RUSSIAN ENERGY:CASPIAN PIPELINE CONSORTIUM UPDATE

C O N F I D E N T I A L SECTION 01 OF 02 MOSCOW 010777

SIPDIS

SIPDIS

DEPT FOR EUR/RUS WARLICK, HOLMAN, AND GUHA
DEPT FOR EB/ESC/IEC GALLOGLY AND GARVERICK
DOE FOR HARBERT/EKIMOFF
DOC FOR 4231/IEP/EUR/JBROUGHER
NSC FOR GRAHAM AND MCKIBBEN

E.O. 12958: DECL: 01/26/2016
TAGS: EPET ENRG ECON PREL RS
SUBJECT: RUSSIAN ENERGY:CASPIAN PIPELINE CONSORTIUM UPDATE


Classified By: Econ M/C Pamela Quanrud. Reasons 1.4 (b/d).


1. (C) Summary. This fall the Caspian Pipeline Consortium
(CPC) faces both its long-awaited expansion decision and a
serious tax case being brought against the CPC's Russian
(CPC-R) operations. Expansion will once again be on the
agenda of the September 27-28 shareholders meeting, where
western shareholders are expected to react to a GOR/GOK MOU
signed in July that lays out one possible way forward for
expansion. The tax case, which threatens to cost the
consortium's Russian operations $700-800 million in back
taxes and penalties, has already made it through its first
test in court, and CPC-R's appeal will be heard in November.


2. (C) New CPC General Director, Vladimir Razdukhov told us
September 19 that he is hopeful he can find a way to
synthesize Russian and Western shareholder interests to allow
the expansion to proceed before the technical studies done
two years ago in preparation for the expansion expire at
year's end. Ian MacDonald, Razdukhov's predecessor and new
head of Chevron (please protect) is also quietly optimistic
that a way forward can be found on expansion, which would
pave the way for Chevron to participate in the
Burgas-Alexandroupolis (BA) Bosporus bypass pipeline. End
Summary.
.
Expansion Plans
Still in Play
--------------
.

3. (C) In separate conversations with Razdukhov and
MacDonald, both said much is hanging on the reaction of
western shareholders this coming week to a July 1 MOU signed
between the GOR and GOK (Energy Ministers Khristenko and
Bakhtvkhoza),which outlines the conditions under which both
governments are prepared to move forward with CPC expansion.
Razdukhov characterized the MOU as a breakthrough in the
GOR's policy toward CPC expansion, but realistically assessed
that western shareholders would unlikely accept the terms of
the MOU without amendment. MacDonald expressed a similar
confidence that a reasonable way forward could be found based
on the MOU, but was unsure if ExxonMobil, in particular,
wanted the deal badly enough at this point in time. We have
not seen the MOU, but both Razdukhov and MacDonald tell us it
addresses the underlying financial structure of the
consortium, something the GOR has sought for years, and
MacDonald's comments suggest that the MOU could be the basis
for a way forward -- at least for Chevron.


4. (C) Timing is also an issue, as the technical study which
lays the groundwork for the expansion is set to expire at the
end of this year. Should the shareholders not find a way
forward by then, the consortium would be forced to decide
whether to commission and pay for a new study, something both
Razdukhov and MacDonald hoped could be avoided.
.
The Tax Issue
--------------
.

5. (C) Razdukhov and MacDonald outlined for us as well a new
issue facing the Russian operations of the consortium -- a
tax case which alleges that CPC-R has been improperly
claiming a deduction for interest on its debt payments.
CPC-R received assurances in writing from Deputy Finance
Minister Sergey Shatalov in 1996 that the interest payments
were legal, and subsequent changes to the tax code would seem
to confirm that opinion. Nevertheless, CPC-R lost an appeal
in administrative court two weeks ago, and has begun to make
installment payments on some $175 million in back taxes for
2002 and 2003. Cases are being opened for tax years 2004 and
2005 right now, based on the same allegations. All told, if
the court rules consistently against CPC-R, the consortium
will owe some $700-800 million in back taxes and penalties,
and will face an annual increase in it tax obligation in
excess of $100 million. MacDonald, as the head of CPC-R
during this period, is worried that criminal charges could be
brought against him as well. (Note: the magnitude of the tax
claim against CPC-R could automatically throw the case into
criminal court, but this has not happened as yet.)


6. (C) CPC-R lost its first trial in the case two weeks ago.
The appeal will be heard in November. According to
MacDonald, CPC has always won these types of cases on appeal

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in the past, but he was hesitant to predict victory this
time. Razdukhov was more hopeful that the consortium would
win on appeal. Should the appeal be unsuccessful, then the
case will go to the Court of Cassation in March. If, in the
end, the case goes against CPC, MacDonald predicted Chevron's
senior management would lose its appetite for CPC expansion.
.
The BA Bypass Pipeline
--------------
.

7. (C) When asked to comment on Chevron's interest in BA,
MacDonald stated simply, "If CPC is expanded we will
participate; if it isn't, we won't. We've told the Russians
that." He also confirmed Chevron's position that the Greek
and Bulgarian governments should not get a stake in the
consortium was just an opening negotiating position.
However, while not giving us a firm number, he did indicate
that his company would not agree to Greece's and Bulgaria's
push for a one-third stake.
.
Comment
--------------
.

8. (C) The quest for CPC expansion continues, and much of
what we report here is similar to previous turning points: a
three-month deadline; tension between the western and Russian
shareholders and between the two major western shareholders;
and external pressure being brought to bear -- this time in
the form of a tax case. What may be different this time is
Razdukhov, who brings a Russian accent to CPC's front office
and with it longtime relationships within the GOR --
including with PM Fradkov, who was Minister for Foreign
Economic Relations (MFER) during Razdukhov's stint as MFER
Deputy Minister. Razdukhov talked about two possible paths
forward for CPC: either find a way forward amicably on
expansion, or take the consortium into bankruptcy, which
would put it in international arbitration. MacDonald had
always shied away from the latter option as head of CPC, but
Razdukhov seems willing to put it more clearly on the table.
This will certainly change the dynamics in the room, but in
ways which Razdukhov himself admits will be unpredictable.
However, he did not, he tells us, take over CPC to watch over
its demise. This week's shareholder meeting will be the
first test of whether he has the skills to keep the
consortium together.
.

9. (C) On the tax problem, the Ambassador will raise this
issue when he meets later this week with Finance Minister
Kudrin. Regarding BA, neither MacDonald previously nor any
other Chevron official we have spoken to has been as blunt as
this regarding Chevron's stance on BA. Without Chevron's
oil, BA's economics deteriorate but we suspect that, if the
GOR wants BA enough, they will find a way to get enough
Russian oil into the pipeline.
BURNS