| "Corrupt influence . . . loads us more
than millions of debt; which takes
away vigor from our arms, wisdom from our councils, and every
shadow of
authority and credit from the most venerable parts of our constitution."
Those words might well have been spoken in an exhortatory state
of the
nation address by Russian President Vladimir Putin rather than
by the 18th
century British statesman Edmund Burke. But Burke, ever the realist,
also
noted that government, like much of human enterprise, is "founded
on
compromise and barter," a view President Putin would no doubt
also share.
The question facing Russia as it undertakes the single most important
economic reform since price liberalization, is how to keep the
compromises
from corrupting the reform process and discrediting the state
that oversees
it. It's a balance President Putin's predecessor, Boris Yeltsin,
never
quite managed.
Last week the Russian Duma, in the first of three votes, approved
a
government-backed package for the restructuring and privatization
of
Russia's power sector, the last major unreformed sector in the
Russian
economy. Acting as both patient and surgeon in this complex operation
is
monopoly utility RAO Unified Energy Systems (UES). The reform
plan itself
has some flaws and more compromises are probably in store as ministers,
oligarchs, regional power brokers and others seek to influence
the final
package. But the biggest question hanging over power sector reform
is
whether its principal architect, Anatoly Chubais, can be trusted
to
implement it.
Mr. Chubais, a former first deputy prime minister and chief of
Boris
Yeltsin's staff, is chairman of the management board of UES, which
controls
Russia's national grid and has stakes in the regional companies
that
generate, distribute and supply electricity and heat to local
residential
and commercial clients. Mr. Chubais has been under attack from
the
Kremlin's top economic adviser Andrei Illarionov and from minority
shareholders. The most serious charge is that UES has been selling
off
generating assets in daughter companies before a market can be
created to
value them properly and without giving minority shareholders a
pro-rata
stake.
The dispute may soon come to a showdown between Mr. Chubais and
minority
shareholders. The largest Russian investment fund, Hermitage Capital
Management led by managing director William Browder has now gathered
enough
votes, 10%, to call an extraordinary shareholders meeting. Mr.
Browder's
aim: Oust Mr. Chubais and prevent UES's management board from
selling off
assets.
While shareholder grievances are common in Russia, this case is
seen as a
proxy for the government's commitment to transparency and corporate
governance as well as to energy sector reform. The government
holds just
under 53% of UES's shares while foreign investors -- which includes
such
big names as Fidelity, Barings, Capital International, JP Morgan
and
Merrill Lynch -- hold between 25% and 30% of the stock. Adding
more urgency
to the issue, the World Trade Organization has made liberalization
one of
the conditions for Russian membership.
No one underestimates the scale of the challenge. UES is the largest
power
company in the world. The power giant serves as Russia's heart,
pumping out
71% of the country's electricity. The heart, however, is badly
in need of a
quintuple bypass. The energy sector in Russia remains the overmanned
and
hugely inefficient monopoly it was during Soviet times -- in need
of some
$30 billion in investment over the next decade by some estimates.
There is
no competition in retail and wholesale markets and low government-mandated
tariffs have driven up electricity consumption. Residential tariffs,
which
are subsidized by industrial users, are a mere 9.4% of the OECD
average.
Under an ambitious 10-year reform plan, the generating, distribution
and
supply assets of UES would be unbundled from the transmission
grid, which
will remain state-owned. The tariff structure would be reformed
from 2004
and, in the final stage, the generating and other assets would
be
privatized with the aim of bringing in foreign strategic investors,
who
have so far done little more than nose around a market that is
overregulated and fraught with risks.
This leaves the government easy prey to the industrial oligarchs.
Russia's
metallurgy, chemicals and oil industries hope to buy up generating
assets
on the cheap to keep their electricity costs at their current
low level.
Power accounts for 12% of aluminum production costs in Russia
compared to
almost double that amount internationally, for example. The overall
value
of the power subsidy to Russian industry is variously estimated
at between
$3 billion and $6 billion annually. Many regional governors benefit
from
control over local generating assets and are loath to see tariff
increases
in their constituencies. Mr. Chubais's job is to manage this massive
restructuring which has repercussions for the entire Russian economy.
There was a time when Mr. Chubais's appointment to a position
of influence
caused Russia's market to rally and when his presence in the room
caused
IMF officials to write out checks for billions. Even after the
controversial loans-for-shares privatizations, in which Russia's
major
banks gained control of the choicest state assets for a pittance
in
auctions they organized and won, he retained the trust of Western
investors
and lending agencies. Indeed, it was foreign shareholders who
lobbied hard
to get Mr. Chubais his job at UES in April 1998, an appointment
that was
cheered by the markets.
But as Mr. Chubais acknowledged to investors in a presentation
last month,
"perception is reality," and the perception these days
is that this master
survivor and deal-maker is undermining minority shareholder interests.
The
move to call an extraordinary shareholders meeting came after
revelations
of a number of deals or planned deals in which UES was disposing
of power
generating assets before the restructuring could take place and
before
minority shareholders were given pro rata stakes in those assets.
. UES agreed to a $10 million loan to the semi-finished Boguchansk
power
plant from aluminum giant RusAl. In exchange, UES pledged a stake
in the
power plant, which is located in the Krasnoyarsk region of Russia.
The
appearance of a sweetheart loans-for-shares deal created an uproar
among
minority investors. Andrei Trapeznikov, a close Chubais associate
and
member of the UES executive responds: "We needed to make
some preliminary
negotiations with the potential investor. After we made the negotiations
we
submitted the results to the board. There were no sales or violation
of
pro-rata distribution." UES says it put a moratorium on this
deal as a
result of shareholder concerns.
. Rostovenergo, a UES subsidiary, sold its 100% stake in the Shakhtinsk
power plant to a company called Energoperspectiva a year ago.
The Chairman
of Rostovenergo, and head of the southern regional district of
UES, Yevgeny
Sitnikov, turns out also to be the chairman of the board of
Energoperspectiva, which acquired the asset, for an amount criticized
by
minority shareholders as ridiculously low. Mr. Sitnikov's Energoperspectiva
additionally acquired from UES its 27% stake in the advanced technology
Shakhtinsk thermal plant, again reportedly for a small sum of
future
earnings as payment.
Minority shareholders say the deal violates Russian laws on interested
party transactions as well as a government decree on power reform
which
calls for pro-rata distribution of daughter company assets. Mr.
Trapeznikov
says that the conflict was unintentional: "Mr. Sitnikov himself
didn't know
he had been elected as chairman of Energoperspectiva's board,"
he says, an
explanation minority investors are likely to find hard to swallow.
"A
special commission created by the board and management of UES
is examining
all these deals in the Rostov region and this commission will
give its
results to the board at the end of October," says Mr. Trapeznikov.
. In another proposed deal, Renaissance Capital (a Moscow investment
bank)
would run a tender for the generating assets of Kuzbassenergo,
in which
Renaissance itself has a 30% stake. Under the terms of the tender,
a buyer
would have the option to pay in shares of Kuzbassenergo and Renaissance
would have the option of putting in a higher bid after all the
bids had
been collected. Minority shareholders again complained of their
interests
being trampled. Mr. Trapeznikov says Renaissance wanted to acquire
a 51%
stake in some of Kuzbassenergo's generating assets and negotiations
ensued.
"The tender terms just were their proposal. No board decision
on adopting
this proposal has been made."
While the government has been mostly silent on all this, Grigory
Yavlinsky,
the liberal politician who heads the Yabloko party in the Duma,
has been
outspoken in his criticism of UES. In a phone interview, he said
"Everything is done in a black box; nobody knows who is going
to have these
pieces and the procedures are absolutely untransparent. It means
that we
are still in the Yeltsin period."
The salutary side of a story that is far from over is that the
outcry of
minority shareholders like Mr. Browder has thrown on the lights
in UES's
boardroom. At an investor conference last month, Mr. Chubais acknowledged
that the negative market sentiment had something to do with "insufficient
consideration of minority shareholders' views," and the "premature
consideration of asset sales." He pledged a moratorium on
all asset sales
and made a number of other pledges, including not to hand over
shares in
UES's subsidiaries in exchange for loans and a promise to carry
out a
pro-rata distribution of UES's assets at each level of re-organization.
The chastened approach has had some effect. UES's stock has risen
17% since
September 25 (against a 4.4% rise in the RTS stock index), when
Mr. Chubais
issued his seven pledges). "It means the market has accepted
our
proposals," says Mr. Trapeznikov.
Mr. Browder isn't buying that, however. "Chubais scared
the markets so much
with his asset sales plans that when there was some possibility
they might
be delayed there was a relief rally. Anyone who believes that
asset sales
are going to stop is just plain naive." He notes that the
wording of the
moratorium on asset sales leaves open the possibility they would
be resumed
as soon as a "valuation methodology" is agreed with
advisors Deloitte &
Touche. Mr. Trapeznikov says Mr. Chubais doesn't want any "massive
asset
sales" until after a market is established and only on terms
minority
shareholders are happy with.
Some have found these promises more reassuring. Says Christopher
Granville,
an equity strategist at United Financial Group in Moscow: "Putin's
ultimate
political interest is to make sure that the population is kept
warm and
lit. Handing out the best generation capacity to oligarchs is
not going to
do that." Mr. Chubais also wins points in some investment
quarters for what
he's accomplished up to now at UES. In 1998, 20% of energy payments
were
made through barter, leaving $3.2 billion in losses. Mr. Chubais
has fired
managers throughout the organization and cracked down on delinquents.
Cash
payments for energy were over 100% (including debt repayments)
last year
and UES paid $1.4 billion in taxes to the government, while increasing
its
investments. And yet none of this settles concerns over who will
end up
owning the generating assets.
Mr. Yavlinsky says he believes that President Putin is well aware
of the
issues threatening to dog the reform that is the centerpiece of
his
economic policy. "I can quote what the president said [about
Mr. Chubais].
He said his credit history is very bad. That is the problem,"
he says. If
Mr. Chubais's credit history is the problem, then the bigger question
is
whether the government is itself a trustworthy guarantor.
Dating back more than a decade, Mr. Chubais has always claimed
that his aim
is to make the reform process irreversible; to create the capitalists
that
make capitalism possible. In that process a lot was, to use Burke's
phrase,
compromised and bartered away: competition, transparency, minority
shareholder rights, fair play. These have been casualties of the
privatization process to date. "Its one thing to make privatization
in
Russia irrevocable. Its another thing to take already privatized
assets
away from the people who own them and give them to somebody else,"
says Jim
Nail, a long-time Russia analyst and partner at Pharos.
Mr. Chubais has already earned his place in the history of post-Soviet
Russia's transformation. The jury is still out whether the reformist
credentials that won him accolades in the West and the trust of
successive
Russian presidents will survive the UES reform.
See also:
Energy
Sector Reform | 