St. Petersburg’s tercentenary celebrations have highlighted the city’s greatest assets, especially the port facilities and shipyards that make it Russia’s principal gateway to the sea. However, it will take more than a lavish birthday party to convince Russian shipping companies or their foreign bankers that the Moscow government can revive the fleet and thereby resuscitate the St. Petersburg yards.

After the Soviet Union’s collapse, the largest state-funded program for shipbuilding in the world at the time rapidly declined. Public finance for Russian ship building shrank steadily until 2001, when the Moscow’s Transport Ministry started a very small subsidy program for interest rates on newbuild contracts with local yards.

This year the Transport Ministry is seeking governmental approval to double the subsidy program. Most domestic shipping companies and banks with an interest in the maritime sector think that this will make little difference in view of the discrepancy between Russian and international bank finance terms for shipbuilding. The Russian maritime industry also worries that, in the aftermath of the war in Iraq, oil prices may sink so low as to reduce local demand for additional pipelines and shipping to carry Russian oil to market.

A state-drafted plan for ship construction in Russia between now and the year 2010 envisages investment of 207.6 billion rubles ($6.7 billion) in a new fleet, with just 5.3 billion rubles ($171 million) from budget funds. Last year, an estimated 6.6 billion rubles ($220 million) were relegated for shipbuilding by Russian companies – just 630 million rubles ($20 million) of this from state funds.

"For the state, the main reason for rebuilding the Russian maritime fleet is the desire to increase the taxation base and to provide for the economic security of Russia," says Dmitry Skarga, chief executive of Sovkomflot, the state-owned leader of Russia’s maritime companies.

Transport Ministry figures indicate that, as of Jan. 1, 2002, Russia had a total of 1,063 ocean-class vessels with a summary deadweight of 11.5 million tons. However, the Russian flag fleet comprised 880 vessels, with just 4.9 million deadweight tons (dwt). Sovkomflot and Novorossiisk Shipping Co. (Novoship) – the latter state-controlled – both lead in the table of Russian shipping companies, and more than half of these companies’ fleets were registered offshore after 1991.

LUKoil Arctic Tanker, a wholly owned subsidiary of LUKoil, Russia’s leading oil producer, owns 10 ice-class tankers of 175,000 dwt, plus two river-sea class tankers. Four vessels are currently under construction in Russian yards. LUKoil has announced a bid to sell the entire fleet, and for the moment is thinking of placing the larger tankers under the management of other Russian fleet operators.

RUSSIA’S TOP SHIPPING FLEETS Company Base No. of vessels Deadweight tonnage, mln Novorossiisk Shipping (Novoship) Novorossiisk 77 3.3 Sovkomflot (SKF) Moscow 70 3.1 Far Eastern Shipping (Fesco) Vladivostok 74 1.4 Primorsk Shipping (Prisco) Nakhodka 45 0.82 Murmansk Shipping Murmansk 42 0.8 Northern Shipping Arkhangelsk 34 n.a. Source: Company-supplied data as of Jan. 1, 2002, except for Sovkomflot, as of July 1, 2002. According to the Transport Ministry, by Jan. 1 of this year, the fleet grew slightly – the first rise in a decade. During 2002, total deadweight rose to 11.97 million tons; but the fleet number was down to 1,027. The Russian flag fleet dropped to 2.98 million tons. Of 177 vessels built for Russian ship owners in 1992-2001, the Transport Ministry estimates that 90 percent were registered under foreign flags. Currently, 58 percent of the Russian fleet is foreign-flagged, compared to just 18 percent in 1991.

The Russian Shipbuilding Agency (Rossudostroyeniye), a public agency that wants to consolidate and take control of flagging Russian shipyards, refuses to answer detailed questions about civil-shipbuilding activities. The agency claims that in 2002 a total of 140 vessels and "sailing objects" were built in Russian yards. Civilian-vessel construction grew by 4.5 percent last year, the agency claims, and naval (military) production by 8.4 percent. These figures do not match those given earlier by Rossudostroyeniye, which reported that in 2001 a total of 100 vessels of various types were constructed in Russia.

At the start of 2002, Rossudostroyeniye said it expected six deliveries from Russian shipyards. But industry sources say that almost all the civil newbuilds Rossudostroyeniye has counted in its aggregate for the year are very small riverine or fishing craft.

The reason Russudostroyeniye is uncommunicative is because it is hoping to persuade the Moscow government to give it the mandate and the money to consolidate St. Petersburg’s major shipyards, and centralize control over commercial and naval shipbuilding. In this bid, Russudostroyeniye is directly opposed by the two leading commercial shipbuilders in St. Petersburg, ICT and NPK . They have told the government that it should allow commercially led consolidation of the shipyards, but choose one of them to lead the way.

Last July, the state-controlled Eurofinans Bank announced that it had a plan to accelerate shipbuilding using a combination of state resources and commercial finance. The vice president of Eurofinans, Viktor Chugunov, proposed that the government set up a new, fully state-controlled shipping company, which would then commission vessels from the yards, finance their construction and charter them to the Russian fleet operators.

His study of the domestic shipyards concluded that almost none have the working capital and order book needed to sustain work on major newbuild contracts. Those that do, he said, are sustained by foreign naval orders, primarily from China and India. "Only a very few individual shipyards – Northern Shipyard, Baltic and Admiralty – are able to continue shipbuilding based on the revenues that they get from foreign military orders for ships." Northern Shipyard belongs to the NPK group, and Baltic belongs to ICT.

Chugunov suggested that Eurofinans was trying to persuade the government to devise a scheme that would address "the lack of accepted banking guarantees the shipping companies and shipbuilders can get in Russia; the lack of credits or disposable working capital of the shipyards to finance shipbuilding themselves; the high interest rates for credits provided by the Russian banks; and the absence of a credit history of Russian shipyards with the foreign banks." The plan anticipated that the finance to be raised by the new company would come not from the federal budget, but from the domestic shipping sector, banks, and insurance companies. The Chugunov plan also aimed at the construction of "primarily small and mid-size vessels."

Nine months later, Chugunov has left Evrofinans, and the plan is dead. The bank and Transport Ministry refuse to say what happened. Other shipping sources told The Russia Journal that the real fight at the moment is between Rossudostroyeniye, which has a plan to take control of shipbuilding, and the commercial shipbuilders.

Spokesman for the Transport Ministry Alexander Filimonov acknowledged that, for the time being, state financing is of limited value. "Mintrans has asked for a twofold increase of budget financing for [subsidizing ship building], but still the volume of financing will be small compared to what is required to produce a qualitative improvement in shipbuilding."

"The current scheme doesn’t make much of an allowance for difference between shipping companies, as it only provides the guarantee that credits will be slightly cheaper. Only the companies that have good borrowing positions, like Sovkomflot, or companies which have financial resources of their own, such as Northwestern Shipping, Volga Shipping or, to a smaller extent, Yenisey River Shipping, can afford actively to build new fleet."

The available data on Russia’s major shipyards reveal that no new major vessels were added to their order books in the past year, except an order of bulkers from the Czech Republic, which is the subject of an intergovernment agreement. Shipyard contracts have not yet been signed.

The commercial-financing alternative to state funding for the growth of Russian shipbuilding has not been taken to. Out of 177 vessels built for Russian shipowners between 1992-2001, 90 percent were registered under foreign flags. Interest rates offered by Russian banks for shipbuilding have been falling, but the repayment terms are still so short as to be practically unacceptable for shipowners. By contrast, foreign banks offer credits for seven to nine years, at half the Russian interest rate. Thus, the future of Russian ship financing remains where it has been for a decade – offshore, among a handful of maritime bankers, such as Christiania, Fortis and Nedship.

The European Bank for Reconstruction and Development (EBRD) was for much of the 1990s the single largest lender to Russian shipping. It closed its loan window following the November 1997 default on a 1996 loan to Sakhalin Shipping Co. (Sasco); by then, the shipping department had given out almost $290 million in three years. At the start of 2001, all 16 of the vessels collateralizing Sasco’s credit had been sold, and EBRD officials claimed they were looking seriously at financing new ice-class tankers, among other projects. Two years later, in March 2003, an EBRD source said discussions had produced no new financing commitment to a Russian fleet order. Instead, EBRD money is going to foreign-flagged vessels operating in Russian waters.

Alexander Alexandrovich, CEO of Volgotanker, the largest domestic tanker operator, told The Russia Journal that "We do not see any changes in terms of domestic bank financing. Since Volgotanker is an international company, we do not have any barriers to getting credits abroad." Volgotanker has demonstrated the strongest momentum of the Russian shipping companies, with overall growth of cargo tonnage of 11 percent last year and 6 percent growth in oil exports. The company now controls two-thirds of the domestic bulk transport market, and is expanding rapidly in the Caspian Sea.

According to Alexandrovich, the next few years will see divestment rather than consolidation in the shipbuilding sector, as shipping companies try to sell off their shipyard assets. Fleet operations and shipbuilding, he says, "are absolutely different sectors of business, and it’s better not to consolidate them."

Igor Borisenko, deputy general director of Sovkomflot, Russia’s largest maritime-fleet operator, said "we haven’t received any particular offers from Russian banks in a long time, because... [w]e cannot afford to pay as much as they want on interest rates, [as] we get cheaper credits abroad."

By contrast, Sovkomflot says that the terms of foreign borrowing have been improving.

According to Borisenko, Sovkomflot "does not use the [state] program for subsidizing interest rates on credits for shipbuilding in Russia, but…quite a few companies do, especially those building river-sea vessels." His forecast for the ship-financing market in Russia is wary. "No radical changes in shipbuilding finance can occur in Russia," he said, "for two main reasons. The first is that, in order to work in the shipbuilding-finance market, domestic banks should have very qualified specialists that are knowledgeable in every detail of the shipping business and its financing. This isn’t the case now. The second reason is that the general economic situation now provides better possibilities for short-term deals, but lending to the shipbuilding sector doesn’t fit into that. Shipbuilding requires longer loan terms."

To achieve that goal, according to Skarga, the immediate priority for Russian shipowners to establish conditions for the development of the maritime fleet in the country. "At the moment, Liberia has taxation of 3 percent for vessels under its flag, while taxation of Russian companies [including amortization payments] amounts to 94 percent to 96 percent, which leaves nothing for the development of the fleet," he said. "Russia should not adopt terms of the register such as in Liberia, as that would be a far-too-radical step. But it has to adopt something similar to Germany, Norway or the United Kingdom."

Skarga acknowledges that shortage of cash is a perennial problem for the fleet’s owners. Sovkomflot has reported that, in the first half of 2002, its profits fell substantially, but that its newbuilding program was still afloat. Operating profit before tax was $77.4 million, a company report said, while after-tax profit was $2.1 million. By contrast, in the first half of 2001, net profit was $64.3 million. More than three-quarters of Sovkomflot’s cargoes are of non-Russian origin.

In yet another state initiative to stop the hemorrhage of fleet operating capital abroad, and revive Russian-flag fleet operations, the Transport Ministry has begun to merge two state-owned enterprises, the Northern Caspian Shipping Co. and the Caspian port of Olya, southeast of Astrakhan. This is part of a broader strategy, directed by the Kremlin, to increase Russia’s maritime presence on the country’s southern approaches and expand ferry transportation to and from Iran. Four ferries will be used on the run between the new all-weather port of Olya and several ports along the Iranian coastline. State orders and funds will be used in this development.

According to Filimonov at the Transport Ministry, a separate company will be set up to operate the new container terminal at Olya. A tender for constructing and operating this facility is expected to be decided by September. Vagna Shipping, the largest Russian operator in the Caspian, and Sovfracht, the Moscow-based shipping broker, are both bidding.

According to Vyacheslav Ruksha, chief of the Maritime Service, a branch of the Transport Ministry, "We have to work on schemes for the return of the fleet to the Russian flag. One way may be to return the fleet under bareboat agreements with creditors. At the same time, the extension of the period of bareboat agreements with creditors to six to eight years would facilitate the return of ships under the Russian flag, if the shipping companies are experienced enough in working with bank credits."

Ruksha said that if lenders continued to restrict their terms to short periods of time, "it makes sense to consider buying used ships, which are also cheaper… I think the Russian banks now understand that they can provide $5 million to $10 million in credits to shipping companies for the purchase of ships….it’s realistic to expect loans lasting six to eight years."