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).

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SUMMARY
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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.

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GAZPROM TO DOUBLE NATURAL GAS PRICE
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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.

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KOCHARIAN'S "DEAL" MAY NOT BE A DEAL AFTER ALL
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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.

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A POTENTIAL "NIGHTMARE"
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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.

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BOTH COMPANIES AND CONSUMERS WILL SUFFER
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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.

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PRESS SPECULATION ABOUT A DEAL CONCERNING IRAN
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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.

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GEORGIAN THREATS "NOT SERIOUS"
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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.

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COMMENT: NOT MANY OPTIONS
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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