RUSSIAN FEDERATION

1. GENERAL ECONOMIC AND POLITICAL SITUATION - 2002

In 2000-2001, important economic and political changes were in progress in the Russian Federation. However, in general, there was definite political stabilization and economic progression. Tax reform is being strongly implemented. For example, individual income tax became unified and is now equal to 13 percent. The profit tax of industrial enterprises was drastically reduced up to 24 percent.

In January 2002, new environmental laws were adopted in Russia which are basically compatible with international environmental laws.

In 2002, a lot of work was done on developing a strategy for the Forestry Complex in the framework of the strategy for social and economic development of Russia for a period up to 2015.

The North-Western Federal Area (with its centre in Saint Petersburg) occupies a special place in the Forestry Complex. The Area is responsible for about 60 percent of the Russia's pulp, paper and board output.

The economic stabilization of 2001-2002 was accompanied by a minor change in a dollar/rouble exchange rate. During 2000, variations of the dollar/rouble rate were between 26.5 and 28.5 roubles per US dollar. During 2001, the rate increased up to 30 roubles per US dollar and during 2002, up to 31.5 roubles per US dollar.

The political and economic stability in Russia resulted in increased foreign investment.

2. PERFORMANCE OF THE PAPER AND WOOD INDUSTRY - 2002

a. Production, consumption and trade

In 2001-2002, the output of pulp and paper products progressively increased in the Russian Federation.

In 2002 the output growth was as follows (compared to 2001 and 2000):

• pulp after cooking: by 5.6 percent (in 2001, by 6.3 %, in 2000, by 17.4 %);

• market pulp: by 3.2 percent (in 2001, by 5.8%, in 2000, by 16.2%);

• paper and paperboard: by 5.8 percent (in 2001, by 5.6%, in 2000, by 17.5%) including:

• all paper grades: by 2.4 percent (in 2001, by 2.9%, in 2000, by 12.5%);

• all board grades: by 9.8 percent (in 2001, by 10.1%, in 2000, by 21.3%).

This significant increase in pulp and paper output was observed on the background of the overall economic upturn that was in progress in Russia. GDP increased by more than 4 percent during 2002.

The following is currently typical for the Russian forestry sector:

• a stable growth in output of pulp and paper products;

• export orientation both of the pulp and paper industry and of the forestry sector as a whole (more than 80 percent of market pulp and about 50 percent of paper and board including more than 75 percent of newsprint are exported);

• raw material structure of exports (exports of roundwood and most inexpensive products prevail);

• unfavourable trade balance as to paper and board (from the second quarter of 2001);

• disputes of managing organizations;

• intensification of environmental problems under conditions of changing environmental laws that do not harmonize with foreign and international laws;

• assets are worn out;

• lack of resource-saving and power-saving technologies;

• sustained growth of prices for energy carriers and services of natural monopolies.

However, despite the political and economic stability in Russia, investment in Russian enterprises, including enterprises of the Forestry Complex, remains low as before. This is due to:

• an unsettled matter of proprietary right (problems of the Ilim Pulp-Sibal, the Vyborg Pulp and Paper Mill, etc.);

• issues of forest management and ownership of forests;

• issues of environmental legislation;

• lack of an influential and efficient lobbying sectorial association;

• comparatively low effective demand.

In 2002, the restructuring of owners continued in the Russian Forestry Complex. Russia's largest enterprise, Ilim Pulp Enterprise Corporation, purchased the Ust-Ilimsk Forestry Industrial Complex. At the same time, a heated struggle raged between the Ilim Pulp Enterprise and the Sibal Company regarding the right of ownership of the Kotlas, Bratsk and Ust-Ilimsk pulp and paper mills.

The OAO Svetogorsk-International Paper and the Syktyvkar pulp and paper mill successfully progressed. The latter was purchased by the Austrian-based Neizidler Company.

Despite these problems, a considerable increase in the attractiveness of Russian forestry enterprises and, correspondingly, in their prices is probable in the next 3-5 years. This increase would be due to availability of highly efficient positive examples (the International Paper Co., Neizidler, and IKEA), the stable growth of output of pulp and paper products and internal market development coupled with export orientation of the Russian forestry sector.

The shortage of capital in the Forestry Complex that has arisen as a result of a reduction in harvesting and a downturn in world markets creates good prerequisites for the economy of logging and woodworking enterprises.

In 2001-2002, most of the Russian forest, pulp and paper enterprises increased their output and raised their profitability. This was a result of their adaptation to market conditions and the structural reorganization of both individual enterprises and the industry as a whole.

The data given in Table 1 shows that despite the stable growth in the output of key pulp and paper products in the last years, the output level of 1988-1989 has yet to be achieved by the Russian pulp and paper industry. The only exceptions are newsprint and offset paper. The total of pulp after cooking, market pulp, and total output of paper and board comprised approximately two thirds of the corresponding output level of 1988-89.

One manifestation of the industry's structural reorganization is the fact that it became an export_oriented industry. Table 2 demonstrates the change in contribution of exports to the total output of the products manufactured by the industry. As may be seen from the data presented, the share of market pulp exports is more than 80 percent (2001) and the share of paper and board exports is more than 42 percent.

From a comparison of the data given in Tables 1 and 2, it follows that despite the fact that Russia's pulp and paper industry has not yet achieved the output level of 1988-89 its volume of export sales in 2001 (and, according to preliminary data, in 2002) has reached an all-time high in the history of the Russian pulp and paper industry.

The markets with the most promise for the Russian forestry sector exist in Western European countries, Asian countries (China, India, Turkey), East European countries, Russia and CIS.

Table 1: Pulp, paper and paperboard output in the Russian Federation, 1995-2002

Products	1988*	1995	1996	1997	1998	1999	2000	2001	2002	2002/ 2001	2002/ 1995	2002/ 1988*
	(thousand t)									%
Pulp total	8331	4151	3028	3170	3205	4225	4960	5272	5568	105.6	134.1	67.0
Market pulp	3076	1743	1144	1169	1320	1722	2018	2136	2233	103.2	128.1	72.6
Paper and Paperboard	8632	3956	3236	3269	3426	4535	5300	5595	5921	105.8	149.7	68.6
Paper total, including:	5465	2760	2274	2179	2325	2966	3320	3415	3524	102.4	127.7	64.5
Newsprint	1693	1457	1243	1201	1386	1622	1694	1732	1713	98.9	117.6	101.2
Offset	396	346	349	337	399	485	461	465	478	102.8	138.2	120.7
Paperboard total	3167	1196	962	1090	1102	1569	1980	2180	2397	109.8	200.5	75.7
Corrugated board	1639	814	610	775	760	1080	1356	1530	1711	110.2	210.2	104.4

* 1988/89

Table 2: Exports of market pulp, paper and board in the USSR (1980-1990) and in the Russian Federation (1993-2001)

Year	Market pulp			Paper and board
	Output (`000 t)	Exports (`000 t)	Share of exports (%)	Output (`000 t)	Exports (`000 t)	Share of exports (%)
1980	2 457	821	33.5	8 688	1 018	11.7
1983	2 840	1 012	35.6	9 556	1 034	10.8
1986	3 233	1 105	34.1	10 395	1 188	11.4
1987	3 371	1 088	32.3	10 566	1 252	11.9
1990	3 255	600	18.4	8 325	900	10.8
1992	2 109	856	40.6	5 750	1 568	27.3
1993	1 682	1 077	64.0	4 462	1 418	31.8
1994	1 328	1 028	77.4	3 410	1 264	37.1
1995	1 736	1 362	78.5	4 070	1 690	41.5
1996	1 267	1 095	85.7	3 220	1 380	42.9
1997	1 193	1 008	82.8	3 331	1 507	45.2
1998	1 311	1 056	75.8	3 540	1 783	50.4
1999	1 725	1 350	78.3	4 467	2 019	45.2
2000	2 000	1 635	81.8	5 239	2 355	45.0
2001	2 136	1 753	82.1	5 595	2 350	42.0

Prospects for further growth of Russian exports of forest-based products correlate with recent trends in the global forestry sector which are as follows:

• The decline in production that began in 2001 in the United States and then continued to Western Europe, which is not temporary in its nature but results from a shift of industrial production into countries of cheap labour;

• Intensification of environmental issues and the special attention focused on them by ENGOs (issues of sustainable development, prevention of global climate change, etc.);

• Strengthening intersectorial links within the Forestry Complex.

Through export of rather inexpensive kinds of products (e.g. newsprint, kraft liner), Russia increases simultaneously imports of high quality paper and board, namely, clay_coated grades, tissue products, high quality kinds of packages and containers. As a result, since the second quarter of 2001, the value of paper and board imported into Russia was more than that of exports (Table 3). This process was further enhanced in 2002.

Table 3: Russian exports and imports of paper and board in 2000-2002 (million US$)

	Exports	Imports	Trade balance
1st quarter 2000	217	153	63
2nd quarter 2000	229	170	59
3rd quarter 2000	237	192	45
4th quarter 2000	237	216	21
1st quarter 2001	270	234	36
2nd quarter 2001	273	281	-8
3rd quarter 2001	220	247	-27
4th quarter 2001	278	338	-60
1st quarter 2002	235	262	-27
2nd quarter 2002	254	338	-84
3rd quarter 2002	228	309	-81

Analysis of the structure of Russia's exports of forest-based products (Table 4) shows that exports of rough timber dominate. A share of pulp and paper products in the total exports (in terms of value) was even reduced somewhat for the last years.

When considering the exports of forest-based products in terms of roundwood, the contribution of roundwood to the total exports increased from 45 to 55 percent in a period from 1990 to 1998-2002. It should be recognized that Finland occupies the first place among importers of Russia's roundwood and accounts for about one third of the total exports of Russia's roundwood.

Table 4: Russia's exports of timber, pulp and paper products in 1998-2000

Products	million US$			%
	1998	1999	2000	1998	1999	2000
Currency earnings including:	3 024	3 300	4 100	100	100	100
Roundwood	938	1 199	1 345	31	36.3	32.8
Market pulp, paper, and board including:	1 143	1 104	1 507	37.8	33.5	36.8
Market pulp	370	382	587	12.2	11.6	14.3
Paper and board	773	722	920	25.6	21.9	22.4

New environmental legislation (the Federal Law No. 7-F3 of 10.01.2002) was passed in Russia in 2002. According to this law, Russia will practice internationally accepted environmental assessments of individual enterprises by comparing them with Best Available Techniques (BAT).

A number of pulp and paper mills (e.g. OAO Svetogorsk, the North-Western Forest Industrial Company) are putting into practice their environmental and economical reconstruction by stages. The reconstruction is aimed at such issues as implementation of chlorine-free bleaching and optimization of the water cycle.

In 2002, the UN Economic Commission for Europe (UNECE) Project on development of the Russian forestry sector continued and there are plans for continuation in 2003.

In late 2001 and early 2002, the Confederation of the Forest Industrial Enterprises of Russia's North-West was established. In December 2002, the RAOBumprom association was reorganized. These associations protect in practice sectorial interests on a wide range of problems, in particular, on extended wood processing in the immediate region of wood growth.

b. Outlook for the future

Sustainable development of the Russian forestry sector is of both national and global environmental importance. This is due not only to the fact that Russia possesses almost a fourth of the world's forest resources but also that among the countries of the Northern Hemisphere, only Russia has a real resource and the scientific and engineering potential for quick and exceptional development of the forestry sector within the next few decades. In this connection, the working out of the development strategy for Russia's Forestry Industrial Complex for a period up to 2015 has assumed a vital national and international significance.

In the summer of 2002, strategy issues for the Russian Forestry Complex were considered in the enlarged session of Russia's State Council, which was held by Mr V.V. Putin, President of the Russian Federation, as well as in a special session of Russia's Government. In preparation for the sessions, Parliament Hearings were held.

In addition, open discussion of possible strategy versions has taken place at a number of international and national conferences and workshops which were held in 2002.

In 1999-2002, a number of international scientific and practical conferences and workshops were held under the framework of the UNECE Project on development of Russia's forestry sector, where such issues as biofuel, certification in the Forestry Complex, etc. were discussed.

At the beginning of work on the project, in December 1999, the UNECE together with the Section of Forest Sciences of the Russian Academy of Natural Sciences, the Section of Forestry Technologies of the Russian Engineering Academy, the Ministry of Science of the Russian Federation, the Government of the Leningrad Oblast and the State Technological University of Plant Polymers held a special workshop on forest certification in the Forestry Complex in Saint Petersburg.

In 2002, within the framework of this project, two scientific and practical conferences were held in Saint Petersburg. They were devoted to Sustainable Development and Certification in the Forestry Complex, Sustainable Development and Biofuel Use and to the Strategy for Forestry Complex Development both in Russia and, especially, in Russia's North-Western Area.

The main problem of the Forestry Industrial Complex both in Russia as a whole and in its North-Western Federal Area is inadequate in-depth wood processing in the immediate region of wood growth. As mentioned above, raw materials such as roundwood dominate in the structure of exports of paper and forest-based products. This results not only in the loss of a significant number of jobs, reduced currency earnings and slowed economic growth, but also in negative environmental impacts because of increased transportation and lack of complex use of forest resources. Because of this, the development of complex in-depth wood processing at an accelerated pace is laid in the strategy foundation.

Such strategy concepts are being developed by the working group that was especially established under the Plenipotentiary of the President of the Russian Federation in the North-Western Federal Area. A concept was developed in more detail by the Ilim Pulp Enterprise Corporation.

Finnish experts believe that the imperfections in the Forestry Complex, particularly, of its legislative base, allow only increased roundwood exports from Russia in the next few years. And only thereafter, Russia could turn to wood processing (but not in-depth) in the immediate region of wood growth. This approach represents the interests of the Finnish forest industry.

Over the last 10-20 years, there has been more than a two-fold increase in roundwood exports from Russia to Finland from 4-6 million cubic meters per annum between 1982-1993 to 10-11 million cubic meters per annum between 1998-2002. Finland has doubled its output of paper and board within the same period. While possessing a lot of pulp and paper mills worldwide (their total capacity is about 36 million tonnes or approximately 12 percent of the global annual output), Finnish forest industrial concerns did not purchase any pulp and paper enterprises in Russia. Finland continues to consider the Russian Forestry Complex as a raw material supplier only. However such an approach contradicts both Russia's national interests and the key principles of the Kyoto Protocol.

As mentioned above, seven Russian Federal Areas are now working out the strategies for their social and economic development for a period up to 2015.

The North-Western Federal Area occupies a particular place in the Russian Forestry Complex as it accounts for more than half of the forest area of the European part of Russia and for about two thirds of coniferous forest area of this Russia's territory. In 2000-2001, pulp and paper mills of the North-Western Area were responsible for approximately 60 percent of the Russia's total output of pulp and paper products, with higher growth rates shown by the Area in 2002. Because of this, it is in the North-Western Federal Area, that intensive actions are being taken to work out and implement the strategy for Forestry Complex development. Of paramount importance are the targets of in-depth wood processing in areas of immediate proximity to wood growth, complex wood processing including in-depth mechanical processing, manufacture of high quality pulp and paper products and biofuel production and use.

A climate favourable for investment is being created in the North-Western Region mainly in the Leningrad Oblast. The Region has a high scientific potential that is capable of providing scientific expertise and staff support to investment programmes.

A certain change took place in late 2002 - early 2003, possibly, as a result of all these factors. The largest Sweden and Finnish companies (e.g. StoraEnso, UPM-Kummene, Metso-Lyto) announced their intention to construct a number of in-depth wood processing enterprises in the Leningrad Oblast Area. Russian investors also initiated construction of new wood processing mills.

The OAO Svetogorsk - International Paper Co. announced their intention to construct a new bleached aspen CTMP plant.

3. ISSUES OF PARTICULAR INTEREST

a. Sustainable development of the Russian forestry sector, its contribution to the global carbon cycle and issues of Kyoto Protocol implementation

The following issues are important for the Russian Forestry Complex in connection with implementation of the Kyoto Protocol:

• rise in forest productivity;

• reduction in the distance of timber and wood residue transportation;

• increase in the intensity of wood processing in the immediate region of trees growing;

• increase in a share of plant fuel in the total power balance;

• change in a power balance structure of pulp and paper mills with a drastically increasing share of wood residue, etc.;

• transition to resource-saving and, in particular, power-saving technologies.

The first of these issues concerns sustainable forest management. While the estimated cutting area in Russia is about 540 million cubic metres a year, felling volume has never been more than 300 - 350 million cubic metres. As a result of the economic recession of the 1990s, felling volume dropped to 82 million cubic metres in 1997 and to 75 million cubic metres in 1998. In 2000 timber hauling was about 100 million cubic metres in Russia. In 2002, tree harvesting was reduced by 6 percent compared to 2001. Thus, no more than 20 percent of the allowable cut is currently being used.

Russia, possessing a fourth of the world's forest resources, is located geographically in the Northern Hemisphere where the greater part of fossil fuel consumption takes place (Western European countries, United States, Japan). As this is the case, Russian forests play a very important part in maintaining ecosystem sustainability. This is one of the most important factors for intensifying forest management in Russia.

Currently, the intensity of tree growth in Russian forests is 1.5 m³ per hectare per year for coniferous species and 2.5-3.0 m³ for deciduous species. Considering global climate change, increased productivity of Russian forests and more efficient use of their wood in manufacturing of both pulp and paper products and biomass are of no lesser importance than the development of healthy growth plantations in Latin America or in the Asian-Pacific Region.

The reduction in felling volume is not only Russia's problem. In a sense, this is the problem of climate change all over the Northern Hemisphere. Intensity of tree growth in Russian forests could be doubled. This would have a major positive impact on the prevention of climate change in the Northern Hemisphere. Implementation of such a programme would require major investment (billions of dollars) into the Russian Forestry Industrial Complex, greater attention from the world's financial institutions and economic stability in Russia.

Thus, in the context of sustainable development and global warming, there is a mutual relationship between the development of the Russian Forestry Complex and large-scale investment from international financial structures. The fact is that in the coming decades, the political and economic situation in Russia will significantly influence the environmental situation on a global level.

A further aspect of the Kyoto Protocol in the context of the global carbon dioxide balance and prevention of the `greenhouse effect', it makes far more sense to process wood as close as possible to the place of its growth rather than to export roundwood from Russia. In this case, transport costs and power consumed to transport the wood are sharply reduced. In addition, the place where carbon dioxide is emitted - a processing plant - remains as near as possible to the place where these emissions can be absorbed - a forest. It is therefore advisable to undertake environmental estimation of the structure of Russian timber exports along with the intensive development of Russia's pulp and paper industry and of the mills where wood is subject to mechanical processing.

In the context of the Kyoto Protocol and macroeconomics, extended wood processing (both mechanical and chemical) immediately in Russia holds much promise. To put this into effect, there is a need to attract investments into the Forestry Complex. The North-Western Federal Area and, primarily, the Leningrad Oblast are preferable regions for the investments. However in 1999-2002, rough wood dominated exports from this region.

Construction of new ports in the Leningrad Oblast, in the regions of Ust-Luga and Vyborg, and expansion of the St. Petersburg Port will open up opportunities not only for developing new logistics schemes for transport of timber cargo but also for constructing large modern timber processing mills which would export both sawn logs and the products of more extended timber processing.

As noted above, such decisions would make sense both in the context of the Kyoto Protocol and employment in Russia. Russia is known to have rather high scientific and engineering potential which could provide intensive development of the processes of extended timber conversion. The present political and economic stability in Russia produce favourable conditions for investment as well as for import of up-to-date technologies into Russia. Taking into account that the level of remuneration of labour will remain significantly lower in Russia than in West European countries, it would be quite promising to export the products of extended wood processing from Russia.

Thus, in the context of Kyoto Protocol implementation, it is advisable not only to increase felling volume in Russia but also to achieve better wood processing in-situ. This would increase wood residue output at the woodworking and pulp and paper mills. In addition, in the context of sustainable forest management, industrial wood and pulpwood logging must be accompanied by firewood logging and logging waste utilization. All the above measures extend considerably the biofuel raw material base both if the raw materials are utilized directly in the region and if they are exported, primarily, in a transportable form (energopellets and briquettes).

The current gas prices on the Russian domestic market are known to differ from those on world markets and from export prices for Russian gas by approximately a factor of ten. A further increase is planned in gas prices on the Russian market in the short term in order to make them equal to world prices. The increase in domestic prices for gas will result in considerable changes in biofuel competitiveness and it is foreseen that wood will become a competitive type of fuel in the North-Western Region of Russia.

In mid-2002, a programme was approved in the Leningrad Oblast for conversion of 47 municipal boiler houses to biofuel. Although the conversion of the existing boiler-houses to wood fuel involves a lot of technical, economic, financial, and organizational difficulties, they are all manageable. The Scientific and Practical Conferences held in Saint Petersburg in July 2001, February and July 2002 demonstrated that intensive construction of boiler-houses operating on biofuel took place in the North-Western Region.

A number of Russian pulp and paper mills increased the share of wood waste in their power balance. For example, the Svetogorsk Mill (International Paper Company) started up a new bark boiler in the autumn of 2001 that has a capacity of 150 tonnes of steam per hour; the Arkhangelsk Pulp and Paper Mill, the Kotlas Pulp and Paper Mill have made fundamental reconstruction of their bark boilers and similar works are being performed at other mills.

In 2002, a number of up-to-date complexes for mechanical wood processing were laid in the Leningrad Oblast. These complexes will each produce from 250 000 to 400 000 m³ of high quality sawn wood, more than 100 000 m³ of pulp chips, more than 40 000 tonnes of biofuel. Provision is also made for biofuel to be produced at the complexes both for internal needs and for export.

a. Forest certification

In recent years, intensive work has been done on certifying forests and the Forestry Complex production to comply with the ISO 9000 and ISO 14000 International Standards Systems. For example, in the summer of 2000 the certificate of conformity with ISO 9001 was issued to the IP Svetogorsk Mill. This mill was accredited in accordance with ISO 9001 in December 2000. Similar work is being done at a number of other enterprises.

In late 2001, the Saint Petersburg GOZNAK Paper Mill was certified to comply with ISO 14000. The Saint Petersburg GOZNAK Paper Mill is the first enterprise in the Russian Forestry Complex which holds the Environmental Management System certificate in accordance with the ISO 14000 International Standards.

The issue of forest certification is considerably more complicated. In 1999, Russia brought into effect the obligatory certification for cut wood. Unfortunately, this system differs from most of the other international and national systems in that it is obligatory and is effected by the state bodies, which manage forestry, rather than by a third independent party. At the same time, representatives from the research and industrial sectors realize that it is necessary for Russia to develop such forest certification systems, which are compatible with international systems.

Taking into account that a considerable portion of roundwood is exported from Russia to Finland (about 30 %) and to Sweden (more than 10 %), these importers try to keep up the agitation among Russian forest enterprises for the certification systems, which are similar to those accepted in their countries - FSC in Sweden and PEFC in Finland. In this connection, a number of international workshops on forest certification have been held in Russia, in which certification schemes such as ISO 14000, FSC and PEFC were discussed.

Within the framework of the UNECE project on development of the Russia's forestry sector, a number of workshops and international scientific and practical conferences have been held on to the issues of certification in the Forestry Complex.

The Forest Environmental Policy has been worked out at the OAO Svetogorsk (International Paper Company) and the Sustainable Forest Supply System has been created and certified as to its conformity to ISO 14000. Russia's first integrated ISO 9000 - ISO 14000 System is being created at the North-Western Forest Industrial Company.

In different Russian Regions a number of pilot projects on forest certification according to different schemes have been started. Currently, realization of the pilot projects and comparative analysis of their compatibility and suitability for Russian conditions are among the primary targets.