Competing for Chinese Destroyers

Lyuba PRONINA

Staff Writer of The Moscow Times

Specially for Eksport Vooruzheniy Journal

The brawl between two St. Petersburg firms about who will get the $1.4 billion con­tract to deliver two Project 956EM (Sovre­menny class) destroyers to China, unleashed in January 2002 was still awaiting the govern­ment's final say in April when this issue went to print.

But the fourmonth long tug-of-war between Severnaya Verf and Baltiysky Zavod has left a bitter aftertaste, proving once again that Rus­sia's arms producers and the government offi­cials lobbying their interests will stop at nothing to twist each other's arms when it comes to lucra­tive export contracts.

Ironically enough, at the center of the Sever­naya Verf and Baltiysky Zavod stand-off was former Deputy Prime Minister Ilya Klebanov, the man who has repeatedly proclaimed that any competition among domestic firms is detrimental to Russia and should be eradicated.

Contesting the contractor

On January 3, 2002 Russia's arms selling giant Rosoboronexport trumpeted the signing of a large contract with China.

As Severnaya Verf had built 17 Project 956 de­stroyers for the Russian Navy in the past and two such destroyers on a previous contract with China, it was widely expected that Severnaya Verf would be the contractor for the deal.

Such views also stemmed from the fact that in February 2001, the Russian Shipbuilding Agency awarded Severnaya Verf with the up­coming contract.

But Severnaya Verf's jubilation was short-lived. An interministerial commission was called at the behest of Klebanov on January 4, 2002 to hold a tender among three shipyards - Severnaya Verf and Baltiysky Zavod in St. Petersburg and Yan­tar plant in Kaliningrad.

While tenders among producers are common practice in the case of orders for the Russian military, calling a tender for an export contract came as a surprise, industry watchers said. Nev­ertheless, the interministerial commission wel­comed proposals on the Chinese deal from all the three contenders on January 15.

Later, speaking at a press conference on March 26, general director of Baltiysky Zavod Oleg Shu­lyakovsky said that he already heard about the upcoming tender for Chinese destroyers on De­cember 28, 2001 and was told to come to Mos­cow on January 4.

Shulyakovsky would not elaborate where the in­formation had come from.

On January 19 the commission recommended Baltiysky Zavod as the contractor for the Chi­nese deal.

Kommersant newspaper reported in its article headlined "Vladimir Putin has halved Ilya Klebanov" from February 19 that among the reasons that swayed the commission in favor of Baltiysky Zavod was a more competitive price. According to Kommersant, Shulaykovsky of­fered to fulfill the contract for $80 million less than Severnaya Verf did.

At a March 26 press conference Shulyakovsky refused to comment on the financial side of the tender.

Shulyakovsky said then that despite the fact that Baltiysky Zavod had not built Project 956 destroyers before, it was fully capable of doing it from scratch. In fact, it was one of the main subcontractors for Severnaya Verf supplying the ship's entire energy block.

At the time, local media speculated that Boris Kuzyk, former President Boris Yeltsin's adviser on military and technical cooperation with for­eign countries and current head of New Pro­grams and Concepts (NPC), a holding company that controls Severnaya Verf, was yielding his power.

Severnaya Verf, however, did not cry foul but adopted a wait-and-see position. Referring to a clause in the contract, which rates the entire in­formation on the deal as confidential, NPC would not comment for this story.

Auditing the past

While no explanation was given as to why the tender was called in the first place, industry players attributed it to an inquiry by the State Duma filed with its budgetary watchdog, the Audit Chamber. The inquiry focused on how Severnaya Verf had handled the first similar contract (in 1997) for China. Copies of the in­quiry were sent to Defense Minister Sergei Ivanov and Rosoboronexport chief Yuri Bely­aninov.

Head of the pro-presidential Unity Party Duma faction Vladimir Pekhtin publicly alleged in late December that Severnaya Verf owed the state budget some $300 million on the previous two destroyers it delivered to China in 1999 and 2000 for a total of $610 million.

The two destroyers had been built for the Rus­sian navy and by the time the government de­cided to sell them to China they were 30 and 70 percent ready.

As the state had financed half of their construc­tion, Pekhtin maintained that as Severnaya Verf financed the remainder and then sold the de­stroyers for more than $600 million to China, it was to redeem at least half of that revenue to the state.

In turn, Servernaya Verf said that all it owed was 186 million rubles ($6 million at current exchange rate - ed.), which was approved by both finance and defense ministries in 2000. At the same time, New Program and Concepts promised it was ready to assist the auditors with all the relevant documentation.

And heads rolled …

But it was too early for Shulyakovsky to crack open the champagne. The government having swallowed a series of blasting re­ports here and abroad, took a pause over the deal.

Meanwhile, for a firm to start work on a con­tract, it has to receive a relevant resolution from the government allowing it to do so, which the government did not rush to conclude with Baltiysky Zavod.

On February 18, the same day as three auditors left for Severnaya Verf, Klebanov, appointed in 1999 to oversee the defense industry and mili­tary-technical cooperation with foreign coun­tries, was demoted on Prime Minister Mikhail Kasyanov's recommendation from his position as deputy prime minister.

Although Klebanov retained his post as Indus­try, Science and Technology Minister, he was denied control over the lucrative arms trade sector.

Kasyanov, who temporarily took the arms export under his supervision, in mid-March ordered a review of the recommendation of the tender commission.

Industry watchers suggested that the contro­versy over the Chinese contract was the straw that broke Klebanov's back. Unconfirmed media reports said that China was extremely vexed by the government shifting its order from one pro­ducer to another, suggesting this uncertainty could potentially jeopardize the entire deal.

Lobbying at play?

While the fate of the billion-dollar contract was up in the air, Baltiysky Zavod was dealt a ma­jor blow.

Its own press release from March 11, 2002, re­lating to successful tests at a sea base of Balti­ysk of the first out of three Project 1135.6 (Krivak class) frigates built for India, was fol­lowed by a denunciation from Navy commander-in-chief Vladimir Kuroyedov.

Kommersant reported in its February 15 story "An Indian Frigate is battling for Chinese de­stroyers", that Kuroyedov revoked the resolu­tion on the tests of the first frigate made by Rear-Admiral Alexander Alexandrov, the chief of the commission that approves test results.

The stumbling block was the advanced Puma cannon, which in line with test requirements was to be tested in similar climate conditions to those found in the Indian Ocean.

But, as tests on the Black Sea were not immedi­ately available, this could have seriously de­layed the completion of the contract. The first frigate of the $1 billion contract is to be deliv­ered in May, while the second and third frigates will be delivered in November this year and May 2003, respectively.

Kommersant speculated that Kuroyedov's de­nunciation of successful tests came as a result of the squabble between the two St. Petersburg firms, and it was Severnaya Verf that got the support of the Navy chief commander.

On January 31, 2002 Novaya Gazeta carried an article headlined "An Admiral in a Jacuzzi" where it related Kuroyedov's wrath with the de­cision of the government commission to award the contract to Baltiysky Zavod. The article at­tributed Kuroyedov's support for Severnaya Verf due to his long-time friendship with NPC's chief Boris Kuzyk.

Shulyakovsky later brushed off allegations that he could have had any connection with this story.

Shulyakovsky reiterated March 26 that the tests were a success though admitting that as this was the first ship in a series, it was prone to face difficulties at the beginning.

"I am absolutely confident that we have man­aged to build a good ship at the time when co­operation [among subcontractors] is broken... At the beginning, many did not believe, and we also were in doubt that this could happen, but with this ship we, for the first time, managed to use various types of weapons and defense tech­nology, both Russian and Indian, and also from European countries", - he said.

Who's the winner?

As the government continued foot dragging on its decision, Shulyakovsky sent a letter to Kasyanov on March 14 threatening he would bail out of any cooperation with Sev­ernaya Verf should it get the Chinese contract.

His letter was spurred by another letter sent by Vladimir Pospelov, the head of the Russian Shipbuilding Agency earlier in March, saying that the agency would stick to its decision from 2001 when Severnaya Verf was chosen as con­tractor for the Chinese deal.

Shulyakovsky wrote that changing the produc­ing plant meant sacrificing principles of fair competition in favor of who's best at lobbying. Moreover, Shulyakovsky argued that, "no battle ship can be built without Baltiysky Zavod par­ticipating, and especially so the Project 956EM destroyers."

"We consider ourselves as winners of the ten­der.... by no means do we want to take part in [this] farce and consider it improper to partici­pate in any way in the assembly of these ships," the letter said.

The response of the government was swift. In­terfax quoted a Cabinet source March 15 as saying that the government would not tolerate any ultimatums from the Baltiysky Zavod.

Later Shulaykovsky said that this was no ulti­matum but simply an appeal to Kasyanov to look into the situation. "This is no blackmail," he said.

Shulyakovsky lamented the fact that the gov­ernment was not clear in its policy when shift­ing orders from one producer to another.

"We did not fight for this contract but were in­vited to participate," he said.

Asked whether Baltiysky Zavod would partici­pate in building the destroyers for China as a subcontractor for Severnaya Verf, Shulyakovsky replied vaguely that the plant would not do what is not profitable for it.

An NPC source was quoted by Kommersant March 15 as saying that components previously supplied by Baltiysky Zavod could be easily re­placed by foreign-made parts.

Friends or foes

But the deal on destroyers is not the only grudge Shulyakovsky has against Severnaya Verf. In his letter to Kasyanov, Shulyakovsky lambastes the Navy for choosing Severnaya Verf to make Project 20380 corvettes. The keel of the first corvette was laid with much pomp at Sev­ernaya Verf last December. Kuroyedov then said that it marked a new era in shipbuilding for the Russian Navy.

Shulyakovsky maintains that his plant won the tender but as Kuroyedov had previously prom­ised that the corvettes would be built at Sever­naya Verf, the final decision was made in its fa­vor.

"We consider that the Russian Shipbuilding Agency and the Navy of Russia are damaging the country's defensive capability with their ac­tions," the letter to Kasyanov said.

While rattling the saber, IST Group, which controls Baltiysky Zavod, announced that in the past year it accumulated around 18,8 percent of Severnaya Verf.

Media reported that Press-Invest, a company close to IST Group, had bought up the shares from insolvent Inkombank, which had previ­ously owned them.

NPC owns 53 percent of Severnaya Verf, while 21 percent is held by the Russian Federal Prop­erty Fund and the remainder is dispersed among over a thousand minority shareholders.

IST vice-president Nikolai Dobrinov told report­ers March 26 that he did not rule out the possi­bility that IST could buy more shares of Sever­naya Verf. Dobrinov said that the main reason behind snapping up the shares was the group's intention to receive information about its rival's cash flows. Dobrinov said that he was counting on his company receiving seats on Severnaya Verf board.

Dobrinov refused to name the price of the transaction. In its March 20 story "IST Will Profit from Destroyers", Vedomosti estimated that the deal was worth no more than $5 million.

Vedomosti quoted NPC's Pogrebenkov as saying that "Baltiysky Zavod and Severnaya Verf are doomed to cooperation and therefore the pres­ence of IST [in Severnaya Verf] will in no way hamper the company." "We have to look for ways to develop our business together," he said.

On March 27 Press-Invest filed a suit with St. Petersburg's arbitration court asking to review results of a shareholding meeting at Severnaya Verf which took place in June 2001, claiming it undervalued the dividends. IST alleged that Severnaya Verf, while calculating the dividends, concealed $300 million worth of profit, Vedo­mosti reported on March 28.

NPC's Pogrebenkov told Vedomosti that Sever­naya Verf's dividend policy was "in line with the current legislation."

A new round?

When the dust kicked up about the Chinese deal starting to settle down, the Audit Chamber on April 19 made public its findings on the audit of Severnaya Verf.

The chamber said in its report that the state did not receive any redemption from Severnaya Verf, nor did it receive the $6 million compen­sation agreed on with the defense and finance ministries.

However, not blaming Severnaya Verf directly, the chamber instead pinned the fault on the De­fense Ministry and other government structures for failing to protect the state interests while selling the destroyers.

The chamber says that the two destroyers were 70 percent and 44 percent completed respec­tively but fails to identify how much it had cost the state. Instead, the Audit Chamber asked the government to do that.

The chamber also urged the government to take measures to reclaim the lost funds as quickly as possible and punish the state officials responsible.

NPC's spokesman Pogrebenkov said that Sever­naya Verf was ready to pay the compensation as soon as the Finance Ministry worked out a scheme on how to do that.

Meanwhile, on April 22 Vedomosti quoted An­ton Laptev, spokesman for IST group, which controls Baltiysky Zavod, as saying that: "We consider the Audit Chamber's decision as the first step in untangling that illegal deal."