on 24 July. The questions focus on offshore companies that control roughly 3 percent of the soccer club. Under British law, they are obligated to disclose their beneficiaries; some of them may have neglected to do so. Observers were careful to note that the inquiry does not affect Chelsea Ltd., the company Abramovich created as the vehicle for his takeover. "The Moscow Times" quoted British fund manager and football analyst Stan Lock on 25 July as saying, "The bid from the gentleman has gone in, it's been accepted and I think that no one's going to put a spanner in the works there." DK

Moscow-based cellular operator Mobile TeleSystems (MTS) paid $45.4 million for 100 percent of Krasnoyarsk operator Sibchallenge, Interfax reported on 23 July. MTS also assumed Sibchallenge's $9.4 million debt, making for a total purchase price of $54.8 million. The acquisition gives MTS a GSM license for a region with a population of 3 million, expanding the company's license zone to 172.2 million people. Sibchallenge has 130,000 subscribers, 106 base stations, and two switching stations. Alfa Group subsidiary Alfa Echo had initially planned to purchase Sibchallenge for its cellular subsidiary Vimpelcom but balked at the $52 million price tag, "Vedomosti" reported on 24 July. Vyacheslav Nikolaev, vice president of Trust Bank's research department, told the newspaper: "This is a good acquisition for MTS for a reasonable price. It paid $431 for each Sibchallenge subscriber, which is cheaper than its previous operator acquisitions in Bashkortostan and Tatarstan." Meanwhile, MTS announced in a 23 July press release that the board of directors of the Moscow City Telephone Network (MGTS) has approved current MTS President Mikhail Smirnov's candidacy to head MGTS. The MTS board of directors will meet on 11 August to name an acting director. Both MTS and MGTS are part of the AFK Sistema holding company. DK

The Natural Resources Ministry has ordered a halt to work at the Upper Salym oil field and threatened to withdraw the license for the field's development, Bloomberg reported on 22 July. Upper Salym is part of a $1.13 billion joint venture between Royal Dutch/Shell and United Kingdom-registered Sibir Energy. According to "International Oil Daily," Salym Petroleum Development (SPD) holds the licenses to the Upper Salym, West Salym, and Vadelyp fields, with estimated crude reserves in excess of 1 billion barrels. Ownership of SPD is split between Shell and Evikhon, the latter 82 percent-owned by Sibir Energy. The Natural Resources Ministry alleges that SPD has drilled horizontal instead of vertical wells and failed to boost production to the levels specified in a 1997 agreement, "Finansovye izvestiya" reported on 23 July. SPD claims that the 1997 agreement was amended and approved in its new form by local authorities. John Barry, head of Shell's Russian operations, referred darkly to events around Yukos (see In Focus below) in his remarks to journalists, saying: "I'm very concerned with what is happening at the moment to the Salym licenses. The sort of attack we're seeing at the moment only adds to the uncertainty in the minds of investors in light of other ongoing events in Russia," the "Financial Times" reported on 24 July. DK

U.S.-based AES Corp. is getting ready to sell its holdings in the Georgian power industry, "Vedomosti" reported on 23 July. AES Corp. owns 75 percent of Tbilisi distribution company AES Telasi, as well as two generating units; it also manages two hydroelectric power plants. AES Corp. has invested $260 million in the Georgian energy sector since privatizing the Tbilisi utility in 1998, "Gazeta" reported on 23 July. News of the possible sale set off a political firestorm in Georgia, where many fear that Russia's RAO EES will move in to replace AES Corp., giving Moscow light and darkness power over Tbilisi. Georgia's presidential administration confirmed on 22 July that AES Corp. and RAO EES are holding talks on the sale of AES Telasi, Tbilisi Prime television station reported the same day. Parliamentary Budget Office chief Roman Gotsiridze reacted furiously, alleging that Russia's purchase of AES Telasi would be the "greatest crime by the Georgian government against the country and people," Tbilisi's "Rezonansi" reported on 24 July. An article the same day by Malkhaz Chachava in "Dilis gazeti" argued that Georgians have only themselves to blame for the difficult circumstances that drove AES Corp. out of Georgia, paving the way for an impending Russian "monopoly" over the Georgian energy sector. Irakli Melashvili, official lobbyist for AES Telasi, seconded this view in 25 July remarks to "Civil Georgia," saying, "The Georgian government did everything to force the company to cease its business in the country." Melashvili said that he has no information on talks between AES Corp. and RAO EES. DK

High-level negotiations between Gazprom and Belarus on the creation of a gas-transport joint venture through Belarus failed to produce tangible results, gazeta.ru reported on 26 July. The sticking point in talks between acting Belarusian Prime Minister Sergei Sidorskii and Gazprom deputy CEO Aleksandr Ryazanov was Belarus's gas transport monopoly, Beltransgaz. Gazprom wants a controlling stake and is willing to pay no more than $600 million; Minsk pegs Beltransgaz at $5 billion and will only surrender 50 percent. The Belarusian economy depends on gas purchased from Gazprom at Russian domestic prices, an arrangement Gazprom is loath to extend without a satisfactory agreement on Beltransgaz. Meanwhile, Minsk is hedging its bets as best it can. Beltransgaz Deputy Director Valerii Zagorodin announced on 24 July that his company has inked a deal for Russia's Tyumen Oil Company (TNK) to deliver 250 million cubic meters of natural gas to Belarus by year's end, Interfax reported the same day. At a price of $37 per 1,000 cubic meters, the contract is worth $9.25 million. A source in the Belarusian government told "Kommersant-Daily" of 25 July, "This contract gives us a certain amount of insurance in a critical situation." According to the newspaper, Belarus is currently holding talks with all of Russia's so-called independent gas suppliers (i.e., not Gazprom) in case of continuing difficulties with the monopolist. DK



The week of 21-25 July ended with no significant break in the clouds gathered over oil major Yukos and CEO Mikhail Khodorkovskii. "RFE/RL Business Watch" took advantage of the relative lull to discuss the situation with Ian Hague, co-manager of the Firebird New Russia Fund and Firebird Republics Fund, two equity-investment funds focusing specifically on the emerging companies of the former Soviet Union. Taken together, Firebird's funds have invested $250 million in the shares of Russian companies.

RFE/RL: How would you describe the reaction of foreign investors to the events around Yukos?

Ian Hague: I think the initial reaction was one of serious concern, if not panic. This has since moderated significantly. Many of the brokers in Moscow have been taking maximum advantage of the perception of "crisis" to refill their proprietary trading positions, and the last few days have seen Yukos's share price come back 6-7 percent. When this happens, you know that the problem is not nearly as serious as it seems on the surface.

It is naturally distressing to see the most successful businessman in the country come under attack by the Kremlin and its law-enforcement/security apparatus. Unfortunately, because in Russia due legal process and other protections that we enjoy here in the United States are largely absent, this kind of thing is a perfectly viable option for the Kremlin in dealing with opponents. Given the situation and the unsavory backgrounds of 98 percent of Russian businessmen, my first thought after hearing about this was: Who's next?

As events evolve however, it is becoming increasingly clear that the dispute is fundamentally political in nature, and therefore that it is resolvable through negotiation. Comments made in recent days by a series of officials (Prime Minister Kasyanov, Economic Development and Trade Minister German Gref, First Deputy Economic Development and Trade Minister Andrei Sharonov, and others) would appear to imply that this step is not intended as a first strike in some kind of War to the Death with the oligarchs, and so the status of private property in general is not affected by this.

RFE/RL: Just how important an event is this? How far-reaching are the ramifications?

Ian Hague: I think that this strike against Khodorkovskii is both the culmination of Putin's drive to consolidate power and the beginning of the government's effort authentically to address some of Russia's long-standing structural economic problems.

Consequence number one is that the oligarchs as a class have been put on notice that their participation in the political life of the country must come out of the shadows and acquire some institutional form. The ad hoc "buying" of government officials, judges, legislators, and governors will, I hope, no longer be permitted in the form in which it now takes place. Russia will have to evolve some new set of mechanisms for business people to play a role in politics. Exactly what these mechanisms will look like is a question I imagine the Russian Union of Industrialists and Entrepreneurs (RSPP) will be discussing with the government over the next few years, since it is that body that claims a mandate from the most prominent business people in Russia to represent their views to officialdom. Just as in the economy, Russia as a polity in is need of structural reform aimed at lowering barriers to entry; increasing the quality of political "goods" produced (laws and policies); and diversification of the sources of political capital. It is refreshing that the government recognizes this as a problem.

Another consequence is probably that the remaining oligarchs will dutifully comply with the Kremlin's call for support for its preferred slate of candidates in this December's Duma election. It may not be enough support to ensure that the pro-Kremlin faction United Russia wins 75 percent of the seats, but at this point virtually any support that is offered will probably be a big help.

Provided they are even moderately successful, it is quite likely that it will become easier for the Kremlin and the government to execute their program of structural reform. Acting through their friends in the government and the Duma, Russian oligarchs (including Khodorkovskii) have succeeded until now in blocking or changing beyond recognition important reforms in the banking sector, the tax regime for oil companies, the restructuring of Gazprom, administrative reform, and a whole host of other things.

We very much look forward to a second Putin term as the one in which important things finally get done.

RFE/RL: From the perspective of foreign investors, what would a "best case" resolution be? What would a "worst case" resolution look like?

Ian Hague: "Best case" would probably be a formal admission of some kind of fault by Kohorkovskii and a request to the government to establish a better framework for addressing the concerns of businesspeople when it comes to corruption and arbitrary actions by government officials. A formal reaffirmation by Putin of his support for the rights of property owners in Russia would also be very much appreciated, at least by investors in the stock market.

"Worst case" would be for Khodorkovskii to be forced into exile like Berzovskii and Gusinskii before him and to have his property confiscated. As it happens, I was glad to see the back of Boris Abramovich and Vladimir Aleksandrovich, but because Khodorkovskii did actually succeed in restructuring Yukos into an authentically efficient and effective oil company, I think it would be a very unfortunate development for the stock market and for prospects for foreign investment in Russia if he were to be kicked out of the country. Russians of all kinds would be that much more wary about making investments in business ventures, or even in keeping their savings in banks. As for foreigners, the perception that someone�s property could be subject to confiscation simply because of political support for regime opponents is a very dangerous one. I think, however, that the government is doing a better and better job of combating that perception.

RFE/RL: Some have argued that a reexamination of privatization would open a Pandora's box, undermining the stability of the Russian business world and potentially the entire economy. How do you view this?

Ian Hague: I think the Pandora's box analogy is very apt. As I remember the myth, this box was deceptively easy to open but impossible to close again. I tend to agree with those who have been saying that catastrophic results would ensue from this. Not so much civil war, but a general economic collapse that could very quickly lead to collapse of the regime. I remember well the period before mass privatization in 1993 and 1994, when there was worry about these scenarios. Fortunately, the likelihood of this happening now is extremely low, so it is not worth my time thinking about.

RFE/RL: Recent polls in Russia have indicated that an overwhelming majority of Russians view "the oligarchs" negatively and would support a reexamination of privatization. What implications, if any, do these attitudes have for business, and investment, in Russia?

Ian Hague: In general, I would say that these attitudes are a challenge; but from the government's point of view, the only way to address them is to press on for still deeper structural reform in order to create a more open and fair economic system. By more "fair" I mean an economic system that is less plagued by corruption and the manipulation of laws and the justice system. For most people, the fact that there is inequality is a lot easier to accept if there is a sense that the game is not rigged against you. There is a recognition of this in the government, I think, and I remain optimistic that, in the long run, the direction of deeper reform will be the one that is taken, notwithstanding the residual fears of the population.

RFE/RL: Everyone is asking: Why Yukos? Why now? Do you have a theory?

Ian Hague: Sure do.

Yukos was chosen because, more than any other oligarch, Khodorkovskii has the resources and has taken opportunities to acquire special treatment with respect to tax, allocation of exploration licenses, etc. For many people, he personifies the arrogance, self-dealing, and manipulative character traits that are associated with the word "oligarch." As such, he represents a very appealing target for political strategists in the Kremlin who need to rally public support for their candidates in the December elections. Add to that the perception of him as usurping some of the government's authority by speaking out publicly against its policies with regard to Iraq, gas-sector restructuring, pipeline construction, and a host of other issues, and you have a very large number of people in official Russia who think he deserves the punishment he is getting.

And it is not just the "siloviki" who have a motive to strike out at Khodorkovskii. Sergei Bogdanchikov at Rosneft and Gazprom have been fighting off attempts by Yukos to shape the future of Russian energy policy to its advantage. Rosneft in particular has been involved in a very bitter and public struggle over Yeniseineftegaz, the holder of a very valuable license to develop the Vankor oil field in the Far North.

I tend to think that the initial motivation for attacking him was mainly political and related to the Duma election: it has been known for a long time that Khodorkovskii had contributed as much as $20 million to support the campaigns of Union of Rightist Forces, Yabloko, and as many as 20 individual candidates from the Communist Party list. Once the attack was under way, however, there was this phenomenon of "piling on" in which business rivals at the state-owned companies offered praise for the actions of the siloviki. At certain moments it almost seems as if they were consulted in the planning of the operation, but of course there is no way to be sure about something like that.

One thing that we do know for sure is that Putin was aware and was a participant in the process of planning the attack. His connections with [Audit Chamber head Sergei] Stepashin, [and deputy presidential-administration heads Igor] Sechin and [Viktor] Ivanov are long and deep, and it is known that political strategy is their particular area of expertise.

The "why now" question is almost more interesting, because there really is no reason why this couldn't have been done safely after Putin is re-elected in March of next year. Here, I think the answer is that Putin would like to run as a champion of further reform and, in order to do that, he needs to start securing the legislation that will finally address Russia's structural problems.