RUSSIA, SERBIA SIGN MOU ON PIPELINE

UNCLAS BELGRADE 002062

SIPDIS

C O R R E C T E D COPY-ADDRESSEE ADDED

SENSITIVE
SIPDIS

E.O. 12958: N/A
TAGS: ENRG ECON EFIN PGOV EIND SR
SUBJECT: RUSSIA, SERBIA SIGN MOU ON PIPELINE

REF: A) Belgrade 404; B) Belgrade 1285

SUMMARY
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1. (SBU) The Serbian Government (GOS),state-owned gas company
Srbijagas and Russian Gazprom-Gazexport signed a Memorandum of
Understanding (MOU) in Moscow on December 20 that establishes a
framework for future cooperation and a possible agreement with
Gazprom on extension of the Blue Stream gas pipeline from Turkey
towards northern Italy. Just days before, Srbijagas had signed a
new gas supply agreement for 2007 with Yugorosgaz, a shady
Gazprom-linked company with its origin in the Milosevic era, instead
of with Gazprom. The apparent link between the gas supply and the
pipeline project demonstrates not only Gazprom's penchant for
playing games, but also the readiness of the Kostunica government to
play along with Russia. END SUMMARY.

MOU FINALLY SIGNED
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2. (U) At a press conference on December 20, Prime Minister Vojislav
Kostunica, Economy Minister Predrag Bubalo and Russian Ambassador
Aleksandar Aleksejev announced that a Memorandum of Understanding
(MOU) between the GOS, state-owned gas company Srbijagas and Russian
Gazprom-Gazexport had just been signed in Moscow. This MOU,
approved by the GOS on November 16, is a non-binding document that
establishes a framework for future cooperation and a possible
agreement with Gazprom on construction of a 400 km gas transit
pipeline through Serbia worth approximately USD 1.3 billion (reftel
B). However, Minister Bubalo said at the press conference that both
sides are committed to implementing this important project.


3. (U) The gas transit pipeline through Serbia would extend the
"Blue Stream" pipeline that feeds gas under the Black Sea to Turkey,
through Bulgaria, Serbia, Croatia and onward to northern Italy. The
construction cost in Serbia is estimated at USD 1.3 billion, and the
total project, at some USD 15 billion. The total capacity of the
pipeline would be some 20-25 billion cubic meters of gas annually,
compared to Serbia's annual consumption of close to 3 billion cubic
meters. Aside from Serbia, only Italy had signed an MOU with
Gazprom. Press reports indicate that Bulgarian gas company
Bulgargaz will soon sign a new agreement with Gazprom on increasing
gas supplies from Russia and on usage of Bulgarian gas pipelines for
transporting gas to the Western Balkan countries.

BENEFITS FOR SERBIA
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4. (U) Bubalo said that the next step is to appoint experts from
both sides to work out technical issues necessary for
implementation; he predicted completion of the deal within six
months. He explained that the pipeline will follow the defined line
of the future highway from Serbia to Bulgaria where the land has
already been expropriated by the state. Construction should begin in
autumn 2007 and be completed by 2010.


5. (U) Milutin Prodanovic, Assistant Minister for State-Owned
Enterprises at the Ministry of Energy, explained that Serbia would
receive significant benefits from Blue Stream. Serbia could receive
EUR 200 million per year from transit revenues, depending on the
specifics of the future agreement (reftel B). In addition, Serbia
would have an alternative route for gas supply; now there is only
one source, the pipeline carrying Russian gas through Ukraine and
Hungary (reftel A). An alternative route, from Bulgaria (entering
Serbia from Dimitrovgrad and heading to Nis) would provide Serbia
with greater supply security. Prodanovic also explained that the
167-kilometer Nis-Dimitrovgrad gas pipeline, worth around USD 65
million, would become a starting point of the extended Blue Stream
in Serbia (reftel A). Construction of Nis-Dimitrovgrad gas pipeline
would enable further internal gasification of 400,000 households in
Central and Southern Serbia.

CONDITIONALITY FROM GAZPROM SIDE
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6. (U) When it comes to construction, Gazprom will manage its
operations in Serbia through Yugorosgaz, says Milos Saramandic,
former investment director at Srbijagas and now working in its
financial department. Yugorosgaz was established as a joint venture
between Gazprom and various Serbian companies back in 1996 to manage
the distribution of Russian gas and investment in gas infrastructure
in Serbia based on two intergovernmental agreements between Russia
and Serbia from the 1990's (reftel A). Just days before the
pipleline MOU was signed in Moscow, Srbijagas on December 18 signed
a new annual agreement for 2007 gas deliveries with Yugorosgaz as a
representative of Gazprom. Srbijagas sources told us that Gazprom
required that Srbijagas sign the 2007 gas supply agreement with
Yugorosgaz, instead of Gazprom.

7. Laza Djurdjevic, Assistant to the Executive Director for
Technical Operations said that the current price that Srbijagas is
paying to Gazprom is USD 260 per 1,000 cubic meters of gas and it
should stay the same since the price of gas is not defined by the
new agreement but is counted according to the specific methodology.
In addition, Srbijagas is paying USD 25 per 1,000 cubic meters to
Hungarian gas company MOL as a transit tax. The deal with
Yugorosgaz as a mediator will increase the total cost to Srbijagas,
said Saramandic. Furthermore, Saramandic said that the stability of
gas supply is at risk since Yugorosgaz has not provided any bank
guarantees for this business worth millions of dollars.


7. (SBU) These agreements from the Milosevic era have never been
confirmed nor rejected by successive democratic governments since
2000, and the status of Yugorosgaz is undefined. Some claim that
these contracts give the Russians exclusive rights to build gas
pipelines in Serbia, although some GOS officials have told us that
the old agreements only permit Yugorosgaz to bid equally with other
bidders in public tenders for any potential projects (reftel A).
Srbijagas deals gingerly with this issue because of its dependence
on Russian gas and its huge debt of approximately USD 235 million to
Gazprom. However, due to the agreement that Serbian Minister of
Economy Predrag Bubalo and Russian Minister of Emergency Situations
Sergei Shoigu initialed on December 13 in Moscow, part of the
Serbian gas debt in the value of USD 188 million will be settled
through the clearing debt of the former USSR toward Serbia. The
total value of the clearing debt is USD 288 million. The rest of
USD 100 million will be used for the general overhaul of the Djerdap
hydroelectric power plant. The amount Serbia is entitled to in the
form of interest will be used for the construction of an accelerator
at the Vinca Nuclear Institute.


8. (SBU) Zorana Milanovic Mihajlovic, formerly energy adviser to
ex-Deputy Prime Minister Labus, said that by signing this new
agreement for gas deliveries with Yugorosgaz, the GOS indirectly
accepted the Milosevic era agreements and the exclusive right of
Yugorosgaz to build gas pipelines and supply Srbijagas with Russian
gas without any public tenders or transparency. Saramandic
confirmed that Yugorosgaz has a license for building gas pipelines
and just recently received a gas trading license like Srbijagas.

YUGOROSGAZ: ANOTHER SHADOWY GAZPROM ASSOCIATE
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9. (SBU) Yugorosgaz has a twisted history in Serbia. Saramandic
said that, when established, its ownership was split 50:50 between
Gazprom and Serbian companies - state-owned oil company NIS, the
Sartid steel mill, foreign trade company Progres-Beograd, Progres
Gas Trading and Beobanka. It was agreed that NIS would have
priority purchasing rights and over time would become the majority
owner of Yugorosgaz. It is unclear why NIS did not use that option.
Another Gazprom associate, Austrian Centrex working through its
subsidiary, Turkey-based Bosphorus Gaz, bought the shares of Progres
Gas Trading and left Srbijagas with only 25 percent in Yugorosgaz,
explained both Saramandic and Milanovic Mihajlovic. (The owner of
Centrex is said to be Alexandar Medvedev, executive director of
Gazprom-Gazexport.)



10. (SBU) Saramandic explained that Progres Gas Trading was a joint
venture company between Gazprom and Progres (linked to Milosevic
cronies) to import gas from Russia during the period of sanctions,
before Yugorosgaz was established. He alleges that Progres Gas
Trading was used as a conduit for money laundering. The management
of former Progres Gas Trading which is still active in Yugorosgaz
today helped Gazprom to buy 25 percent of Progres Gas Trading in
Yugorosgaz and become the majority owner in it.

NEGOTIATION WITHOUT EXPERT OPINION
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11. (SBU) Saramandic said that the idea for extension of the Blue
Stream though Serbia originated with Srbijagas and was first
proposed by Serbian President Boris Tadic to Russian President
Putin. Putin accepted the idea and Kostunica appointed Bubalo and
Minister of Finance Mladjan Dinkic to negotiate with the Russians.
However, Srbijagas then was sidelined in the discussions. For
instance, Saramandic confirmed that the new director of Srbijagas
did not see the final version of the MOU before it was adopted.


12. Saramandic asserted that Bubalo and Dinkic did not get much
from Gazprom in return for entering the Serbian market. They
managed to include the Serbian debt to Kuwait assumed by Gazprombank
that would be settled through the Serbian allocated portion of the
transit fee but they did not receive commitments to lower gas prices
or percentages of Serbian company participation in gas pipeline
construction. These details were left for the working groups, which
takes a longer period of time and further compromises. Saramandic
said the Serbian side was told implicitly that the signing of the
2007 gas delivery agreement would be a condition for the signing of
the MOU.

POLT