Business Watch: December 16, 2003

England's "Financial Times" reported on 12 December that the apparent collapse of the Yukos-Sibneft merger could cost Roman Abramovich, the politically savvy oligarch who is believed to control Sibneft, as much as $5 billion. Yukos core shareholder Leonid Nevzlin told the newspaper that Abramovich would have to not only give back the $3 billion he has received from Yukos, but also pay Yukos shareholders $1 billion-2 billion to compensate them for the drop in the company's share price since the merger began to founder. Meanwhile, others are interpreting Abramovich's moves to undo the merger as a multistage ploy to gain control of embattled Yukos, which has been at the center of a legal maelstrom since July; the company's top shareholder and former CEO, Mikhail Khodorkovskii, is in jail on fraud and tax-evasion charges and tax authorities are now suggesting that the company owes $5 billion in unpaid back taxes. Erik Wigertz, co-head of research at United Financial Group in Moscow, is quoted in the 15 December issue of "Business Week" (No. 3862) as saying, "The Sibneft guys are some of the smartest businesspeople [in Russia].... When they smell weakness, they'll go for it." William F. Browder, CEO of Hermitage Capital Management Ltd., agreed, telling the magazine, "If you look at Abramovich's situation, there is a clear economic logic to what he's doing." DK

An arbitration court in Yakutia ruled on 11 December to grant Surgutneftegaz a 25-year license to develop the central block of the Talakan oil and gas field, RBC reported, citing sources in the company. The ruling, which effectively transfers permanent development rights to the field from embattled Yukos to Surgutneftegaz, has a complex prehistory. When the rights to Talakan were originally auctioned in 2001, Sakhaneftegaz won with a bid of $501 million; Surgutneftegaz came in second place with an offer of $61 million. Sakhaneftegaz, which was acquired by Yukos in 2002, failed to come up with the money, however, and began developing Talakan through a subsidiary under a temporary license until a second auction could be scheduled. Surgutneftegaz subsequently appealed, asking to be granted the license as the second-place finisher in the tender. Gazeta.ru reported on 11 December that it had obtained a copy of the arbitration court's decision -- it awards the long-term license to Surgutneftegaz as the runner-up in the 2001 tender. According to RusEnergy, Talakan holds 124 million tons of oil reserves and 47 billion cubic meters of natural gas; the addition of Talakan will increase Surgutneftegaz's total reserves by at least 10 percent. DK

Germany's E.ON has chosen to sell its 32.1 percent stake in East German gas distributor Verbundnetz Gas (VNG) to German gas trader EWE, dealing a blow to Gazprom's hopes of European expansion, industry site oilcapital.ru reported on 9 December. The Russian gas monopolist, which already owns 5.26 percent of VNG, had been acting in concert with Germany's Winterhall, itself the owner of 15.79 percent of VNG. The acquisition of a 32.1 percent stake would have given Gazprom and Winterhall a controlling interest in VNG, which controls more than 90 percent of the market in eastern Germany. As one of the main exporters of natural gas to Germany, Gazprom could have increased its profits by "cutting out the middleman" if it had acquired a hefty stake in VNG. No comments were forthcoming from the parties to the deal, but a source "close to the negotiations" told "Vedomosti" on 9 December that Gazprom offered E.ON a stake in future Russian gas projects rather than cash for the shares, decreasing the attractiveness of its offer. Press estimates valued the 32.1 percent stake at between $640 million and $780 million. German antimonopoly authorities had obligated E.ON to divest itself of the VNG shares in the course of the company's merger with Ruhrgas. DK

Faced with uncertain prospects on Chinese and South Korean markets, Russian-British TNK-BP has decided to begin developing the Kovykta natural-gas field with an eye to Russian consumers, "Vedomosti" reported on 8 December. The company plans to invest $676.4 million into the project over the next 30 years, contributing 30 percent of the funds itself and obtaining the remainder in the form of a loan from Sberbank. According Viktor Vekselberg, TNK-BP's production and technology director, the company plans to create the Eastern Siberian Gas Company (VSGK) in conjunction with the Irkutsk Oblast administration to act as the project operator, "Vremya novostei" reported on 8 December. Shares in the new company will be divided equally between TNK-BP and Irkutsk Oblast. TNK-BP also plans to offer Gazprom a chance to involve itself in the project, Regnum reported on 8 December. A Gazprom manager told "Vedomosti," however, that the company has not yet received an official offer; moreover, the gas monopolist feels that the project could require up to $2 billion in investment. Gazprom also believes that the maximum price for gas in the Irkutsk oblast is $60-80 per 1,000 cubic meters. Still, a TNK-BP senior manager told "Vremya novostei" that the project will break even in eight to nine years even if it sells gas at a price of $45-50 per 1,000 cubic meters. The license to develop Kovykta belongs to Rusia Petroleum, which is owned by TNK-BP (62.42 percent), industrial holding company Interros (25.82 percent), and Irkutsk Oblast (11.24 percent). DK

Uralsib Bank made public the new composition of its supervisory board on 10 December, revealing that Nikoil Financial Corporation has controlled approximately 75 percent of the bank for at least 1 1/2 months, "Kommersant-Daily" reported on 11 December. Nikoil representatives now occupy seven of the 11 seats on the board. Nikoil President Nikolai Tsvetkov had confirmed that his company purchased a 14 percent stake in Uralsib from the Bashkir Property Ministry on 29 October, but the shareholder registry for elections to the board was closed on 20 October, indicating that Nikoil had bought into Uralsib even earlier. In another sign of an impending merger, Fuad Akhundov, deputy chairman of the board at Nikoil-owned Avtobank-Nikoil, was named president of Uralsib on 8 December, "Vedomosti" reported the next day. Moreover, Tsvetkov and other high-level Nikoil managers met with Uralsib management in Ufa, where Uralsib is based, on 9 December, "Vremya novostei" reported the next day. According to data cited by "Vedomosti," Uralsib is Russia's 11th largest bank in terms of assets, ninth largest in capital, and 10th largest in private deposits. Bashinform reported on 11 December that Nikoil and Uralsib are planning to integrate their operations to create a network with 580 offices in 90 Russian cities. Standard & Poor's analyst Yekaterina Trofimova told "Vremya novostei" that "such a network cannot yet compete with Sberbank (with its tens of thousands of branches and offices), but it will give Uralsib a significant advantage over any private competitor." DK

The Commission for Protective Measures in Foreign Trade recommended on 9 December that the government eliminate export tariffs on aluminum and important tariffs on raw materials used to produce aluminum, "Gazeta" reported the next day. The recommendation confirms that tolling -- the practice of importing raw material for processing and then exporting a finished product in such a way as to avoid export duty -- is slated to come to an end for the Russian aluminum industry. Russia's new Customs Code specifically outlaws tolling schemes, and the commission's move is intended to ease the pain of the 20 percent value-added tax (VAT) that will affect exported aluminum starting on 1 January. Although estimates of lost budget revenue vary, "Kommersant-Daily" quoted State Duma Deputy Vladislav Reznik on 8 December as saying that the state loses $115 million each year as a result of tolling schemes. ("Gazeta" reports that Russia's largest aluminum producer, Rusal, which uses tolling arrangements for 80 percent of its production, has claimed that the elimination of the practice could cost it up to $400 million annually.) Aluminum industry lobbyists have successfully torpedoed several previous efforts to end tolling; if they are to make another try, they have limited time to do so. DK

Telecom-centered financial-industrial group AFK Sistema announced in an 8 December press release that it has acquired 50 percent of SkyLink, a project aimed at expanding IMT-MC-450 (CDMA2000) mobile-communications networks in Russia. (Still a rarity in Russia, CDMA2000 offers higher data-transmission speed, making the Internet and other multimedia functions more accessible through mobile phones.) "Kommersant-Daily" reported on 8 December that Sistema paid for the SkyLink shares with bits and pieces of other assets -- 23.5 percent of Moscow Cellular Communications and 83.25 percent of Personal Telecommunications (better known by its brand name, Sonet). Analysts told the newspaper that the shares that changed hands were likely worth around $60 million. SkyLink intends to build its next-generation network on the basis of current networks that use outmoded NMT-450 technology; Sistema President Yevgenii Novitskii announced that participation in SkyLink will "give new life to our NMT assets," cnews.ru reported on 8 December. United Financial Group analyst Aleksei Yakovitskii told "Vedomosti" on 8 December that Sistema's move could be seen as an attempt to buy into the new technology before it becomes a competitive threat to Sistema's existing networks. The analyst cautioned, however, that developing a new network could cost up to $300 million a year, wondering, "Where are they going to get that kind of money?" Sistema already controls Mobile TeleSystems, Russia's largest cellular operator. DK

Ukrainian President Leonid Kuchma fired Deputy Prime Minister Vitaliy Hayduk on 5 December after the latter made inflammatory comments about Ukrainian-Russian energy-sector cooperation at a press conference the same day, Interfax reported. Hayduk told journalists that the Odesa-Brody pipeline, originally intended to ship Caspian oil to Europe, should not be reversed to allow Russian companies to export oil through the Black Sea, that Russia's Gazprom and Unified Energy Systems (EES) should not be allowed to privatize companies in Ukraine's energy sector, and that Ukraine should not transfer its gas pipelines to a nascent Russian-Ukrainian gas-transportation consortium (GTK). If implemented, the proposals would deal a serious blow to energy cooperation between Ukraine and Russia. Ukrainian government spokesman Aleksei Gorshkov told RIA-Novosti on 5 December, however, that Hayduk's comments should be treated as "his own personal opinion," and not as an official position. The GTK supervisory board is set to meet on 15-16 December, and "Kommersant-Daily" opined that Hayduk's comments could be seen as an attempt to sketch out "the most radical [possible] Ukrainian negotiating position in talks with Russia." Oleg Strelnikov, director of consulting company FKG Ukraine, saw Hayduk's sacking as a possible boon to the GTK. He told "Vedomosti" on 8 December that Hayduk had done everything in his power to hinder the gas consortium, and that a more amenable figure could ensure the ratification of all necessary agreements "by the fall of 2004." DK

A cherished view of Russian history holds that Russia is a rich country reduced to poverty by factors beyond the citizenry's control. Various schools of thought pick and choose their reasons: Geographical determinists point to a harsh climate, liberals to tyrannical government, reformers to wanton corruption, and patriotic conservatives to cunning enemies. Yet all share the basic belief that freeing the country's abundant natural resources from constraints can open the door to the prosperity that has eluded Russia throughout its history.

Recent political fashions have decanted this old wine into a modern bottle -- hitting oil companies with increased production taxes and royalties (payments for the right to produce oil on state land) and then pumping the added funds into the state budget or simply distributing them to citizens. The basic idea is that the state should try to collect "economic rent" -- i.e., the profits one reaps from cultivating a piece of land -- from businesses that make money from the extraction of nonrenewable resources. In the case of oil companies, the logic behind collecting "mineral-leasing revenues" is twofold: First, oil companies do not own the oil that makes them rich, only the right to extract it from the ground; second, the profits they earn when oil prices are high are so great that they can afford to "share the wealth."

In a 5 December survey of campaign slogans in elections to the State Duma, Valerii Panyushkin wrote in "Kommersant-Daily" that parties across the political spectrum all agreed on four basic ideas: empire, Russian resurgence, the collection of mineral leasing revenues, and support for President Vladimir Putin. While the parties differ on the particulars of how mineral-leasing revenues should be collected and distributed, Panyushkin writes, "not one party is against mineral leasing revenues."

The idea enjoys broad support among the population. According to a poll conducted by the All-Russia Center for the Study of Public Opinion, nine out of 10 Russians feel that all resource-extracting enterprises should be forced to pay mineral-leasing revenues, "Russkii kurer" reported on 6 December. The newspaper goes on to note that the practice is widespread in countries with oil-dependent economies such as the United Arab Emirates, Kuwait, Norway, and Saudi Arabia. In Alaska, for example, a Permanent Fund was established in 1976, according to information provided on the fund's website (http://www.apfc.org). The fund's purpose is to "set aside at least 25 percent of certain mineral revenues paid to the State for deposit into a public savings account to be invested for the benefit of the current and all future generations of Alaskans." In 2003, the fund paid eligible Alaska residents a dividend of $1,107.56, according to Alaska's Permanent Fund dividend website (http://www.pfd.state.ak.us).

While support for the idea of collecting mineral-leasing revenues is widespread, politicians have offered widely varying estimates of how much extra money is available for redistribution. RBC reported on 27 November that Sergei Glazev, a leader of the patriotic Motherland bloc, sees $40 billion-45 billion a year in added revenues; Egor Gaidar, a free-market economist affiliated with the Union of Rightist Forces, envisions $3 billion-4 billion. Communist Party leader Gennadii Zyuganov claims a potential $100 billion boon, "Gazeta" reported on 9 December.

Experts incline toward the lower estimates. Auditing and consulting company FBK examined the 2002 net profits of Russia's eight largest oil companies and average profitability figures for the industry. Assuming an average price of $24 per barrel for Russian crude, FBK arrived at a figure of $5 billion a year, "Russkii kurer" reported. If the proceeds were redistributed among the population, each Russian citizen would theoretically receive an extra $35 a year. Given the cost of divvying up and distributing the funds, each citizen would actually get only $17 according to FBK.

Legislators are poised to join the debate over mineral-leasing revenues. Pro-Kremlin and patriotic forces will hold a commanding majority in the new State Duma when it goes back into session in late December. Dmitrii Rogozin, one of the leaders of the Motherland bloc, told Radio Mayak on 8 December that the first issue he intends to raise is "a law on the collection of mineral leasing revenues."

Still, experts queried by "Gazeta" on 9 December felt that populist rhetoric might prove to be more bark than bite. Igor Nikolaev, head of the strategic analysis department at the above-mentioned FBK, told the newspaper, "The moderate approach of [pro-Kremlin] Unified Russia" -- party spokesmen have mentioned $10 billion as a maximum figure -- "will likely prevail over the radical ideas of Gartung or Glazev." (Valerii Gartung is an independent Duma deputy who has already proposed a mineral-leasing-revenues bill. According to Gartung, had his bill been law in 2003, it would have produced an additional $45 billion in revenue. Since the draft bill calls for distributing 80 percent of the proceeds directly to citizens, Gartung claims that each Russian would have received almost $250.)

Given the popular mood and a compliant parliament, the Kremlin will likely have a free hand in crafting its approach to mineral-leasing revenues. Moreover, it can expect little resistance from the once-mighty oil lobby -- politically outspoken oil tycoon Mikhail Khodorkovskii is in jail awaiting trial on fraud and tax-evasion charges, and his company, Yukos, has found itself in a slowly tightening noose of legal troubles. Against this backdrop, other industry bigwigs are doing everything they can to remain in the Kremlin's good graces.

Oil prices are high. (Russian Brent crude is currently trading at around $30 a barrel, according to the "Financial Times.") Russian oil companies might soon find, however, that their profits depend less on world commodities markets and more on political developments closer to home. DK