Russia - Mining black gold

Why invest your hard-earned money in the politically unstable,mines the role of Western accountants in attracting investment to the region’s energy and mineral industries. fledgling economies of the former Soviet Union? Quite simply, because – as with any high-risk investment – the financial rewards could be fantastic. But as any potential investor should know, there is also the threat of losing everything.

The Russian Bear, and the emerging ‘capitalist’ economies of its satellite states, might only just be crawling out from hibernation, but analysts predict that when it stretches its massive arms after a long dormancy it will roar loud enough for all the world to hear.

And roar it should. Buried under the vast expanse of the Commonwealth of Independent States is more than a third of the world’s reserves of oil and gas. Enough resources to power the CIS, with plenty left over to sell abroad. And there’s a similar story when it comes to gold and diamonds.

There’s just one problem – getting the stuff out of the ground cost-effectively.

Prospecting is an expensive business, and it is a business that does not guarantee success. Undoubtedly there is money to be made, but the CIS does not have the money to do it alone. Foreign investment is the key to success, but would-be backers are finding plenty of hurdles that must be overcome.

Knowing just what kind of a company you are ploughing your money into is the first obstacle. Teams of Western accountants from all the Big Six are currently working on a series of high-profile audits to international accounting standards, designed to give a true and fair view of the health of leading Russian businesses.

Price Waterhouse’s daunting audit of Unified Energy Systems Russia, the holding company for more than 70 regional energy companies, is a prime example. The work, described by PW Moscow partner Harold Straker as his ‘greatest challenge’ in 30 years as an auditor, will give UESR and its 28% foreign shareholding a clear idea of how far the business has come since it emerged from the centrally planned economy in 1993.

More importantly, it will define just how far the business still has to go.

Benefits of Western audit standards

Lenenergo, one of the 72 ‘energos’ under UESR’s umbrella, is also benefiting from Western audit standards, but Sergey Vjazalov, the company’s general director, realises there are no quick answers. ‘We have never thought we will find a foreign investor who will come and invest all the money we need,’ says a matter-of-fact Vjazalov. ‘From a financial point of view, we have to rely on ourselves.’

Returns could be good for utility investors, but oil is rapidly emerging as the key area where big money is to be made in the CIS. America grew fat on its oil reserves, and the same could happen in the former Soviet Union.

Oil giant Yuksi, formed in March through a merger of privatised Russian companies Yukos and Sibneft, has already attracted foreign investment thanks to a PW check of its books. French concern Elf Aquitaine bought a 5% stake in the business, which has known crude oil reserves three times the size of BP’s, for $528m.

Other international tie-ups include Royal Dutch/Shell’s link with Gazprom and BP’s interest in Sidanco.

Elf invested in Yuksi to gain access to an estimated 700 million barrels of oil lying deep beneath the remote Sugmut field in western Siberia.

At first glance it seems a bargain, but the reality is far from simple. The scale of projects right across Russia, including the inhospitable wilds of Siberia, means that billions of dollars in investment is needed to develop infrastructure alone.

Add to that the fact that Yuksi, and virtually every other Russian company, has long-standing social responsibilities which it can’t just walk away from. Instead of just setting up a small Siberian outpost to produce the oil, Yuksi built entire towns to service the process.

That all took place under Soviet rule, and ruthless business minds would slash the operation to a minimum to cut costs, but things in the CIS are never that simple.

Alexey Golubovich, a Yuksi vice president, explains: ‘We have 600,000 employees, which is too many for our production volume, but we can’t reduce that number. It is very difficult to create jobs in Siberia and we have to think about what will happen to those people.’

Golubovich is clear of the benefits of Western money, but stresses that the Russian government will have to provide an attractive platform for potential investors.

‘Foreign investment depends on whether the government will take the necessary steps to encourage it, which includes approval of a new tax code,’ says Golubovich. ‘There must also be effective regulation of the stock market and we must have a Western accounting system so that investors can understand whether a company has truly made a profit or a loss.’

Kiryenko set to make a difference

No doubt a few vodka glasses were raised last week, as the Russian Duma finally yielded to the will of president Yeltsin and agreed to appoint former energy minister Sergei Kiryenko as prime minister. He, more than anyone else, knows the problems facing the sector, is keen to sort out the mess and pull in foreign investment in the process.

Problems encountered by Western investors in Russia are multiplied many-fold in the remote southern state of Azerbaijan. Bordering the Caspian Sea, Azerbaijan stands on the brink of an oil boom. The country is potentially the world’s third largest oil producer, with reserves of more than 200 billion barrels (Saudi Arabia has 250 billion).

Twice before, the Azeris have seen the riches oil can bring, and twice before the wealth has been squandered. This time, the government is actively encouraging foreign investment and major Western oil interests have poured into the region. In the current round, oil prospectors have been flocking to Baku, Azerbaijan’s ancient capital, since 1989, when Aberdeen-based Ramco set up in the search for Caspian black gold.

Ramco, which is concentrating on start-up projects, must jump through the same tiresome tax hoops as its competitors. Company director Hikmet Alishev, who has produced a study for the Azeri government showing how uneconomic the tax regime is, talks hopefully of change.

‘The tax regime must be predictable to allow planning for the future and it must be more simple. Joint ventures currently face up to ten taxes which make projects uneconomical,’ he explains. ‘I hope our study will convince the government of the need for change.’

Pennzoil’s James Tilley, president of the Caspian International Petroleum Company joint venture, adds: ‘In Europe, all the tax laws are set, allowing you to make an investment decision. But in Azerbaijan and Russia, we have an ongoing dialogue with officials. There are no real enforceable oil and gas laws and tax movements can easily kill a project. But the Azeris want to do business and want the oil industry to develop – it is an attitude decreed by the president.’

That president, the ageing Heidar Aliev, a former head of the KGB, is committed to developing his nation and stamping out the corrupt practices that are all too obvious to the Western visitor. Success, however, probably rests on the shoulders of his successor, and Aliev is currently considering who to appoint.

His choice is vital for Azerbaijan and investors. That is why, despite the potential fortune waiting to be made, taking the Caspian gamble is not a sure-fire bet.

ST PETERSBURG: INCENTIVES FOR FOREIGN INVESTMENT

Attempts are being made to encourage foreign investment in Russia, not least in St Petersburg, where the city’s elders have drawn up an impressive strategic plan designed to create 200,000 jobs and boost the city’s revenues by 20% in real terms.

Igor Artemiev, St Petersburg’s finance committee chairman, has already overseen the implementation of three special laws designed to make the region a more attractive place to invest. His measures, which are due to come into force in June, include an end to the 50% tax on investment profits, and tax breaks for any foreign business investing more than $1m for four consecutive quarters.

Individual businesses are also making an effort – even those previously thought beyond the private sector. The romantically named October Railways (after the month it was formed in 1837 rather than the revolution), which serves the route between St Petersburg and Moscow, has produced a detailed catalogue of investment opportunities, ranging from $56,000 for a children’s railway to $60m to fund the construction of a terminal complex to process foreign freight.

A high-speed rail link between the two cities is also planned.

But old habits die hard, especially communism, and while Anatoly Zaitsev, the railway’s general director, is a reformer, he accepts the difficulties.

‘The people, especially the old, do not want to belong to new structures.

They were used to the old system,’ he says. ‘So we are not in a hurry and we refuse to make changes if it means the conditions will be worse for the people.’