RUSSIA: E/CBA FRANK MERMOUD'S ENERGY DISCUSSIONS

C O N F I D E N T I A L SECTION 01 OF 03 MOSCOW 011256

SIPDIS

SIPDIS

DEPT FOR EUR/RUS WARLICK, HOLMAN, AND GUHA
DEPT FOR EB/ESC/IEC GALLOGLY AND GARVERICK
DOE FOR HARBERT/EKIMOFF/PISCITELLI
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: RUSSIA: E/CBA FRANK MERMOUD'S ENERGY DISCUSSIONS

REF: MOSCOW 10984

Classified By: Acting ECON M/C Laura Lochman. Reasons 1.4 (b/d).


1. (C) Summary: During his September 18-21 visit to Moscow,
E/CBA Frank Mermoud's GOR and private sector interlocutors
described continued GOR debate on new subsoil and strategic
sectors legislation, growing displeasure with Production
Sharing Agreements (PSAs) coupled with assurances that
existing agreements will be honored, conflicting views on the
need for additional foreign investment in the energy sector,
and clear-eyed analyses by U.S. energy companies on the need
for Kremlin support for their activities here. Rosneft's
Chief Financial Officer (CFO) Peter O'Brien was upbeat on
Rosneft's cooperation with ExxonMobil on the Sakhalin-1 PSA,
and did not expect Gazprom to use the same aggressive tactics
to get into the project as it is using to get into Shell's
Sakhalin-2 PSA. End summary.

Subsoil Law: Ongoing Debate
--------------


2. (C) Chairman of the Duma's Committee on Natural Resources,
Natalya Komarova, confirmed that the GOR is still reviewing
the proposed new subsoil law, originally introduced to the
Duma in mid-2005 and recalled by the GOR for improvements in
November of last year. Meanwhile, amendments to the current
subsoil law are passing through the Duma. Komarova observed
that while the new subsoil law and the proposed strategic
sectors laws, both of which will outline restrictions on
foreign investment in the energy and other &strategic8
sectors, are not temporally linked, their contents are
logically being closely coordinated.


3. (C) In response to Mermaid's observation that clear rules
of the road are needed for investors, Komarova retorted that
the current subsoil law is functional, and assured that any
new legislation would preserve the sanctity of contracts
negotiated under current legislation. She added that
Russia's energy sector was so large and attractive that the
oil majors will not turn their back on Russia, regardless of
any uncertainly surrounding new legislation.


4. (C) Commenting on the proposed new subsoil law, Chairman
of the Duma Committee on Energy, Transport and
Communications, Valeriy Yazev, linked the decreasing
thresholds under which oil and gas deposits would be
considered &strategic8 (and therefore fall under foreign
investment restrictions) to barriers to Russian investment in
the EU,s downstream markets. He also asserted that Russia's
energy sector was attractive enough to domestic investors
that there was no need for any special legislative regime
aimed at attracting foreign companies.


5. (C) Anatoliy Yanovskiy, Director of the Department of Fuel
and Energy Complex, Ministry of Industry and Energy was not
certain that the inter-agency consensus on the subsoil law
will be reached before the end of this year. Yanovskiy noted
that the subsoil law will put in writing what would be
considered "deposits of strategic importance." He argued
that this law will establish a clear and transparent basis
for deposits in designated fields.


6. (C) Meanwhile, U.S. energy majors and energy services
companies told Mermoud that while they continue to hope for a
new subsoil law with clear rules of engagement, they will
still need to rely on support from a handful of people in the
Kremlin to conclude deals and ensure their continuity. One
company told us that even under current legislation, they
would be open to taking a 49% stake in collaboration with a
Russian company to tap unexplored Western Siberia resources.


PSAs: We Don't Like Them, but We'll Respect Them
-------------- ---


7. (C) Duma Natural Resources Committee Chair Komarova
welcomed foreign partners, investment and technology,
particularly as relates to deep drilling. However, she made
no bones about her dislike of Production Sharing Agreement
(PSA) legislation, under which several oil and gas projects
on Sakhalin Island are being developed. While she
characterized PSAs as bad deals for Russia that are no longer

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reflective of the current investment climate, she asserted
that the terms of the current projects should be fully
respected. She also expressed concern about the recent
aggressive inspections of the PSA projects by Russian
oversight agencies reviewing compliance with environmental
regulations, commenting that the agencies, status and
competencies lacked clarity.


8. (C) Duma Energy Committee Chair Yazev told Mermoud that
the PSA schemes were necessary to attract foreign investment
in the turbulent 1990,s, but were no longer relevant.
Russia does not need foreigners, capital or technology, he
claimed. What Russian companies need is equitable and
reciprocal access to foreign energy markets. Yazev did
concede that as long as foreign companies currently
developing Russian energy resources observed Russian law,
they should be allowed to continue their work. While he
rejected foreign help in developing Russia's oil and gas
reserves, he welcomed U.S. company assistance in
manufacturing machinery for the sector.


9. (C) Yanovskiy of the Ministry of Industry and Energy
asserted that the integrity of the PSA contracts will be
maintained, and that there was no attempt by the GOR to roll
back, re-write or revoke the terms of the PSA agreements.
That said, he noted that there was significant concern about
the budget over-runs of Sakhalin-2, and argued that it was
understandable that there would be a peer and partner review
of the costs. He downplayed the possibility of political
considerations as being behind the review of Sakhalin-2.
Yanovskiy said the Ministry was pleased with the progress of
the project itself, with LNG-planned construction nearly
complete as well as the north-south pipeline.

Rosneft: Minding Its Domestic Business
--------------


10. (C) Rosneft's CFO Peter O'Brien (please protect) reported
that Rosneft worked closely and well with majority partner
ExxonMobil on the Sakhalin-1 oil and gas PSA. O'Brien was
optimistic that the additional reserves recently discovered
in the Chayvo field, not originally mapped out under the PSA
but adjacent to it, would eventually end up with the PSA
either through a GOR decision or Rosneft acquisition of the
reserves via auction (Reftel). He was not concerned that
Gazprom would subject the Sakhalin-1 project to the same
aggressive tactics employed vis-a-vis Shell's Sakhalin-2 PSA,
since there were plenty of ways to "bring Gazprom in." One
of them could be to sell Sakhalin-1's gas to Gazprom just
prior to exporting it so that Gazprom could maintain its
export monopoly.


11. (C) Regarding Rosneft's strategic plans, O'Brien said
that the company is focused on its domestic operations and
was not looking to launch serious overseas ventures at this
time. One reason is the asset valuation gap, by which
Russian assets are discounted due to difficulties in getting
the oil out of the ground, political risks, etc., and
therefore undervalued vis-a-vis foreign assets. Rosneft
prefers to wait until the gap narrows or vanishes so it can
negotiate on more favorable terms. O'Brien stressed that
Rosneft can narrow its own valuation gap by being more
responsive to its shareholders and working in an open and
transparent manner. Domestically, Rosneft sees continued
opportunities in Western Siberia, and fewer in East Siberia.
Rosneft knows the Western Siberia fields well, and has no
real need for Western partners.

American Businesses Concerned about WTO
--------------


12. (C) Representatives from leading American companies,
including Boeing, Merck and Citigroup and AIG, as well as the
president of the American Chamber of Commerce expressed
concern that if a WTO bilateral agreement were not reached,
there would be a negative spillover for their businesses in
Russia. Failure to reach agreement, they argued, would be
blamed, regardless of the actual situation, on the United
States, and could trigger a backlash against American
consumer products. If an agreement on WTO were reached,
these executives, already bullish on the Russian economy,
said they would be even more sanguine about Russia's market
potential for American consumer products and financial

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services.


12. (U) E/CBA Mermoud cleared this message.
BURNS