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DERIPASKA UNDER PRESSURE IN MEGA ALUMINIUM MERGER

By John Helmer in Moscow

Oleg Deripaska is under unexpected personal pressure, at home and abroad, just when his plan to take control of one of the largest bauxite and aluminium producers in the world is close to final government approval. And that is exactly why the trouble for Deripaska is growing now.

Russian government authorization this month of the creation of a monopoly aluminium concern, integrating domestic and foreign bauxite, alumina, and aluminium production assets, has followed a no-objection ruling from the European Commission (EC) in Brussels. The unconditional ruling was issued by the EC on February 1.

The published text indicates that EC anti-trust regulators found no evidence that the new United Company Rusal will control a significant volume of the alumina and aluminium traded in the European Economic Area. The Commission concluded, says the release, ” that the operation would not significantly impede effective competition in the European Economic Area (EEA) or any substantial part of it.”

A fortnight later, the Russian Federal Anti-Monopoly Service confirmed its conditional ruling on February 14. Unlike the EC, the FAS concluded that “United Company RUSAL Limited can limit competition in world markets”. Accordingly, following a government-wide review, FAS has made its approval conditional.

On the surface, the provisos appear relatively benign for Deripaska. The new Rusal must price its aluminium to consumers in line with the London Metals Exchange (LME) price, FAS has ordered: this, plus a markup of no more than 5% for domestic consumers; 10% for foreign consumers.

The Russian anti-trust regulator told The Russia Journal it has imposed five additional conditions: implementation of all supply and delivery contracts, especially for Russia’s military plants; prohibition on shutting down production facilities; non-discrimination in supply and pricing between customers; the obligation to supply Russian plants with metal to meet their consumption capacity; and a duty to notify FAS ahead of price increases, and to disclose details of the chain the group uses for its trade.

“In actual fact, the situation described on paper is already the one in operation”, a Moscow newspaper quoted Rusal spokesman Vera Kurochkina as saying. Under the surface, new and tougher conditions are being imposed as the Kremlin’s price for the merger.

A website statement, attributed to Alexander Bulygin, chief executive of Russian Aluminium (Rusal), the prime mover of the merger, claimed the approvals support “the creation of Russia’s first transnational corporation and the new leader of the global aluminium industry. We are now ready to round off the merger and plan to close the deal in the near future.”
The merger of Rusal, owned by Oleg Deripaska; SUAL owned by Victor Vekselberg; and alumina assets of Swiss-based Glencore was announced in October 2006. They have agreed that, if there are no challenges to asset ownership in the proposed merger, Deripaska will own 66% of the new company, with Vekselberg and his associates 22%, and Glencore, 12%. Asset problems for Deripaska may produce a premium in cash or shares for Vekselberg, and vice versa, according to private undertakings between them.

The candidate chairman of the new company is SUAL chief executive, Brian Gilbertson. But he recently said he may drop out — either because he doesn’t want to wait for the initial public offering that has been planned for London; or because he will be ousted at the insistence of shareholders, or the Kremlin.

Rusal claims the combined company “becomes the world’s largest aluminium and alumina producer, employing more than 110,000 people in 17 countries on five continents. The company will account for approximately 12.5% of global aluminium and 16% of global alumina production, respectively. The annual volume of production will be approximately 4 million tonnes of aluminium and 11 million tonnes of alumina.”

Rusal remains a highly secretive operation, and has never issued public financial reports audited to international standards. Moreover, Bulygin has threatened investment advisors and banks lending Rusal money that if financial details of the company’s books are leaked, the banks face exclusion from lending syndicates.

So secretive is Rusal’s trade, both for incoming bauxite and alumina shipments to feed its Russian smelters, and for outgoing exports of aluminium, that employees in Rusal’s transportation and trade divisions have been threatened with firing, if they reveal anything. Shipping companies which transport Rusal cargoes have also been threatened. Banks have also been pressured not to disclose the complex security arrangements and loan covenants which attempt to tie down, in case of borrower default, the movement of metal, as it passes from one Rusal affiliated company to another, in lengthy chains.

In Brussels, the secretiveness and complexity of Rusal’s trading operations appear to have daunted anti-trust analysis. After two weeks of persistent questioning, the competition division spokesman Jonathan Todd released some of the data on which the EC approval was based. These show that the new Rusal share of the European market for aluminium would be at least double the 12.5% percentage which Rusal has released for the global market, and double the 16% estimate from Rusal for its global alumina market share.

According to Todd, the EC analysis found that, based on the most recent tonnage data for shipment and sales into the European Economic Area, the new company would take up to 35% of the market for smelter grade alumina (SGA). In the European market for standard primary aluminium, the new Rusal would have a market share of between 25% and 35%.

These market-share numbers are big ones — and they were not revealed when the EC issued its finding that “the new entity’s positions would be well below a level where it could prevent effective competition on any of these markets.” For one thing, the EC did not release a fthreshold figure for “effective competition.” For another, the EC analysis may have missed a substantially larger volume of aluminium that flows from the Rusal group into the European market, unreported in standard customs reporting.

Just how much metal and market share Todd and his colleagues may have missed is indicated by other Russian sources.

In February 2002, Renaissance Capital issued one of the very few investment bank reports ever done in Moscow on Rusal. Its author, Vladimir Titkov, was subsequently hired by the Rusal management. Titkov reported that Rusal was selling 85% of its metal internationally, but less than 15% of the volume went to end-users. International traders Glencore and Gerald Metals took the lion’s share of the export volume. This complicates the task of identifying where Rusal’s aluminium ends up. But according to Titkov, Europe was taking 31% of export volume; Asia 39%; the Americas 30%.

According to the latest Russian customs data, in 2003, out of a total recorded export of 2.5 million tons of aluminium, 16% went to the European Union; that is, before its enlargement by 10 members. In 2006, the aggregate export volume jumped to 4.2 million tons, but destination data for the expanded Union, and the even larger European Economic Area, are not yet available from Russian customs.

A leading independent aluminium consultant in Moscow, Galina Stelmakova, warns that elaborate corporate identity changes and complex trading schemes conceal the final destination of Rusal’s trade. “It is very difficult,” she said, “to determine by Russian export statistics what is really happening. European statistics show absolutely nothing. Rusal, for example, has a branch in Portugal. They have been exporting more than 1 million tons there, but Portugal never needs this volume of aluminium. So the scheme is that when the vessel is loaded, the declared destination is Portugal, but on the way the metal gets redirected to wherever they need to sell it.”

London aluminium consultants told The Russia Journal that aluminium trading schemes operated by Rusal also use Monaco and Lichtenstein as pseudo-destinations. Lawyers who have tracked Rusal’s metal for litigation claims report destinations including Panama, British Virgin Islands, and other tax havens.

Rusal’s London representative, Jon Simmons, was asked to clarify Rusal’s export figures. Company officials were uncontactable for a response.

Did the European Commission inadvertently misread the trade data, leading to the conclusion that Rusal’s exports, and hence total exports to Europe of the proposed merged company, were lower in tonnage than is true? Did the EC competition directorate diminish the market share of Russian exports into the European Economic Area, in order to conclude that the competitive impact of the merger would be negligible? Todd declines to answer.

Yet, one year ago, in February 2006, the same EC competition division in Brussels analyzed the rough diamond trade and concluded that an export of $275 million in rough diamond value from Alrosa, the Russian diamond-miner, to De Beers, the global mining leader, constituted an anti-competitive relationship. This was despite data showing that the amount represented less than 4% of De Beers’s annual rough diamond trade, and less than 10% of Alrosa’s.

Ancillary evidence produced after the EC issued its ruling to end all trade between the two suggested that ruling had less to do with the evidence, and more to do with a private negotiation between De Beers and EC officials, kept secret from Alrosa. Lawyers for Alrosa have challenged the ruling, and have filed an appeal to void it in the European Court.

Suspicion that the EC’s ruling on the Rusal merger may be flawed is unlikely to be challenged by a lawsuit in the European Court. However, in Washington, US anti-trust regulators may take a closer look. The US Government is already reviewing fresh evidence on Deripaska’s business conduct, as officials defend their decision not to renew the temporary entry visa Deripaska was issued in 2005.

In Russia, there have been fresh signs that, while the Kremlin is agreeable to the creation of a national champion in the aluminium sector, it is reluctant to let Deripaska control it, at least not in the fashion in which he has been managing Rusal to date.

The state owned and managed military-industrial complex has told Deripaska it wants to take over Russia’s molybdenum mines, which Deripaska controls through his Moscow holding, Basic Element.

Sources at the federal Finance Ministry acknowledge they are considering a plan to change Russia’s tax laws, putting an end to schemes for minimizing tax onshore by transferring cashflows to havens offshore. The new Rusal company has announced that it proposes to register in the Channel Island of Jersey.

Transfer pricing has been illegal under Russian tax law for many years, but there has been no enforcement. Minimizing tax through tolling and trading schemes is illegal, if Russian tax men can prove the legal ties between the onshore and offshore companies. Until now, attempts to do that for Rusal have been stopped as soon as they have started.

For the moment, however, there are signs that high Kremlin officials want to put a stop to Rusal’s tax optimization, while governors of regions, where Deripaska operates smelters, are supporting the status quo. The issue is so sensitive, some governors told Mineweb they will not discuss it.

In parallel, a move by Russia’s trade ministry proposes to cancel the 10% import duty protecting the Russian market from foreign aluminium competition. If imports are freely allowed entry into the market to compete with the new Rusal, government officials have hinted that they may encourage foreign-owned aluminium companies to establish their own smelters to compete even more vigorously.

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