BUSINESSWEEK ONLINE : NOVEMBER 20, 2000 ISSUE
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INTERNATIONAL -- EUROPEAN BUSINESS

Gazprom on the Grill (int'l edition)
Questions are mounting about officials' self-serving deals

It was one of Viktor S. Chernomyrdin's last deeds as Prime Minister of Russia. In February, 1998, he signed a decree handing a federal contract worth millions of dollars to Moscow-based Stroytransgaz to lay gas pipelines in Russia's regions. It was an interesting selection. The Prime Minister's son, Vitaly, was a first vice-president of the enterprise as well as holder of a 6% stake. And Stroytransgaz itself was a satellite of Gazprom, Russia's huge gas conglomerate. Chernomyrdin the elder presided over Gazprom before entering the government in 1992. And he went back to Gazprom as chairman shortly after approving that contract.

Sounds questionable. A lot of things, though, were questionable in Russia's tumultuous progress to capitalism--and allegations of management abuses at Gazprom surfaced often through the years. To no avail, however: Gazprom, protected by the politically powerful Chernomyrdin, was long considered sacrosanct. Yet the history of Gazprom's insider deals is now gaining special prominence. A more aggressive board, the rising anger of shareholders, and wider availability of documents are all putting the transactions at Russia's biggest company under intense scrutiny.

Most important, President Vladimir V. Putin is moving aggressively to tighten government control over the mammoth enterprise, which wielded so much political clout in the past that it became known as Russia's ''state within a state.'' Putin may even clean up the company, which is 38% owned by the government, to prepare for an overhaul. A first step in this direction, already on the agenda, is a breakup of Gazprom's monopoly on gas pipelines.

Such a bold reform would go a long way toward fulfilling Putin's vow to improve Russia's economy. Gazprom's vast assets dwarf the holdings of oligarchs so far targeted by Putin's regime such as tycoon Boris Berezovsky, whom federal prosecutors are now threatening to charge with embezzlement in a case connected to national airline Aeroflot. ''The government is clearly concerned about possible asset transfers from Gazprom. Before now, it was totally passive,'' says Oleg Vyugin, an architect of Putin's reform plan.

As a result, official Moscow is abuzz as more information leaks steadily out about the questionable goings-on at Gazprom when Chernomyrdin served as Boris N. Yeltsin's Prime Minister and after he rejoined the company. The thrust of the allegations: that Gazprom executives transferred assets and shares at below-market prices to relatives and other insiders and awarded sweetheart contracts to Gazprom-connected companies. Gazprom officials deny any wrongdoing. But the authorities are looking into several of the allegations. Documents obtained by BUSINESS WEEK reveal insider dealings between Gazprom and Stroytransgaz and also indicate that a Gazprom senior manager has a stake in an upstart producer, Itera Group.

FAMILY AFFAIR. The tale of Stroytransgaz, the winner of that federal contract, encapsulates all the criticisms leveled at Gazprom. The pipeline maker's list of shareholders, filed with Russia's Federal Securities Commission (FSC), includes not only Vitaly Chernomyrdin but his brother, Andrei, and Tatyana Dedikova, the daughter of Gazprom Chief Executive Rem Vyakhirev. The president of Stroytransgaz, Arngolt Bekker, is a Gazprom board member. In fact, Gazprom managers and relatives own at least 60% of Stroytransgaz. It currently has $1.2 billion in orders on its books, over 80% placed by Gazprom. Perhaps the most lucrative gift of all: In 1995, Gazprom transferred to Stroytransgaz a 4.83% block of Gazprom shares, according to FSC documents. Gazprom charged just $2.5 million for securities that had a market value at the time of up to $80 million, according to Moscow brokerage United Financial Group. The FSC is now probing asset transfers from Gazprom to Stroytransgaz, which may have violated laws barring insider dealing. Stroytransgaz says it is a transparent company with nothing to hide.

Share purchases are at the heart of another allegation focusing on links between Gazprom and Itera Group, a privately held company headquartered in Moscow. Over the last three years, Itera has shot up to become the world's fourth-largest holder of gas reserves, while Gazprom has remained No. 1. This has raised eyebrows because most of Itera's reserves have come from Gazprom.

The government has ordered the State Duma's Audit Chamber to probe possible illegal dealings between the two companies, an effort due to be completed by the end of the year. Officials have already referred one of the probes of Gazprom practices to the Prosecutor's Office, where it is being investigated further for possible legal action.

Yet in an interview with BUSINESS WEEK, Itera Vice-President Vladimir I. Martynenko defended his company's dealings with Gazprom. ''Gazprom is not giving anything for free'' to Itera, Martynenko declares, saying Itera has paid market prices for access to Gazprom pipelines and that the state approved the company's purchases of Gazprom assets. He says no Gazprom managers own personal stakes in Itera.

But BUSINESS WEEK has obtained filings that appear to provide the first concrete evidence of a link between a senior Gazprom manager, Viktor Bryanskikh, and Itera. Bryanskikh is a major shareholder of a corporation called Lanka Promkomplekt, which is registered at the same Moscow address as Itera, and is owned in part by companies with links to Itera. In February, 1999, Lanka also bought a chunk of Sibneftegaz, a Gazprom affiliate. Those shares eventually ended up under Itera's control.

The Sibneftegaz shares were also sold on the cheap. Sibneftegaz registered its shares in the 1999 sale at a value of $1.8 million--while independent analysts put a much higher valuation of $80 million on the shares. Fellow purchasers of the discounted stock were Gazprom senior manager Vyacheslav Kuznetsov, his spouse, and a company owned by the son and brother of Gazprom CEO Vyakhirev.

Bryanskikh declined to comment; Itera's Martynenko says Lanka Promkomplekt is not an Itera company. ''But if they [Gazprom managers] have some shares in Itera holdings, what's wrong with that?'' he added.

The big question is how this wheeling and dealing has affected Gazprom as a company. Because of underinvestment, production at Gazprom is projected to drop to a 10-year low this year. It has reported total losses of $10 billion in the last two years. A company with $15.4 billion in sales and $40 billion of gas reserves, Gazprom has a market capitalization of only $6.8 billion.

Another charge leveled is that Gazprom managers appear to be using tax schemes to transfer assets to Itera. According to a recent report of the Audit Chamber, Gazprom, paid 1998 and 1999 taxes to the Siberian regional administration of Yamal-Nenetsk in the form of gas. The gas was valued cheaply at $2 per thousand cubic meters. The region, headed by an elected governor who also sat on Gazprom's board, sold the gas to Itera at the same low price. Itera, in turn, sold the gas on world markets for as high as $60 per thousand cubic meters. According to the Audit Chamber, Itera garnered $1.8 billion in 1999 through such means. The Audit Chamber has passed its findings on to prosecutors for possible legal action. ''Itera is such an egregious rip-off [of Gazprom shareholders], one blinks with disbelief,'' analyst Eric Kraus at the Moscow brokerage Nikoil Investment Co. declared in a Nov. 2 report on Gazprom.

Gazprom declined to respond to phone calls and written questions from BUSINESS WEEK. The company's management has previously denied any misdeeds and said it is acting to make Gazprom more transparent. Chernomyrdin also declined to respond.

TIGHTER REINS. Gazprom has new directors who are a lot more aggressive about policing it. The board voted just last month to require management to obtain directors' approval for any asset sales, a stipulation that did not exist in the past. At the insistence of Gazprom director Boris Fyodorov, a finance minister in Yeltsin's administration, a discussion on the company's Itera ties was placed on the agenda for the next board meeting in late November. The government's representatives on the board backed that move against CEO Vyakhirev's protests--but it's still not clear whether they will join Fyodorov, who represents minority shareholders, in forcing Gazprom to divulge all its questionable transactions. Seeking to increase the pressure for reform, Fyodorov on Nov. 3 sent Vyakhirev a letter--a copy of which has been obtained by BUSINESS WEEK--demanding further information about Gazprom's relationship with Itera and asking about the involvement of Stroytransgaz in Gazprom's Blue Stream project--a $3 billion venture, in which Gazprom and the Italian company ENI are equal partners to build a gas pipeline linking Russia's Black Sea coast with Turkey's. In 1998, Stroytransgaz received a contract to build the pipeline's first phase. Fyodorov wants to know if it was competitively awarded. Stroytransgaz says this contract and others were all awarded on a tender basis.

To be sure, not all of Gazprom's problems are of its own making. Its performance has long been hamstrung by the state because the government has forced it to subsidize the rest of the economy by keeping domestic gas prices low. Gazprom has also been blocked from cutting off supplies to major companies that can't afford to pay. But the extent of insider dealing at Gazprom, cynics say, simply proves Russia is incapable of reform.

Not so. Gazprom represents an old style of business that progressive executives and policymakers are eager to change. Putin says he wants to build an open economy that consumers and investors can trust. This is his chance.

By Paul Starobin and Catherine Belton in Moscow

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