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FM AMEMBASSY BELGRADE
TO RUEHC/SECSTATE WASHDC 8882
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UNCLAS BELGRADE 001013 
 
SIPDIS 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: PREL ENRG ECON EINV SR
SUBJECT: GOS TO PURSUE PHASED PRIVATIZATION OF OIL COMPANY 
 
 
SUMMARY AND COMMENT 
------------------- 
¶1.  The GOS will move forward on a draft privatization 
strategy for state-owned oil and gas company Naftna 
Industrija Srbije (NIS) submitted by adviser Merrill Lynch, 
according to the head of the privatization steering group. 
In a recent meeting, Slobodan Sokolovic, Assistant Minister 
of Energy and Mining, confirmed that the GOS will approve the 
strategy in all its key aspects at its council of ministers 
meeting on July 6.  The strategy calls for a three phased- 
approach to privatization under which the strategic investor 
initially would purchase a minority share in the oil company, 
but with full management control, with a more-or-less 
guaranteed right to acquire a  majority stake. 
 
¶2.  This strategy is certainly second best to an immediate 
sale of majority ownership to a private investor. 
Unfortunately, various political interests have once again 
prevented taking the most direct path to a fully free-market 
situation.  That said, if the GOS actually moves forward with 
this plan, the sale of NIS, whose revenues are more than 
eight percent of GDP, would be a major step forward in 
decreasing state control over the economy.  END SUMMARY AND 
COMMENT. 
 
DRAFT PRIVATIZATION STRATEGY SUBMITTED 
-------------------------------------- 
¶3.  Econoffs met with Slobodan Sokolovic on June 20 to 
discuss the Government's view of the draft privatization 
strategy of NIS.  Sokolovic, who also leads the GOS steering 
committee on privatization, described a three-phased approach 
to privatization that will include an immediate change in 
management control of the company.  He said that he expects 
the Government to approve the strategy as presented at its 
July 6 session.  This tender likely will open in October, 
after Merrill Lynch prepares the documentation necessary, 
Sokolovic said. 
 
¶4.  The strategy lays out three phases.  The first phase 
calls for selling 35 percent of NIS as an integrated company 
to the strategic partner with a complete transfer of 
management control.  Sokolovic explicitly said that 
management control will include investment decisions, with no 
veto power remaining with the GOS.  After the initial 
transaction, the state of Serbia will have 40 percent in NIS, 
the potential buyer 35 percent, Serbia's Share Fund, 18 
percent and NIS workers, 7 percent. 
 
¶5.  Phase two, to take place in three years, will permit the 
strategic partner to purchase an additional stake in the 
company to bring its share up to 51 percent.  Sokolovic said 
that this would be guaranteed as long as the strategic 
partner meets certain benchmark investments, the key one 
being the investment of USD 300 million to bring refinery 
products up to European standard.  The final phase would 
allow the strategic partner to purchase the remaining stake 
in the company after Serbia joins the European Union (EU). 
 
¶6.  When econ chief asked how the buyer would be guaranteed 
majority ownership in phase two, Sokolovic said that such 
specific elements had not been fully defined; Merrill Lynch 
will make recommendations on this and other implementation 
issues.  However, one solution could be an Initial Public 
Offer (IPO). 
 
¶7.  Sokolovic said that the reasons why the GOS does not want 
to sell the majority in NIS immediately can be explained by 
the GOS objectives in carrying out the privatization: to 
retain an integrated oil company that can compete in the 
region, and to create a dynamic company that will also 
promote growth in other parts of the economy.  Other 
objectives include creating a competitive market and 
attracting strategic investors who will invest and modernize 
the company and produce Euro-quality products. Sokolovic 
acknowledged that the two-phase strategy was intended to 
guarantee the government that the investments take place 
before it authorizes the majority transfer. 
 
¶8.  On June 19, Merrill Lynch presented the strategy to the 
NIS Managing Board and NIS Trade Union.  The Board allegedly 
fully accepted the strategy, despite its intense media 
campaign to stave off privatization through a variety of 
stratagems:  sale of a low percentage to a consortium, 
"first-modernization, then-privatization," etc. (Merrill 
Lynch reports having consistent problems in getting data out 
of the company.)  On the other hand, Sokolovic said that the 
trade union only expressed interest in the distribution of 
shares for union members, e.g., when they would be able to 
cash them in. 
 
¶9.  According to terms of reference for the privatization 
advisor, in the second phase Merrill Lynch will present a 
detailed analysis of all aspects of the privatization: 
operational, financial and legal due-diligence; environmental 
review; valuation of the company and preparation of the 
tender documentation.  Merrill Lynch is responsible for 
preparing each phase of the transaction process to give 
potential investors a clear picture of the privatization 
process. 
 
¶10.  The final, implementation phase, will encompass the 
following: launching and managing the bidding process; 
managing the due-diligence; collection and evaluation of 
bids; managing and/or conducting negotiations; preparing of 
the Final Legal Documents and advice on and support the 
closing of the transaction. 
 
OTHER OUTSTANDING ISSUES TO BE RESOLVED 
--------------------------------------- 
¶11.  Other controversial issues like whether to let 
consortiums bid on the tender, the amount of social program, 
or compensation, for workers to be released, and how to value 
shares in the second transaction, will be worked out by 
Merrill Lynch in the next phase of their work, Sokolovic 
said.  He said that Merrill Lynch will seek to define 
conditions under which consortiums could participate in the 
tender without the fear that NIS will be split into parts 
after privatization. 
 
¶12.  With regard to regulatory issues, Sokolovic explained 
that some sort of import tax for crude oil and oil products 
will be maintained for another three to four years after 
privatization of NIS, to give NIS and a future strategic 
partner more time to modernize its refineries ahead of 
privatization.  The decree banning imports will be replaced 
by an import excise that will decline over time, while 
pricing will become an automatic mechanism that will no 
longer require Ministry of Finance approval.  (However, the 
Government only days ago extended its decree banning 
companies other than NIS from importing oil derivatives, 
except euro diesel 4, through the end of 2010.)  (Note: 
Prominent economist Kori Udovicki, a former central bank 
governor, attacked the GOS's move to extend the decree, but 
in the same statement she also called for a declining tax to 
replace it, similar to what Merrill Lynch has proposed.) 
 
¶13.  When asked whether the Ministry was concerned that a 
decline in oil prices over the next few years could impact 
the valuation of the company three years down the road, 
Sokolovic said that Merrill Lynch's projections foresee the 
price of crude oil and refinery margins remaining high over 
next five years.  Sokolovic mentioned that the Petrohemia 
complex in Pancevo, which is linked in every way to 
processing of oil in the refineries, will be privatized 
separately from NIS, but Merrill Lynch will handle the 
process in parallel with NIS privatization. 
 
POLT