Identifier
Created
Classification
Origin
05WARSAW1282
2005-03-08 11:17:00
CONFIDENTIAL
Embassy Warsaw
Cable title:  

POLISH PIPELINE COMPANY FINALIZING A BUSINESS PLAN

Tags:  EPET ENRG EINV PREL PL 
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C O N F I D E N T I A L SECTION 01 OF 04 WARSAW 001282 

SIPDIS

STATE FOR EUR/NCE TARA ERATH AND MICHAEL SESSUMS
STATE FOR EB/CBED AMB. MANN AND ERIC JONES
STATE FOR EB/ESC STEVE GALLOGLY AND MATT MCMANUS
USDOC FOR 4232/ITA/MAC/EUR/JBURGESS AND MWILSON
TREASURY FOR OASIA MATTHEW GAERTNER
DOE FOR IA-42 ROBERT PRICE

E.O. 12958: DECL: 03/15/2016
TAGS: EPET ENRG EINV PREL PL
SUBJECT: POLISH PIPELINE COMPANY FINALIZING A BUSINESS PLAN
FOR ODESSA-BRODY-GDANSK, STILL LOOKING FOR CHEVRON SUPPORT

REF: (A) WARSAW 1080 (B) KIEV 381

Classified By: Economic Counselor Richard Rorvig, reasons 1.5 (b and d)
.

-------
Summary
-------

C O N F I D E N T I A L SECTION 01 OF 04 WARSAW 001282

SIPDIS

STATE FOR EUR/NCE TARA ERATH AND MICHAEL SESSUMS
STATE FOR EB/CBED AMB. MANN AND ERIC JONES
STATE FOR EB/ESC STEVE GALLOGLY AND MATT MCMANUS
USDOC FOR 4232/ITA/MAC/EUR/JBURGESS AND MWILSON
TREASURY FOR OASIA MATTHEW GAERTNER
DOE FOR IA-42 ROBERT PRICE

E.O. 12958: DECL: 03/15/2016
TAGS: EPET ENRG EINV PREL PL
SUBJECT: POLISH PIPELINE COMPANY FINALIZING A BUSINESS PLAN
FOR ODESSA-BRODY-GDANSK, STILL LOOKING FOR CHEVRON SUPPORT

REF: (A) WARSAW 1080 (B) KIEV 381

Classified By: Economic Counselor Richard Rorvig, reasons 1.5 (b and d)
.

--------------
Summary
--------------


1. (C) As promised, PM Belka met with his Ukrainian
counterpart PM Tymoshenko early in her tenure to discuss
practical steps the two sides could take to deepen their
bilateral ties. The two Prime Ministers agreed to form a
bilateral committee to accelerate work on linking the
Odessa-Brody oil pipeline to the Polish oil grid in Plock.
The Polish pipeline company and its Ukrainian counterpart UTN
will prepare a financial and business plan for the pipeline,
and hope to secure the interest of Chevron or another Kazakh
oil shipper. Chevron reports it does not rule out becoming
involved "eventually," but wants to avoid angering Russia, a
goal Poland and Ukraine share. The two delegations also
discussed the potential for Poland to develop gas storage in
Ukraine, Ukraine's interest in investing in a Polish steel
mill and electricity exports. End Summary.


--------------
Initial Poland-Ukraine Consultations
--------------


2. (U) On March 3-4, Polish PM Marek Belka paid an official
visit to Kiev to discuss a wide range of economic cooperation
topics, including the Odessa-Brody oil pipeline, Ukrainian
electricity exports to Poland, and Kiev's interest in
investing in the state-owned Czestochowa steel mill. Polish
papers report the two sides agreed to set up a special
working group to extend the Odessa-Brody (OBG) oil pipeline
to Plock in central Poland and on to the port of Gdansk.
According to the Polish press, Ukrainian PM Tymoshenko
stressed the importance of using the pipeline to ship Caspian
and other oil to West European markets as a means of
diversifying Europe's sources of oil. An MFA official told a

Polish paper that it will be essential to attract investors
from Kazakhstan particularly Chevron.

--------------
Reversal in Principle, but Not Now:
--------------


3. (C) Halina Trymucha, Director of the Ministry of Economy's
Energy Security Department, who participated in the meetings,
and said the most important achievement was an agreement to
form a committee to accelerate inter-governmental efforts to
extend Odessa-Brody to Plock and Gdansk. The Polish
delegation was very pleased that Ukrainian PM Tymoshenko
provided such strong statements endorsing the western
orientation of Odessa-Brody. It is also very happy that she
did not announce the GOU would reverse the pipeline
immediately. Trymucha reported both sides agreed they would
work to build the necessary link to the Polish system, after
which the pipeline would be reversed. Trymucha said the
minutes of the meeting agreed by the two heads of delegation
suggested that the outer limit to complete the OBG pipeline
would be three years, i.e., 2008.

--------------
Kazakhstan is Key:
--------------


4. (C) While the Polish Government is pleased with the
renewed Ukrainian commitment to the project, Trymucha
believes the participation of a Kazakh oil producer like
Chevron or ConocoPhillips will be key to making the project
work. Cezary Filipowicz, the president of Sarmatia, the
PERN-UTN joint venture formed to realize Odessa-Brody-Gdansk,
explained that the companies had looked at shipping lighter
Azeri crudes, but these have too many other good alternatives
to use OBG on a cost-effective basis. Chevron and Kazakhstan,
on the other hand, are looking for a new outlet for a large
quantity of oil from Chevron's Caspian Pipeline Consortium
(CPC) pipeline, which Chevron hopes will be expanded by 2007.
The Director for International Agreements at the Polish
Pipeline Company (PERN),Cezary Lewandowski, said Chevron is
still the best fit for the project, in part because Chevron
has done far more analysis than other shippers on the details
of OBG. He said Chevron also has the greatest potential
interest in increasing returns for its CPC-blend by gaining
direct pipeline access to European markets.

--------------
Chevron Still Watching:
--------------


5. (C) Luis Coimbra, Director of Chevron's Marketing
Transportation Department, said his company is still watching
Odessa-Brody carefully, and thinks Chevron may get involved
"eventually," but needs to wait for the right time. Coimbra
thinks it could be useful for PERN and UTN to develop
Odessa-Brody in such a way that it could facilitate oil
exports through both the northern and southern Druzhba
systems into Europe. He suggested it would be useful for the
new GOU to declare publicly that Odessa Brody can be used to
export Russian Urals blend through the southern Druzhba
(through Croatia) and CPC blend through the northern Druzhba
through Poland. Coimbra also reported that Kazakhstan may be
willing to finance the construction of a 52 kilometer
pipeline to connect CPC to OBG without having to tanker oil
between Novorossysk (the current terminus of the CPC
pipeline) and Odessa. Coimbra cautioned, however, that a
number of steps have to be taken for Chevron to be
comfortable getting involved in OBG. One of the most
important steps is to persuade Russia (particularly pipeline
operator Transneft) to agree to the project. Coimbra also
noted that Chevron is considering other options, which may be
more commercially attractive. He concluded by stating "OBG
is not that important for us to be throwing mud in Russia's
face at this time. We are working with TNK-BP on the
Burgas-Alexandropolous bypass and the Russians on CPC
expansion."

--------------
Opening the Door to Russia:
--------------


6. (C) The Polish Government would like to find a way to
involve Russia in the project in a constructive way.
Lewandowski said that PERN is planning to leave 10 percent of
the project open to Russian companies. Trymucha noted the
difficulty of getting the sequencing right, however, in
approaching Russia. Poland does not want to exclude Russia,
but also wants to avoid giving Russia an effective veto over
its development.

--------------
Financial Model by End of March:
--------------


7. (SBU) PERN's Lewandowski reports that PERN has been
working closely with its Ukrainian counterpart, Uktransnafta
(UTN),and expects to have completed work on a financial
model by the end of March. PERN has already prepared a basic
business plan, which it will augment once the financial model
is complete. To enhance the plan's credibility, PERN hopes
to attract a serious partner (preferably Chevron) to the
project and release the plan as a joint product.


8. (C) Tariffs will be an important part of the financial
model, but will ultimately depend on the volumes of oil
shipped. Filipowicz said initial calculations suggest that,
for smaller volumes of 9-12 million tons per year (MTA),OBG
would have very high tariffs, of up to $15 per ton, compared
to $3-5 for competing Bosphorus bypass pipelines like
Burgas-Alexandropolous. One of the key goals of the joint
PERN-UTN working group will be settling questions related to
the tariffs Ukraine will expect on the pipeline. The two
companies will also continue to look at ways to shave costs,
including potential changes in routes. In examining
potential route changes, PERN's management is reluctant to
endanger ongoing operational links with Transneft in the
management of the Druzhba system, which is likely to minimize
the potential for building a link to Adamowo instead of Plock.

--------------
Finding Money:
--------------


9. (C) Lewandowski said that the Polish Government will have
to make a strategic decision in the second half of 2005r
whether it wants private companies to develop this project,
or whether the government will want to spend the money
necessary to build the pipeline (at an estimated cost of $500
million to extend the pipeline from Brody to Plock). He
confirmed that the European Investment Bank has volunteered
that it would be willing to finance up to 500 million Euro
($650 million) for the project, depending on the scope of the
project. This loan, however, comes with a number of
conditions which Lewandowski said may make commercial
financing easier. Commercial banks will want to see that a
significant oil shipper is committed to the project, however.
While he still expects the GOP to look to commercial
companies to finance the project, Lewandowski said that it is
possible that the GOP could decide that it is too important a
project to let it languish should no clear sponsor step
forward. Lewandowski expected that this decision will have
to wait for a government to be formed after this year's
general elections (expected June 16),as, currently, the
project lacks a committed senior sponsor in the GOP.

--------------
Gas and Electricity:
--------------


10. (C) Economy's Trymucha said Poland and Ukraine agreed to
explore opportunities to develop gas storage for the Polish
Gas Company (PGNiG) in Ukraine. Poland is still smarting
from Gazprom's cutoff of Belarus (which cut gas for a day to
Poland) in February 2004, and has been looking to develop
short-term storage options. Western Ukraine has several
natural formations which may fit the bill, and provide an
early sign of tangible cooperation between Poland and the new
GOU. Trymucha noted that the Polish papers had widely
reported a statement Belka made that the two sides would
examine prospects for Ukrainian electricity exports to
Poland. Trymucha said that Belka is trying to play up the
meeting's achievements. The reality is that Poland looked a
year ago at the prospect of buying electricity from western
Ukraine, but decided it was simply too costly. Poland is
working first with the EU to ensure it joins the European
electricity grid (UCT),which it is most likely to do through
a connection through Silesia to the Czech Republic. Poland
will probably wait for UCT plans to link the EU's system to
Ukraine by 2008 before investing in any projects to link
systems over the border. Trymucha said Poland could decide
over time to import electricity from Ukraine if it developed
problems meeting its Kyoto emissions targets in coming years.

--------------
Other Areas of Cooperation:
--------------


11. (SBU) Polish papers report that Ukraine expressed
considerable interest in bidding on the privatization sale of
the Huta Czestochowa steel mill. A Ukrainian firm, Donbas,
is reported to have submitted a lower bid than the Indian
steel company, LNM, although the latter has until April 13 to
better Donbas' offer. At the end of February, Treasury
Minister Socha told Econoff that Donbas had submitted a good
offer, and had a good chance of winning the tender, although
he noted price would be the most important factor in making
the final decision.


12. (U) Polish papers also reported that the two prime
ministers agreed to develop a project with Russia to link
their rail systems. In cooperation with a consortium of
investors, including the American firm DEC, Polish Railways
(PKP) developed new technology in 2004 which allows rail cars
to move from European track to Russian gauge track without
offloading their cargo. PKP hopes that this will allow
greater traffic flows with Russia and Ukraine, starting with
passenger service and eventually expanding to freight.

Comment:
--------------


13. (C) The GOU's declaration of support for the westward
orientation of the project is very important in reassuring
potential shippers like Chevron. Even more important,
Ukraine and Poland refrained from "re-reversing" the pipeline
until an alternative has been developed. Finalizing the
much-delayed business plan will be the next step, which
should help illuminate the key questions both Poland and
Ukraine need to address if this project is to be realized
(e.g., tariffs and taxes). Completing the business plan will
make the project look both more commercial, encouraging
potential shippers to take one more look, and less political,
potentially opening the door for a face-saving end to Russian
opposition. Unfortunately, as history has shown, the
remaining steps may not be easy for the parties to complete.
Upcoming Polish elections may also slow the process of GOP
decision-making, although the opposition parties generally
support OBG as a means of increasing Poland's energy security.


ASHE