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 �0A;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 MOSCOW 00011256 002 OF 003 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 MOSCOW 00011256 003 OF 003 services. ¶12. (U) E/CBA Mermoud cleared this message. BURNS