Business Watch: March 11, 2003

Sibneft and Tyumen Oil Company (TNK) shared their plans for divvying up Slavneft in a 5 March joint press release on the companies' websites (http://www.tnk.ru, http://www.sibneft.ru/). The two companies together control 98.5 percent of Slavneft after acquiring a 74.95 percent stake for $1.86 billion at a December privatization auction. According to the press release, Sibneft and TNK will split up Slavneft's production assets and sales network equally, while continuing for the moment to share its two Russian and one Belarusian refineries. Sibneft will also sell TNK its 38 percent stake in TNK subsidiaries Orenburgneft and Onaco for an undisclosed sum. "Kommersant" reported on 6 March that TNK would pay "a maximum of $550 million," while "Vedomosti" reported the same day that the figure could be as large as $800 million. It remains unclear how TNK's chunk of Slavneft will be integrated into the company's February agreement with BP to combine the two companies' Russian assets. Stephen O'Sullivan of United Financial Group told "The Moscow Times" on 6 March, "It will be an interesting test case which will show how this new partnership works." The asset-division plan left some wanting more information. Analyst Aleksandr Vertlyugin told "Finansovye izvestiya" on 6 March that the agreement "did not really clear up the question of dividing assets between TNK and Sibneft." Analysts polled by "Kommersant" agreed that "it's a long way to a final resolution." TNK and Sibneft are, respectively, Russia's third- and fifth-largest oil companies. DK

LUKoil and Urals Energy began talks on 6 March to settle a conflict over jointly owned oil producer Tebukneft after a week of dramatic charges and countercharges, "Vedomosti" reported on 7 March. Urals Energy fired the first salvo with a 3 March official announcement accusing LUKoil of unlawfully seizing control of Tebukneft, a small oil company that produces 1 million metric tons of oil annually, "Kommersant" reported on 4 March. Urals Energy, a minor-league oil company associated with former President Boris Yeltsin's former son-in-law Leonid Dyachenko, and LUKoil each own roughly half of Tebukneft. LUKoil succeeded in gaining control of Tebukneft's board in late February and installing new management, drawing the ire of Urals Energy. Dyachenko and LUKoil CEO Vagit Alekperov were unable to resolve the conflict at a 28 February meeting. The dispute reached its peak when Urals Energy representatives accused LUKoil of creating a "criminal threat," "Gazeta" reported on 5 March, and LUKoil spokesman Dmitrii Dolgov promptly diagnosed Urals Energy management with a "persecution complex." Urals Energy even threatened to target LUKoil's foreign holdings with a spate of lawsuits, "Vedomosti" reported on 4 March. If the current talks fail to produce an amicable settlement, "Kommersant" reported, the two companies have the option of holding rival shareholders meetings in late March. DK

The cabinet approved the Finance Ministry's debt strategy for 2003-2005 at a 6 March meeting, and First Deputy Finance Minister Aleksei Ulyukaev announced that the Paris Club has agreed to convert 10 percent of the $42 billion Russia owes it into securities, RBK reported the same day. As a result of the agreement, each of the 19 countries in the Paris Club will be able to issue securities for one-tenth of the sum Russia owes them for subsequent sale to private companies. Trust and Investment bank analyst Aleksandr Ovchinnikov told "Vedomosti" on 6 March that the move will pump up Russia's securities market by $4 billion and make the structure of the debt more transparent. Under the debt strategy, Russia's foreign debt will be $126.8 billion in 2004, $122.7 billion in 2005, and $113.3 billion in 2006. Prime Minister Mikhail Kasyanov expressed his satisfaction that the current debt load does not pose a threat to the country's economy. DK

Prime Minister Mikhail Kasyanov signed a resolution on 28 February guaranteeing state-run diamond monopoly Alrosa its export quotas for the next five years, RosBusinessConsulting (RBK) reported on 4 March. Although the exact figures in carats and dollars are a state secret, "Vedomosti" reported on 5 March that the amount is roughly $800 million annually, or half of Alrosa's current production. (The company recently announced that it plans to boost production to $2 billion a year by 2005.) The five-year export guarantees will make it easier for the diamond giant to obtain cheap, long-term credit, allowing it to invest in production and reduce its short-term debt load. The export guarantees are only half of what Alrosa needs, however. As Fedor Andreev, Alrosa first vice president, put it, "We need two things to get credit: the five-year quotas and the European Commission's approval of the contract with De Beers," "Izvestiya" reported on 4 March. The European Commission has doubts about a $4 billion, five-year contract between Alrosa and South African diamond powerhouse De Beers. The two companies will present a document on 17 March in which they parry charges that the contract stymies competition. DK

A bill to maintain Alrosa's current legal status and ownership passed its first reading in the Yakut parliament on 4 March, "Kommersant" reported the next day. Local lawmakers are worried that the federal government may try to increase its stake in the diamond concern at Yakutia's expense. Under the current ownership structure, the Russian government owns 37 percent of Alrosa; Yakutia, 32 percent; Alrosa employees, 21.71 percent; eight Yakut uluses (regions), 8 percent; and the company's managers, 1.29 percent. Audit Chamber head Sergei Stepashin suggested in February that the Yakut uluses' 8 percent might be better off in the state's care. Zenit Bank analyst Aleksei Tretyakov told "Vedomosti" on 4 March that Yakut legislators may be wasting their time: "The Yakuts just want to freeze the status quo." More ominously for Yakutia, a source in the Property Ministry told the newspaper that plans are moving ahead to return the 8 percent stake in Alrosa from the uluses to the federal government. DK

Prof-Media, a part of Vladimir Potanin's Interros holding, acquired a 35 percent stake in the Dutch-owned Independent Media publishing company, "Kommersant" reported on 4 March. At the same time, Yukos-affiliated Menatep SA gave up its 10 percent stake in Independent Media. Independent Media publishes a number of glossy journals in Russia, as well as "The Moscow Times" and "Vedomosti" (the latter in conjunction with the "Financial Times" and "The Wall Street Journal"); Prof-Media holds stakes in newspapers "Izvestiya," "Komsomolskaya pravda," and "Ekspress-Gazeta," as well as magazines and radio stations. Prof-Media did not reveal how much it paid for the 35 percent stake; media estimates ranged from $10 million ("Kommersant") to $35 million ("Gazeta"). An unidentified source told "Gazeta" on 4 March that Independent Media insisted that Prof-Media not view its involvement as a "political investment," which was, according to the source, the approach Menatep had taken. For his part, Independent Media CEO Derk Sauer reassured reporters from "Vedomosti" and "The Moscow Times" that the group would remain true to its name, saying, "I don't expect you to change anything in your reporting of Interros or Menatep or any other company," "The Moscow Times" reported on 4 March. Nevertheless, "Vedomosti" competitor "Kommersant," itself acquired in 1999 by now-exiled oligarch Boris Berezovskii, jibed in its headline about the deal, "Independent Media Loses a Third of Its Independence." DK

American billionaire Warren Buffet's time-share VIP airline NetJets announced its entrance into the Russian market with a 4 March advertising blitz in major newspapers. NetJets pioneered the concept of fractional aircraft ownership -- clients purchase a "fraction" of an aircraft and can then fly for a certain number of hours depending on how much of the plane they buy. In the United States, for example, a one-sixteenth interest grants 50 hours of occupied flight time a year. Fractional ownership is targeted at people who fly between 50 and 500 hours a year, a company spokesman told "Vedomosti" on 3 March, as those who fly less will do better with charters, and those who fly more should probably spring for an entire plane of their own. NetJets faces limitations in Russia, however. Strict controls on Russian airspace mean that the company may have difficulty keeping its promise to make planes available within six hours, "Gazeta" reported on 5 March. Also, NetJets is not licensed to fly between destinations within Russia. Still, Charles McLean, NetJets' director of communications and public affairs, told a Moscow news conference on 4 March, "We are convinced that there's a tremendous amount of business [in Russia]," "The Moscow Times" reported the next day. NetJets' cheapest package is one-sixteenth of a Cessna Citation Bravo for $375,000. DK

Officials from Tatarstan's Tax Ministry claimed the seizure of 2.2 billion rubles ($69.7 million) worth of truck manufacturer KamAZ's production and assets on 4 March in an effort to collect back taxes, Tatnews.ru reported the same day. A KamAZ spokesman disputed both the fact and legality of the seizure, telling "Vedomosti" on 5 March that the truck producer had obtained court decisions invalidating 3.5 billion rubles of a 3.8 billion-ruble bill submitted by the Tax Ministry. In addition, Tatarstan bailiffs told the newspaper that they had performed no such seizure. KamAZ representatives explained to "Kommersant" on 5 March that journalists had "misunderstood" comments by Tatar tax chief Rinat Khairov and KamAZ General Director Sergei Kogogin. An unidentified source in the Tax Ministry informed the newspaper that while the seizure writ did exist, "it existed for only 15 minutes, and then the two sides found a compromise." "Finansovye izvestiya" reported on 5 March that a conciliation commission will try to get to the bottom of the situation. Russia's Property Ministry owns 34 percent of KamAZ, with smaller stakes belonging to Vneshtorgbank, the Republic of Tatarstan, the European Bank of Reconstruction and Development, and Sberbank. One-quarter of its shares are in free circulation. Last year, KamAZ restructured its $1.3 billion debt to the federal government and the republic. DK

Shipbuilder Baltiiskii Zavod and weapons developer Altair may face off in court over a malfunctioning missile system that has delayed the delivery of two frigates to the Indian Navy, "Kommersant" reported on 4 March. The "Talwar" and "Trishul," part of an order for three frigates to be worth $900 million, were to have been handed over in 2002, but a grumpy Shtil-1 missile system has necessitated further tests and adjustments. The delay has imposed extra costs on Baltiiskii Zavod, opened the door to fines from the Indian side, and harmed the reputation of Russia's arms exporters. Baltiiskii Zavod Director Oleg Shulyakovskii told "Gazeta" on 5 March that Altair hawked untested missiles; Altair Director Oleg Efimov alleged that shipbuilders crammed the frigates with an excess of electronics, interfering with the Shtil-1's guidance system. Efimov threatened that if Baltiiskii Zavod sues, "We're not going to pay them; they'll end up paying us big money." The "Times of India" reported on 7 March that the Indian Navy is looking forward to commissioning the first of the frigates in April "after a protracted delay." The newspaper noted that in 2002, "two crews returned to India empty-handed after languishing in sub-zero temperatures at St. Petersburg for several months," although it did not say whether India's armed forces would seek compensation for their troubles. DK

Vimpelcom announced in a 6 March press release on the company's website (http://www.beelinegsm.ru) that the cellular operator won a tender to provide mobile-communications services to the 450 members of the State Duma. Vimpelcom will charge lawmakers a monthly fee of $7.50, $0.15 per minute for outgoing calls in Moscow, and $0.35 per minute for outgoing calls to the rest of the country. Vimpelcom's BeeLine brand became the de facto parliamentary standard in January, "Kommersant" reported on 7 March, albeit without the tender required by law. Competitors raised a huff, and Vimpelcom faced off against rival Mobile TeleSystems (MTS) in the ensuing contest. MTS spokesperson Eva Prokofev grumped to "Vedomosti" on 7 March that the tender commission took a mere 20 minutes to study, and reject, her company's 35-page proposal. Despite the small size of the contract -- less than $1 million annually -- Vimpelcom sales director Mikhail Yakovlev stated proudly in the company's press release, "It is an honor for any operator to serve a client such as the State Duma." DK

Cellular operator MTS announced in a 3 March press release on the company's website (http://www.mts.ru) that it has received a license to operate in Samara Oblast. Nineteen percent of the region's 3.3 million residents have cellular service, 6 percent more than the national average, "Vedomosti" reported on 4 March. MTS will face stiff competition: Megafon with 285,000 subscribers, Smarts with 185,000, and Vimpelcom with 22,500. MTS had tried to buy local operator Smarts to gain entry to the region, but the two companies were unable to agree on a purchase price. ACM-Consulting analyst Anton Pogrebinskii told "Vremya novostei" on 4 March that competition will make Samara a tough nut to crack for MTS, but with cellular penetration seen rising to 60 percent by 2007, the region offers encouraging growth potential. DK

Step, for a moment, into the designer Italian shoes of a Russian oligarch. No, not an oilman, or even an exiled financier -- your wealth comes from aluminum. What worries gnaw at you as your jet-black Mercedes purrs from palatial office to lavishly appointed villa?

Electricity worries you. Aluminum, you see, is fickle stuff. It cannot simply be drawn from the earth like diamonds or gold. It must be coaxed -- first extracted from ore in the form of aluminum oxide, or alumina, and then shorn of its oxygen in an energy-intensive electrolytic divorce. It takes 13 to 17 kilowatt-hours of electricity to produce 1 kilogram of aluminum. And there's no other way. As the Aluminum Association (http://www.aluminum.org) puts it, "While continual progress has been made over the more than 110-year history of aluminum processing to reduce the amount of electricity used, there are currently no viable alternatives to the electrometallurgical process."

Electrical energy in Russia is the sovereign domain of Unified Energy Systems (EES), a nationwide grid of power plants and lines that is the largest electric utility in the world. The power giant is, however, slated to lose much of its unity thanks to reforms that are designed to create a bona fide market for electrical energy in place of the current Soviet mishmash. The man appointed to oversee the perilous process is EES Chairman Anatolii Chubais, who began his career in the early 1990s as the darling of reform in the Western press and the devil of privatization in the Russian popular imagination. But despite a somewhat tarnished reputation abroad and the enmity of the Russian masses at home, Chubais never lost his footing in the corridors of power. In the starched and pressed Putin era, his official image is that of the arch professional, the manager's manager.

Chubais is now poised to apply his managerial skills to another round of reform. On 3 March, Federation Council committees and the Natural-Monopolies Commission recommended that the upper house of parliament pass the raft of energy-reform legislation that recently emerged from the State Duma, "Kommersant" reported on 4 March. Economic Development and Trade Minister German Gref reminded wavering council members that they will still have a two-year transition to tweak the changes. Key legislation is set for approval by the Federation Council on 12 March, and it appears that electrical reform is finally beginning to creak and wheeze into action.

As reform looms on the horizon, the EES board becomes more and more important -- it is the watchdog charged with ensuring that no skullduggery taints the inevitable redistribution of assets. A 28 February board meeting illustrated the complexity of the task. At the meeting, the board approved changes to the utility's charter that will be submitted to the annual shareholders meeting. Developed together by government, management, and minority shareholders, the changes to the charter would have required board approval for any asset sale over 15 million rubles ($475,000). The version approved on 28 February for submission to shareholders, however, omitted any concrete figures, leaving the exact parameters to the board's discretion, "Vedomosti" reported on 3 March. The board argued that this approach would be more "flexible" than figures set in stone. Dissenting board member Aleksander Branis objected that it would ease dubious deal making.

Naturally enough, it is in the general context of dubious deals and asset-stripping schemes that our imaginary aluminum tycoon reenters the picture. Under the current ownership structure, 52 percent of EES belongs to the state and some 20 percent to foreign investors. The remainder is, so to speak, a matter of speculation.

With the price of electrical power set to rise as reform progresses, the captains of power-dependent industries have not been sitting idly by waiting for their bills to rise and profits to fall. Ever proactive, they have been buying up stakes both in EES and its regional subsidiaries. In fact, according to a 6 March report in "Gazeta," analysts believe that "the shares in EES that have been bought up by various companies already comprise a blocking stake."

The list of suspects reads like a who's who of Russian industrial heavyweights: MDM Group, SUAL, Rusal, Yukos, Norilsk Nickel, LUKoil, Severstal.... Leading the pack is MDM Group, a consortium with interests in coal, metals, and finance. "Gazeta" reports that MDM has spent hundreds of millions of dollars to acquire a chunk of EES that could be as large as 17 percent, plus substantial holdings in regional generating assets.

While some maintain a traditional oligarchic silence about their acquisitions, others are increasingly open about their involvement. Viktor Vekselberg, co-owner of Tyumen Oil Company and aluminum giant SUAL, recently created Complex Energy Systems (KES) for the express purpose of investing in regional utilities. KES spokespeople told "Vedomosti" on 5 March that they own substantial stakes in regional utilities Permenergo, Rostovenergo, Sverdlovenergo, Komienergo, and Pechora GRES. Aton analyst Aleksandr Korneev pointed out to the newspaper that, with the exception of Rostovenergo, the geographic distribution of the utilities overlaps with that of SUAL's production facilities.

A 7 March report in "Konservator" expands the list still further, noting that Vladimir Potanin's Interros holding (Norilsk Nickel) has acquired a 25 percent stake in Kolenergo and a 40 percent stake in Krasnoyarskenergo, while oil company Yukos has snapped up blocking stakes in five regional utilities.

Still, none of these stakes yet offers full control, leading "Vedomosti" to ask in a 6 March editorial, "Why did the oligarchs suddenly feel such a need for these shares?" The answer: "The oligarchs plan to participate in energy reform, which will allow them to convert their small stakes into controlling ones, thereby privatizing one of the last branches of industry still under state control and giving them a say in the production and pricing of electricity." To this end, the oligarchs will do everything in their power to hasten energy reform after the 2004 presidential elections. As one insider colorfully put it to "Vedomosti," if the government drags its feet after that, "We'll beat them over the head with bamboo sticks."

The bamboo sticks could come out as early as May, when EES's annual shareholders meeting will elect 15 board members from a slate of 32 candidates. The list of candidates is a smorgasbord of high-ranking government officials, financial-industrial group representatives, and foreigners. With the lion's share of seats expected to go to government, management, and oligarchs, the question is whether any minority-shareholder representation will survive. Aleksandr Branis of Prosperity Capital Management, who currently represents minority shareholders on the EES board, told "The Moscow Times" on 7 March that minority investors will have to band together to guarantee themselves at least one seat. Even then, he allowed, they could be left out in the cold.

Slipping back into your role as aluminum tycoon, you can relax a bit behind the tinted glass of your Mercedes. You've made wise investments in the EES subsidiary that supplies your production facilities with electrical power. And you own a nice block of the parent company. Your consummate negotiating skills will likely gain you a seat on the board when elections roll around in May. A long ride down a bumpy road awaits you, of course, but with a little of the same luck that helped you to your current position, you have every chance of ending up in the driver's seat. DK