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Analysis: Kremlin eyes metals sector

By PETER LAVELLE

MOSCOW, Nov. 8 (UPI) -- The Kremlin's drive toward majority control of Russia's vast oil and natural resources is all but complete. The last remaining sectors deemed to be strategic by the government and off-limits to large foreign investment are metals and minerals. There is growing evidence the Kremlin will seek to extend its control and ownership of Russia's largest metals company -- Norilsk Nickel.

President Vladimir Putin's call for the government to identify strategic sectors of the economy off-limits to foreign majority control has focused on the oil and natural gas sectors through state-control Gazprom and state owned Rosneft Oil Company. Thus far this has not included the very lucrative metals sector and its flagship company Norilsk Nickel, co-owned by Vladimir Potanin and Mikhail Prokhorov, each believed to be worth approximately $5.4 billion.

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In many ways, the state already exercises considerable control over the metals sector -- the only large Soviet-era sector the Kremlin has left to market forces. Through industrial regulation and heavy taxation, the state's leverage over the sector is immense. However, with companies such as Norilsk Nickel buoyant with windfall profits on the back of high international metals prices and metal's giant projection to post revenues of $6 billion this year, the Kremlin appears to have changed course.

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Market-watchers agree the metals sector will probably return to the Kremlin fold soon, possibly before the 2007 parliamentary elections and 2008 presidential poll. The only outstanding question is how this will be done: purchasing the company to create a new state-controlled industry holding or buying out major shareholders to form a state-owned and stand-alone company.

A precedent already exists for the government of purchase Norilsk Nickel to create new mega-industry holding -- the recent Gazprom-Sibneft tie up. Diamond monopoly Alrosa, accounting for 25 percent of the world's uncut diamond production and with an annual turnover of $2 billion, could act as a conduit for the Norilsk Nickel purchase. Alrosa plans to IPO in the near future; having Norilsk Nickel as part of its portfolio could significantly boost its valuation and attract the attention of potential minority investors -- much in the same way Gazprom intends once it liberalizes it share price regime.

One approach not in the cards is another Yukos affair. The Kremlin has no need to pressure shareholders to sell or to force Norilsk Nickel through huge back tax claims. It is rumored that Potanin has been in talks to sell his 26.5 percent stake in the company to Alrosa as the first stage of a future merger of the two.

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The market has long assumed that Potanin and Prokhorov are not long-term shareholders of Norilsk Nickel and would very willing cut a deal with the state, particularly if the Kremlin took a greater interest in the sector in light of the Yukos affair. The only outstanding question is the right price to exit. With commodity prices at the peak of a thirty-year cycle, selling now would extract a maximum exit valuation.

Merging Norilsk Nickel and Alrosa would also be a step toward restructuring the entire minerals and metals sector. The Kremlin is believed to be planning to increase the federal government's current 37 percent stake in Alrosa to majority control. Again Gazprom stands as an example. The government's decision to increase its stake to majority control in the company before liberalizing the share regime is part of the Kremlin's restructuring of the oil sector in favor of the state. The same strategy looks to be applicable to the entire minerals and metals sector.

The Kremlin's eventual buy-out of Potanin and Prokhorov also has a precedent. For Gazprom to acquire oil giant Sibneft, it paid Roman Abramovich's investment vehicle Millhouse Capital $13.1 billion. Buying out individuals known not long ago as oligarchs now appears to be the state standard procedure to acquire assets it deems of "strategic" interest.

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In the wider scheme of things, it can be said that Putin intends to complete his commanding heights agenda for the economy. Gazprom and Rosneft are the state's flagships in the oil and gas sectors, Vneshtorgbank, 99.9 percent owned by the state is Russia's largest commercial bank, and now Norilsk Nickel-Alrosa are poised to do same for the state in the minerals and metal sectors. In all three foreign investors are welcomed to a degree -- as long as they are satisfied with minority status.

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Peter Lavelle is a Moscow-based analyst.

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