Ukrainians Aim at Deripaska

MOSCOW, Russia -- The first Russian businessman to lose the Ukrainian assets he acquired during ex-President Leonid Kuchma's regime could be Oleg Deripaska, the Moscow oligarch who controls Russian Aluminium (Rusal), one of the world's leading producers of aluminium. At stake is Rusal's umbilical cord to the Nikolaev Alumina Refinery, in the Ukrainian port city of the same name.

The Ukrainian move to cut that cord also affects the rivalry among Russian, Chinese, American, and local groups to mine bauxite in the Republic of Guinea. If the ownership of the Nikolaev refinery is unravelled by the authorities in Kiev, that will rebound on the Rusal-controlled Guinean bauxite mines, which have supplied Nikolaev since the Soviet period.

Sources in Kiev today told The Russia Journal that the Ukrainian Prosecutor-General's office has filed a high court claim accusing the former Ukrainian government of violating the law in allowing Deripaska to change the investment conditions he undertook, when he first acquired the state's 30% stake in the refinery in the year 2000. The privatization auction which Deripaska won ended a bitterly contested tussle for control of the refinery with the Trans World metals and the Reuben brothers of London. The stake cost Deripaska about $100 million. But the additional investment conditions obliged him to spend much, much more.

The latest action is not a direct attempt to invalidate the original privatization. A source close to Deripaska told The Russia Journal earlier this month that he was confident this would not happen. Ukrainian government officials had also said as much in public statements. However, the latest action by the prosecutors could have a similar impact if the court rules that the previous government acted unlawfully to favour the Rusal group. A spokesman for the Prosecutor-General's office in Kiev told The Russia Journal that an order of the former Ukrainian government, no. 550p, issued on August 10, 2004, violated Ukrainian law. That order, they claim, unlawfully changed the financial terms which Deripaska's acquisition of the Nikolaev refinery obliged him to meet.

Nikolaev currently produces more than 1.3 million tons of alumina per year, feeding Rusal's four Russian smelters which, altogether, produced 3.1 million tons of primary aluminium last year. Nikolaev's output comprises more than a third of Rusal's Russian smelter requirement. Without it, Rusal's pledges to build new smelters in Irkutsk and Khakassia and increase annual output of metal to 5 million tons, would be difficult to achieve, if not impossible.

A Ukrainian government source, who has been close to Rusal's attempts to hang on to the refinery, but change the investment requirements, told The Russia Journal, on condition of anonymity, that a court review of the issue, which began in 2003, is still under way. The source expressed surprise at the prosecutors' independent court action.

Asked if this had been prompted by Ukrainians seeking to recover the refinery from the Russian group, the source said " Honestly, I don't know the background for their decision. It shows their initiative." She confirmed that Deripaska had earlier agreed with Yushchenko's ministers not to put the Nikolaev refinery on the government's black list of privatization deals that are to be reviewed, possibly cancelled, or put for fresh sale.

Last year, while Leonid Kuchma was President and Victor Yanukovich , his Prime Minister and designated successor, Rusal's Ukrainian affiliate Ukral had appeared to be in an impregnable position, following a shift in policy at the Ukrainian Fund of State Property.

A year earlier, in June 2003, Mikhail Chechetov, Chairman of the Fund, had announced publicly that Ukral had failed to commence construction of a new aluminium smelter at Pervomaisk, in the eastern Kharkov region of the Ukraine. As this project was one of several conditions Rusal and Ukral had agreed to, when they acquired the state shareholding in the Nikolaev refinery, Chechetov claimed his agency would go to court to decide whether to reverse Rusal's acquisition of the asset.

After Deripaska had defeated the Trans World group for control of the refinery in 1999, he then agreed with the government in Kiev that within two years he would expand alumina output at Nikolaev to 1.3 million tons; halt tolling operations at the plant; and start building a new 100,000-ton capacity smelter at Pervomaisk. But he dragged his feet on all three.

In 2004, according to Ukral's spokesman, "we are proceeding with expansion of production capacity of the plant [up to 1.3 million tons per year] at full speed, and we plan that production capacity of the plant will be increased to the agreed level in the first quarter of 2004. For the second year now, Nikolaev is working on a regular import-export basis and doesn't use tolling schemes." The promised upgrade to 1.3 million tons of output had been the subject of a negotiation with the Ukrainian government, which agreed in August of 2002 to postpone the deadline until 2004.

Chechetov had earlier said that, because the new smelter project had not started, the government in Kiev would insist on cancelling the transfer of the state's shares in Nikolaev, and reprivatize them. Then in a change of tone, Nina Burlyuk, spokesman for the Fund, announced last year: "Currently, the Nikolaev refinery is the property of Ukral, and we see no changes to be made to that. What's happening is [that] currently there is a discussion at the government level about removing the condition of building the Pervomaisk plant, because it's absolutely economically ineffective, and changing that condition to something else [requiring] equal investment."

In the past, Rusal sources have told The Russia Journal that energy costs in the Ukraine have been too high to make the new smelter project economically viable. Ukral, according to its spokesman, tried to negotiate a lower energy tariff regime with the government in Kiev to improve the proposed plant's commercial prospects. But when that proved impossible, Ukral said it would propose modifying the terms of the original investment agreement. Burlyuk's announcement signaled that this was the approach that senior Ukrainian government officials wanted to adopt, mollifying Deripaska ahead of the presidential election campaign.

What has now been confirmed by the Prosecutor-General's office is that Kuchma and Yanukovich agreed to issue order no. 550p, allowing the Pervomaisk smelter plan to lapse. Instead, Ukral undertook to lift the capacity at Nikolaev by another 300,000 tons, or a 23% increase on the current level.

Burlyuk of the State Property Fund told The Russia Journal: "There was a first order to build a plant in Pervomaisk with a capacity of not less that 100,000 tons. There was nothing more exact. The ministerial cabinet decree number 550-p was the basis for Ukral and the Property Fund to sign a change of investment conditions from new plant construction to existing plant expansion. Unfortunately, I am not an expert, so I am not available to calculate the costs for both variants. I am not sure that anybody in the Fund will be able to do that. It's actually not our business – we do privatization procedures."

An international industry source said that in current international practice, the cost of the refinery expansion would be $1,000 per ton of increased capacity, making a total of $300 million. The source also told The Russia Journal that the cost of building the new smelter would be roughly $4,000 per ton of capacity, making $400 million in all. The cost difference, saved for Deripaska, appears to have been not less than $100 million.

There is no sign of the "equal investment" proviso in the official change of agreement. Prosecutors in Kiev confirmed that order no. 550p did not require "equal investment", and they added that this is an aspect of the legal violation they are now investigating. Asked if they are investigating whether any of the money saved by order 550p may have found its way into the bitter Ukrainian election presidential campaign, a spokesman said: "We are not investigating this matter."

Victor Demodenko, the press spokesman for Ukral, told The Russia Journal: "Ukraine Aluminium [Ukral] is managing and completing all the required investment obligations." Officials at Rusal in Moscow declined to comment. Speaking at an investors' conference on the Ukraine last Friday, Rusal's deputy general director for international relations, Alexander Livshits, sounded a hopeful note, and did not refer to the Nikolaev dispute. "Ukraine's investment climate is typical for the first year after a revolution. Ukrainians will improve their investment climate if the government actually does what it promises."

Source: The Russian Journal