DEMARCHE DELIVERED ON RESPONDING TO ENERGY SUPPLY

C O N F I D E N T I A L SECTION 01 OF 03 ALGIERS 001918

SIPDIS

E.O. 12958: DECL: 09/11/2015
TAGS: ECON ENRG EPET AG
SUBJECT: DEMARCHE DELIVERED ON RESPONDING TO ENERGY SUPPLY
DISRUPTIONS

REF: STATE 163206

Classified By: Ambassador Richard W. Erdman,
for reasons 1.4 (b) and (d)

SUMMARY
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1. (C) Ambassador delivered reftel demarche concerning
post-Katrina energy supply disruptions, as well as longer
term conservation measures, to Minister of Energy and Mines
Khelil September 11. Khelil said the shortage of refining
capacity was a large contributing factor to current petroleum
shortages and that refining capacity would be not be
sufficiently augmented in the near future. Algeria was
working to increase its refining capacity, but the bigger
problem globally was that producers did not want to invest in
new production because the rate of return was low, the risks
were high, and they would not be able to refine the
additional product. Investments in exploration for new
reserves have been slow to follow price hikes because
suppliers have been thinking price spikes were temporary.
Only now are they concluding significantly higher prices,
compared to those of recent years, are here to stay. Algeria
expected to produce 1.4 million barrels of oil in 2005 and
1.5 million in 2006. Natural gas production exceeded
targets.


2. (C) The new hydrocarbon law was having a positive effect,
but the new independent regulatory agency was only now being
set up and it would take about five years before new fields
were explored under the new law's parameters. Finally,
Khelil noted Algerian dissatisfaction with the bidding
process for new projects in Libya, which Khelil termed not
credible and subject to corruption. (End Summary.)


3. (C) Ambassador, accompanied by PolEc Chief, delivered
reftel demarche September 11 on responding to energy supply
disruptions in the aftermath of Hurricane Katrina to Minister
of Energy and Mines Khelil. Leaving behind a non-paper,
Ambassador stressed the short-term actions the United States
has taken to shore up supply and the long-term actions taken
to promote energy conservation. In response, Khelil said
Katrina was a temporary problem that affected production
facilities in the Gulf of Mexico and on shore. The
facilities would eventually come back on line. The release
of oil from U.S. strategic reserves and the additional
provision of petroleum by the International Energy Agency
(IAE) were "good calming influences" on the markets. That is
the reason reserves were set aside.

SHORTAGE OF REFINING CAPACITY
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4. (C) The lack of maintenance on refineries was a large
contributing factor to the current shortage, said Khelil. To
keep pace with demand, refiners were postponing needed
maintenance, leading to breakdowns. The problem would likely
be exacerbated as refineries began to produce relatively more
fuel oil, and relatively less gasoline, for the winter
months. The postponement of maintenance in order to keep
pace with demand for petroleum products was a problem three
months before Katrina struck. There would be a continued
shortage of refining capacity for the foreseeable future,
predicted Khelil.


5. (C) According to Khelil, Algeria was working to increase
its refining capacity. Construction of a new refinery at
Adrar was almost finished; construction had just begun on a
second at Skikda; and construction of a third refinery at
Tiaret was planned. The first two refineries would turn out
100,000 barrels of oil per day, while the third would turn
out three times that amount. The issue was not one of
production but rather one of refining capacity. The
constraints on refining erected a bottleneck in the
distribution system. Either refining capacity needed to be
increased or global demand reduced to prevent continue
increases in petroleum prices. The latter was unlikely with
economic growth in China, at 9.5 percent, stronger than had
been predicted a year ago. Despite Katrina, added Khelil,
the U.S. economy was still strong. Demand, therefore, would
be maintained.

PRODUCERS UNWILLING TO INVEST IN EXPANDING PRODUCTION
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6. (C) Ambassador asked for Khelil's views on pricing in
such a climate. Khelil said refining constraints established
the price, and breakdowns in equipment led to price spikes
The current future market price of crude oil was $65 for
delivery in March 2006. The dilemma was that the cycle
formed a vicious circle. Producers did not want to invest in
new production because they would not be able to refine the
additional product. At the same time, they did not want to
invest in refining capacity because the rate of return in
that sector was low. Of course, the lack of refining
capacity led to still higher prices for consumers.

7. (C) Investments in exploration for new reserves have been
slow to follow price hikes, explained Khelil, because
suppliers thought spikes were only temporary. Five years
ago, no one thought high oil prices were sustainable.
Ambassador asked if the mind-set had changed. Khelil thought
companies were purchasing their shares of stock rather than
investing in expanding production. There was much rhetoric
about increasing OPEC production, but with existing
technologies there was cause for additional investments in
production.

ALGERIA A YEAR BEHIND OIL PRODUCTION TARGET, AHEAD IN GAS
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8. (C) Ambassador asked the Minister if Algeria was on
target for its own production goals. Khelil said Algeria was
producing 1.4 million barrels of oil this year and was on
track to produce 1.5 million barrels in 2006. Algeria was
one year behind in attaining its oil target. In natural gas,
however, Algeria had exceeded its targets in production
capacity. A new underwater pipeline to Spain was expected to
be usable in 2008. The Tunisians were looking to expand the
capacity of the pipeline to Italy, and the Government of
Tunisia had given its okay to approve shipping contracts to
Italian companies. Construction contracts had been finalized
for a pipeline from Tunisia to the Italian mainland via
Sardinia. Italy imported about 25 percent of its natural gas
from Algeria.

IMPLEMENTATION OF RECENTLY PASSED HYDROCARBON LAW
-------------- --------------


9. (C) Ambassador asked Khelil if the implementation of the
new hydrocarbon law had affected Algerian behavior. Khelil
said the state-owned energy company, Sonatrach, had already
made adjustments in the way it did business. It had, for
example, identified what clearances were needed for new
pipeline routes. Obtaining the clearances caused the
Government to delay publishing the law until the pipeline
routes were established, but the new procedures in the long
run would increase efficiency and government revenues.
President Bouteflika had been asked to approve the
establishment of five regulatory agencies: two for mining,
two for hydrocarbons, and one for electricity/gas. It would
take 3-4 years to make the system work efficiently and 4-5
years before new fields were explored under the parameters of
the new law.


10. (C) Asked by Ambassador for additional impacts on
Sonatrach, Khelil explained that the state-owned firm would
need from now on to sign a contract for each field just like
any other company. It would be held accountable for costs
and profits from each field rather than from total
production. Sonatrach would no longer be able to cover
losses in some fields from profits in others. This would
increase both efficiency and tax revenues. Asked if recent
suspensions of Sonatrach personnel for alleged corrupt
activities had a positive impact, Khelil said the suspensions
were not the first of their kind. Since the Government was
suing companies found not to have followed established
procedures and such matters were before the courts, Khelil
declined to provide additional information.

U.S. HUMANITARIAN PROJECT IN OUARGLA GOOD FOR ALL
-------------- --------------


11. (C) Ambassador briefed Khelil on a project approved by
U.S. authorities (note: EUCOM) for which the Embassy was
waiting for $500,000 in USG funding that we hoped to leverage
with private sector money for humanitarian purposes. The
project, explained Ambassador, had the support of the wali of
Ouargla and called for the construction of a community center
that would increase the skills of area workers and help to
alleviate unemployment. Microsoft would train instructors
for the unemployed; Anadarko would furnish equipment and
contribute toward the start-up costs; and Nabors Drilling
would contribute to covering the personnel costs. The goal,
explained Ambassador, was to increase the pool of employable
people by teaching English and computer skills. This would
benefit the people and the oil companies, which needed
speakers of French and English. We envisioned the
establishment of a fitness center, library, and Internet
center.


12. (C) Khelil praised the idea and noted that the GOA was
focusing on educating girls in the south of the country. The
emphasis was on educating girls, explained Khelil, because
they were disadvantaged compared to boys. Ambassador
commented that he had been struck that the best workers were
often women but that, for cultural reasons, it was hard to
reward the added productivity of female workers with higher
salaries. Khelil agreed that rewarding efficiency was a big
problem in the Algerian economy, which continued to have an
egalitarian cultural outlook. This was true in Sonatrach,
where a new system was being implemented to reward group
performance. Each work group competed with others and was
rewarded as a group based on performance. This added a
powerful incentive to team leaders, not to mention the
workers themselves.

COMPLAINTS ABOUT HYDROCARBON PROJECTS IN LIBYA
-------------- -


13. (C) Asked by Ambassador about doing business with Libya,
Khelil complained that the bidding process for projects in
Libya was not credible. Occidental recently won 9 blocks
with one partner; Algeria one block; and none for the
Europeans. Khelil made clear he was not criticizing U.S.
companies but rather the lack of credibility in the Libyan
bidding process. The rules were not equally applied.
Sonatrach, for example, was forbidden from bidding in
conjunction with a foreign partner because, the Libyans had
explained, Algeria was an Arab country and could not bid with
"foreigners." Paying off key people was sufficient to have a
block rewarded. Sonatrach did not play that game, stressed
Khelil. Nor by U.S. law could U.S. firms, added Ambassador.


14. (C) Ambassador inquired about Algerian participation in
the Libyan natural gas sector. Khelil said Algeria held an
11 % stake in new upstream investments, 22% in pipelines. In
addition, Algeria was making money from existing operations
in Libya.

ERDMAN