ARMENIA HOPES FOR A DEAL ON GAZPROM'S THREATENED

C O N F I D E N T I A L SECTION 01 OF 03 YEREVAN 002129 SIPDIS E.O. 12958: DECL: 12/07/2015 TAGS: ECON ENRG AM RU SUBJECT: ARMENIA HOPES FOR A DEAL ON GAZPROM'S THREATENED PRICE INCREASE REF: A) KIEV 4897 B) CHISINAU 1476 C) YEREVAN 2118 D) YEREVAN 1725 Classified By: Amb. John M. Evans for reasons 1.4 (b,d). -------------- SUMMARY -------------- ¶1. (C) Despite Gazprom's recent announcement that, as of January 1, 2006, it plans to double the price of natural gas exports to Armenia, the GOAM appears to be holding out hope that it will be able to negotiate a deal to minimize the impact of and/or delay the price increase. According to press reports, President Kocharian discussed the matter with Russian Prime Minister Mikail Fradkov, who recently visited Yerevan, but no agreement was reached. Deputy Minister of Energy Areg Galstyan told us that such a large increase in gas prices on such short notice would be a "colossal problem" for Armenia. According to Galstyan, the price increase also would violate a verbal agreement that Kocharian had with Gazprom to maintain the current rate of USD 55 per thousand cubic meters for the next two years. While the GOAM is working to minimize and/or delay the rate increase, the Deputy Minister appeared resigned to the fact that Armenian consumers eventually would have to adjust to paying world prices. End Summary. -------------- GAZPROM TO DOUBLE NATURAL GAS PRICE -------------- ¶2. (C) On November 29, Gazprom Deputy Chairman Aleksandr Ryazanov announced that, as of January 1, 2006, Gazprom plans to double the rate charged per thousand cubic meters of natural gas imported by Armenia from the current USD 55 to USD 110. According to ArmRusGazprom's General Director Karen Karapetyan, Armenia will import 1.7 billion cubic meters of gas from Russia in 2005, up from 1.33 billion cubic meters in ¶2004. The Armenian press has speculated about a pending rate increase for months, but the timing of the announcement seems to have caught both the GOAM and the Armenian public by surprise. The rate change coincides with proposed rate increases for many other CIS countries (refs A and B). Rates for Armenia and Georgia, however, would be lower than the rates that, we understand from press reports, have been proposed for other CIS countries: Moldova ) USD 160, Ukraine - USD 160, the Baltic States - USD 125. During his visit to Armenia on December 2-3, Russian Prime Minister Fradkov claimed the price increase was not politically motivated and reflected changes in the world energy market. He called for understanding on the part of the Armenian government. -------------- - KOCHARIAN'S "DEAL" MAY NOT BE A DEAL AFTER ALL -------------- - ¶3. (C) On December 6, we discussed the proposed rate increase with Deputy Minister of Energy Areg Galstyan. He appeared to have been surprised and disappointed by Gazprom's announcement because the GOAM was under the impression that Kocharian had struck a deal with Russia to fix gas prices. In October, President Kocharian told Assistant Secretary Fried that Armenia had obtained a fixed price of USD 55-56 from Gazprom for three years and two years remained on the deal. According to Kocharian, the fixed price was part of an agreement by which some Armenian debts to Russia were liquidated and Russia obtained shares in Armenia's gas monopoly, ArmRusGazprom. (Note: Gazprom controls 45 percent of ArmRusGazprom and the Russian gas company Itera controls an additional 10 percent. End Note.) Despite Kocharian's earlier comment to Fried that a deal is a deal, Galstyan told us that to his knowledge there was no written agreement. He suggested that the GOAM was resigned to an eventual price increase to near world market levels, but believed the increase should be gradual and over time. -------------- A POTENTIAL "NIGHTMARE" -------------- ¶4. (C) Galstyan told us that if there was no agreement and the price of gas increased to USD 110 on January 1, it would be a "colossal problem" for the government. He explained that the GOAM had been working on the assumption that the three-year agreement would hold. Following the advice of international experts (including USAID experts),the GOAM has been encouraging citizens to convert their residential heating to natural gas because it is more efficient than heating with electricity. Furthermore, the GOAM has been working to improve collection rates on both residential and business energy services. The proposed price increase would be a "nightmare" according to Galstyan, and would have a particularly devastating effect on the Armenian poor. -------------- BOTH COMPANIES AND CONSUMERS WILL SUFFER -------------- ¶5. (C) Ironically, the price increase would negatively impact many Russian-owned energy companies in Armenia as well. Russian companies own approximately 55 percent of ArmRusGazprom, and RAO-UES recently acquired a controlling stake in the Armenian energy distribution network ENA (ref D). The Hrazdan Power Plant, which relies on natural gas as an input, is also Russian-owned as a result of a debt-for-equity swap in 2002. Hrazdan accounts for less than 20 percent of local electricity production and USAID contractor PA Consulting estimates that if the entire gas price increase is passed through to retail customers, the average end-use electricity tariff in Armenia would increase by approximately 20 percent. Acting Chief of Party for PA Consulting Armen Arzumanyan noted that the GOAM could use existing profit from plant revenues to minimize the impact of the price hike. According to Arzumanyan, it will be more difficult to shield the approximately 500,000 consumers who use natural gas for residential heat and the many Armenians who use natural gas to power their cars. These consumers, because they use natural gas directly, could conceivably see their rates double. Deputy Minister Galstyan told us, and the Armenian Prime Minister and other GOAM representatives have publicly stated, that the GOAM will try to minimize the impact of any price increase on consumers. -------------- - PRESS SPECULATION ABOUT A DEAL CONCERNING IRAN -------------- - ¶6. (SBU) On December 6, the Russian National News Agency (ANN) reported that Russia offered to lower the tariff increase to "an insignificant level" if the GOAM were to agree to limit natural gas imports from Iran. The press report stated that the Armenian President and Russian Prime Minister had discussed such a deal during Fradkov's visit but failed to reach agreement. Unidentified Armenian politicians were quoted in the local press saying that the proposal violated Armenia's economic sovereignty and was an inappropriate intervention in Armenian-Iranian relations. ¶7. (C) Galstyan was unaware of this story until we brought it to his attention. He questioned the credibility of the report and noted that limiting ties with Iran would leave Armenia even more vulnerable to Russian manipulation in the energy sector. Recently, there has been an increase in cooperation between Armenia and Iran on energy issues (ref C). He qualified his statement, however, by saying there were certain conversations during the Fradkov visit in which he did not take part. -------------- GEORGIAN THREATS "NOT SERIOUS" -------------- ¶8. (C) Galstyan was aware of reports that Georgia has threatened to increase the transit rate on natural gas sent from Russia through Georgia to Armenia if Armenia is able to negotiate a price lower than Georgia's. The Georgian government allegedly would design the transit rate increase so that Armenia's final price matched Georgia's. Galstyan initially described such threats as "not serious" because they would mean increasing the transit rate from the current USD 6 per thousand cubic meters to USD 30 or more. Later in the conversation, Galstyan said that charging such excessive transit fees for apparently political reasons would violate international norms and asked what the U.S. reaction would be if Georgia instituted such a policy. He reflected that Armenia had been trapped when Russia stopped shipments of gas to Georgia when it closed its southern border following the Beslan school tragedy. ¶9. (C) Galsytan said that the price of electricity Armenia exports to Georgia would rise if there was an increase in the cost of gas. Export prices are based on the cost of electricity produced at the thermal power stations. Seventy percent of the cost of that power is the gas itself. Only internal consumers have access to the less expensive power produced by Armenia's nuclear plant and its various hydro sites. -------------- COMMENT: NOT MANY OPTIONS -------------- ¶10. (C) The GOAM appears hopeful that it will be able to minimize the impact of the Gazprom price increase, but it is in a very poor position to negotiate. While the GOAM may succeed in delaying the price increase, Armenia remains heavily dependent on Russian energy and Armenian consumers eventually will have to adjust to paying world-market prices. The GOAM regularly expresses concern over Armenia's lack of energy independence and may use Gazprom's price increase to justify the continued operation of the unsafe Armenian Nuclear Power Plant or to explain the apparent deepening of energy ties between Armenia and Iran (ref C). EVANS