Interview of the director of the Department for State Regulation of Tariffs and Infrastructure Reforms of the Ministry for Economic Development and Trade of Russia K.G. Androsov, PRIME TASS agency, 05.09.2005.

PRIME TASS interview of the director of the Department for State Regulation of Tariffs and Infrastructure Reforms of the RF Ministry for Economic Development and Trade Kirill Androsov.

Question: Can there be a change in the mechanism for raising funds under the deal to increase the state's share in the Gazprom equity capital? Is it still on to arrange initial public offering /IPO/ of Rosneft shares or is it possible to auction off the oil company shares to a strategic investor?

Answer: Rosneftegaz is currently arranging credit facilities in the amount of 7.5 bln dollars, which are to be used for paying for a 10.74 per cent stake in Gazprom. To repay the loan, Rosneftegaz will have to sell assets it owns, and the only asset owned by Rosneftegaz is Rosneft shares. Hence the need to sell the shares at the highest price possible. In our opinion, arranging for a Rosneft initial public offering / IPO / will make it possible to generate significant interest in Rosneft on the part of investors and increase the market value of the company. After the Rosneft IPO, the free float /the shares in public ownership/ based on generally accepted estimates for oil and gas majors may be in the range of 10-15 per cent, which is sufficient for obtaining fair quotes.

This way, Rosneftegaz will be in a position to sell the stake in Rosneft to a strategic investor but based on the market price for the shares. This being the case, Rosneft will receive the IPO proceeds and channel them into its profitable investment projects and into restructuring of the accounts payable, with Rosneftegaz being in a position to take advantage of the proceeds from the sale of the Rosneft stake, which it will use to repay the loan. The key requirement is for Rosneftegaz to keep its stake in Rosneft at 51 per cent or more since the state must keep its controlling interest in the Rosneft company at this stage.

Question: What is the take of the Ministry for Economic Development and Trade on bridging the price gap between the Urals and Brent blends?

Answer: Urals and Brent are conventional standards for commercial grade oil. The Brent blend has a certain set of specifications in terms of density, viscosity, sulphur content, the same as the Urals blend. The oil exports from Russia are currently classified based on transport corridors /export outlets/. This or that crude oil pipeline as an export outlet delivers crude with a given set of specifications, which differ from the Urals standard. For example, the crude specifications at the Novorossisk terminal differ from the crude exported via Primorsk /Baltic Pipeline System/, from the oil delivered to Europe through the Druzhba pipeline, etc.

According to the estimates by the Economic Development and Trade Ministry, the weighted average value of the oil blend we currently export is better in terms of quality than what is specified as the Urals blend. To date, the discount for the Russian oil is 8-10 per cent of Brent. The Economic Development and Trade Ministry believes that based on the quality specifications of Russia's crude, a fair discount must be somewhere in between. This being the case, it is necessary to introduce a new standard for Russia's crude in the global export market, as well as a new pricing mechanism.

If Russia wants to export upgraded quality oil, it is necessary to minimise the negative impact of the Tatar and Bashkir crude streams, their quality performance being below the Urals specification, on the oil from other production regions.

There are two solutions. The first solution is to increase deliveries of crude from Tatarstan and Bashkortostan for petroleum refining and petroleum chemistry within this country. Such projects are being developed in the regions. The second solution is to provide incentives for the companies Bashneft and Tatneft to improve the quality of crude. For example, this can be may be an abatement of the tax on production of minerals /extraction tax/. In this context, the funds saved on the extraction tax must be used to develop petroleum chemistry and introduce measures to improve the quality of crude.

With all such measures in place, we would be in a position in 2-3 years' time to deliver standard-quality oil via most export outlets.

Question: What is the bone of contention between the Federal Property Management Agency and Economic Development and Trade Ministry in respect to settling the amount of Transneft dividends for 2004?

Answer: There is no bone of contention to speak of between the Federal Property Management Agency and the Economic Development and Trade Ministry; there are certain differences on the issue. The Federal Property Management Agency, which is responsible for budget revenues, takes the view that 10 per cent of the profits of a state-owned company must be paid out as dividends, i.e., into the state coffers. The view of the Economic Development and Trade Ministry, Industry and Energy Ministry goes beyond the short-term as they are responsible for long-term, strategic, fundamental development of the sectors they supervise. That is why the draft directive on the Transneft 2004 dividend rates was submitted to the government with a discrepancy report.

The Economic Development and Trade Ministry believes that if a company can justify using the net profits for high-performance investment projects, which in the long term will result in the company's value going up, it makes better sense to use the profits to fuel growth. In the event that the company has no development strategy, no add-value investment projects the profits are to be skimmed as much as possible. Transneft needs to build a pipeline to East Siberia, which requires billions in investments. The company's net profit is a major source of financing the project, along with borrowing. It makes no sense at this juncture for the state to claim Transneft's revenues as dividends, only to start then looking for ways to arrange additional financing for the company's investment projects using budget funds.

Question: What must be the philosophy of the Programme to develop in Eastern Siberia a single system for gas production and transport and gas supply with an option of exporting gas to the markets in China and other APR countries?

Answer: The issue of Eastern Siberia's development as part of the Programme to develop in Eastern Siberia a single system for gas production and transport and gas supply with an option of exporting gas to the markets in China and other APR countries should not be treated exclusively as an issue of gas field development. It is a multi-dimensional issue and it must take into account all business projects for mineral production in the region, as well as provide solutions for problems of infrastructure.

As for gas field development, the key question is what direction to choose for the gas transport system. It must take into account the priorities of the development of Russia's single gas-supply system, export directions based on the evaluation of the potential of the South-Korean and Chinese markets. Moreover, it is necessary to produce a forecast for domestic consumption in the region of Eastern Siberia and Far East. These problems in their entirety are the brief of the task force of the Industry and Energy Ministry. The task force is expected to complete in September the Eastern Siberia's development programme, which will then be reviewed in the government.

Question: What is the position of the Economic Development and Trade Ministry on the scenarios for using the funds of Gazprom's investment programme?

Answer: The Economic Development and Trade Ministry has the necessary means to voice its opinions on the priorities of Gazprom's investment programme. Firstly, there is the Board of Directors as a tool for approving the investment programme; secondly, there is the government, which reviews the investment programmes prior to their approval by the Board of Directors.

As for Gazprom's investment programme for 2005, it has been approved with a proviso that it might be amended subject to Gazprom's situation. The September meeting of Gazprom's Board of Directors is expected to review the question of updating the 2005 investment programme in terms of tapping into reserves and additional sources for financing the programme, in particular, in the light of the sale of Gazprom treasury stock.

So far Gazprom has been focusing its investment programme very sharply on the development of export transport links, seeing it as its long-term strategy. At the same time, Gazprom has yet to give us, in the framework of its strategy, an answer to the question of the drivers to boost the gas production in the RF territory. There are essentially two major sources: Yamal and Eastern Siberia. There have been no official documents received by the Economic Development and Trade Ministry from Gazprom, featuring information as to what and when gas fields in Yamal and Eastern Siberia will be brought on line. We feel that given the RF falling gas production and Gazprom's major fields being increasingly worked out, the principal investment accent must shift to gas production and transport in the RF territory without lingering on export outlets. This will be our position regarding the focus point and use of surplus funds under Gazprom's investment programme.

Question: What does the Economic Development and Trade Ministry think of Gazprom's initiative to diversify into the oil business? What rewards can there be for a gas monopoly to expand into the oil business?

Answer: If Gazprom finds that investments into the oil sector increase the NPV /net present value/ of the company at a greater rate than investments into gas production, the company's Board of Directors must give such proposals proper consideration. To date, there has been no justification provided to the Board of Directors as to why Gazprom should be going into the oil sector.

Question: What sense, if any, does it make, according to the Economic Development and Trade Ministry, for Gazprom to acquire the Sibneft oil company, seeing that the oil company is currently reporting a slump in the production of crude?

Answer: I find it is hardly a question of falling production; everything has its value. Here it is necessary to think in terms of the project's investment prospects. In this context, the Economic Development and Trade Ministry, if the Gazprom management has produced an in-depth analysis of the prospects for the company's value growth as a result of investing into Sibneft, will be willing to study the proposals in question and deliver its opinion.