RUSSIAN OIL TO LITHUANIA -- MIXING REVENGE AND BUSINESS

C O N F I D E N T I A L SECTION 01 OF 03 MOSCOW 009482



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: 08/29/2016

TAGS: EPET, ENRG, ECON, PREL, LH, RS

SUBJECT: RUSSIAN OIL TO LITHUANIA -- MIXING REVENGE AND

BUSINESS



REF: A. WARSAW 1592



B. VILNIUS 801 AND PREVIOUS

C. MOSCOW 8340



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



1. (C) Summary: As is often the case in Russia's relations

with its neighbors and former Soviet comrades, Moscow's

decision to shut-off crude deliveries to Lithuania's Mazeikiu

Nafta (MN) refinery in the wake of a July 29 oil spill along

the Druzhba pipeline (Ref C) appears driven by a mix of

geopolitical revenge and common-place commercial

considerations. The good news may be that there is little

more the Russians can do to worsen the situation (like cut

off shipments from Primorsk to Butinge) and the refinery is

unlikely to fold. The bad news is that refinery profits are

likely to suffer until there is another shift in the oil

delivery paradigm facing MN. End Summary

.

FIRST THE REVENGE

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.

2. (C) In the wake of the cutoff of Russian oil through the

Druzhba pipeline to MN, we spoke to Shawn McCormick

(protect),TNK-BP's government affairs rep, whose company is

one of Russia's largest shippers. He said despite losing out

to PKN Orlen in the MN bid, TNK-BP had offered to sell Orlen

about 180,000 barrels per day (b/d) (going up to 240,000 b/d)

last May-June, and that Transneft was fully on-board with

this offer. Then in early July, Igor Sechin, Chairman of

Rosneft (another Russian firm who lost out on the MN bid) and

Deputy Head of the Presidential Administration, phoned German

Khan, Executive Director at TNK-BP, asking if the oil

delivery contract had been signed. Upon finding that it had

not, Sechin "instructed" TNK-BP (via Khan) to withdraw its

offer, which it did. In an August 29 conversation, Andrey

Gaidamaka (protect),Lukoil's VP for Strategy, confirmed for

us that Sechin was the interested party behind the cutoff in

the Kremlin and that Lukoil and TNK-BP were still under

pressure not to contract with MN for piped oil.

.

3. (C) In August 22 conversations with Emboffs, Gintautus

Siulys and Minijus Samuila of the Lithuanian Embassy

characterized the shutdown of the pipeline as a political

decision taken at a "very high level" to make Orlen drop its

bid for MN, which awaits EU approval, expected in October.

Despite all this, Siulys and Samuila seemed cautiously

optimistic that the oil supply issue would be resolved soon

in Lithuania's favor. Siulys suggested the Russians might

ultimately back down out of fear the Lithuanians might shut

down the rail link to Kaliningrad (supposedly to make

repairs). As soon as Lithuanian officials began hinting at

problems with the rail link, Siulys noticed a change in

Russian behavior, adding, "in our experience with the

Russians, we always do better when we negotiate out of a

position of strength." He pointed out that not only do

Russian civilians rely on the rail link, but the line is

critical for supplying Russian military forces in the

Kaliningrad Oblast.

.

COMMERCIAL CONSIDERATIONS

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.

4. (C) Over the last several years, Russia has adopted a

policy of avoiding export across transit states. Lukoil's

Gaidamaka offered a pretty convincing explanation. Even

though the Druzhba was clearly built more for political

purpose than anything else, Gaidamaka explained that during

the Soviet era the pipeline made more economic sense than it

does today. Today, each country along the pipe charges a

transit fee, making the route much less attractive for

Russian shippers. Following the break-up of the Soviet Union

and the extinguishing of the "friendship" in the "friendship

pipeline," downstream consuming countries colluded, forcing

shippers to sell into a monopsonistic market, which led to a

"Druzhba discount" relative to other routes.



5. (C) Over the past several years, the GOR and Transneft

have taken several steps to reduce the power of the

downstream traders and have virtually eliminated the "Druzhba



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discount." The most important component of this effort has

been the expansion of the Baltic Pipeline System (BPS),whose

nameplate capacity Transneft just announced it plans to

increase further from 1.2 to 1.4 million b/d. Before long,

Gaidamaka predicted a "Druzhba premium" will emerge. This

jives with what we have heard from numerous Russian oil

companies -- it is simply cheaper to export out of Primorsk

than out of Baltic ports because of Transneft's lower transit

fees.

.

6. (C) With piped oil stopped, rumors were rife that the

Kremlin might "order" Russian shippers to stop tanker cargoes

from Primorsk to Butinge to completely deprive MN of Russian

oil, but these appear unfounded. McCormick says that there

is "absolutely no pressure coming from the Kremlin to stop

shipments of oil from Primorsk." Our Lithuanian Embassy

contacts confirm that tanker shipments from Primorsk to the

oil terminal at Butinge in Lithuania have not been

interrupted, and they doubted that the GOR would intervene

with private Russian shippers. Oil traders at Lukoil,

Surgut, TNK-BP, and Gazpromneft confirm they have not

received any order to stop shipments out of Primorsk,

something Gaidamaka corroborated as well on behalf of Lukoil

senior management. These and other international traders say

that to stop such deliveries would require Russian firms to

include in their crude sale contracts a clause forbidding

on-sale of crude to Butinge, something they describe as

"virtually impossible" -- western majors would never agree,

and they are a crucial link in this chain. One trader said,

"It would be a major violation of free trade and I'm very

skeptical that it is feasible. If I see that Butinge offers

the best price, I'll do my best to buy a Russian cargo and

resell it to Butinge."

.

TRANSNEFT AND MFA: FIXES ARE COMING,

BUT CAN'T SAY WHEN

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.

7. (C) When we talked to Transneft this week, our contact

stuck to the company's public line that shipments to

Lithuania are a casualty of the July 29 oil spill on the

Northern Druzhba pipeline. He said that experts from

Rosteknadzor are investigating the spill, and had visited the

site August 21-23 to &make clear what had happened and what

needs to be done.8 Repairs are pending the outcome of

Rosteknadzor's investigation. Arkadiy Sundeyev, Director of

the MFA,s Office of Lithuanian Affairs, told us August 25

that he believed Rosteknadzor's pipeline investigation could

be completed in a matter of weeks. He said this issue was

not "political . . . We want to make the repairs and resume

supplying oil as soon as possible." Traders with close ties

to oil traders here confirm reports that Belarusian

refineries normally supplied from the Northern Druzhba are

still receiving oil. To that, our Transneft contact said

that after the accident, Transneft restored some flow through

&temporary fixes8 although the pressure had to be reduced

so the amount of oil flowing is off sharply.

.

COMMENT

--------------

.

8. (C) Given the history of this pipeline and MN, it is not

surprising that revenge appears to be playing a significant

role in the process of bringing the Druzhba back up to

capacity, and we do not put it past Sechin to at least try

and stop Russian shippers from supplying Primorsk. One

interesting item of note in this case is the degree to which

Sechin and his interests have been unable to stop Russian

companies/traders from supplying the refinery, who follow

Russian practice of f.o.b. (free-on-board) delivery. MN can

just as easily, if more expensively, buy barrels from

non-Russian sources, and the international oil majors' are

reluctant to agree to contracts excluding Butinge -- both of

these facts give Lithuania and Orlen leverage to fend off

whatever Russian demands may actually be behind this

situation. When conditions are right, Russia's ability to

use energy as a weapon (even when the will may be there) is

limited.

.

9. (C) How this will all unwind is still not clear. The



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Rosteknadzor report will come before too long, and repairs

will no doubt drag well into the fall. Despite Siulys,

optimism that the Russians might back down over the rail line

issue, we doubt there is much leverage to be found here, nor

can the Russians credibly threaten to go around Lithuania to

Kaliningrad via ferry, as suggested this week by Kaliningrad

Oblast Governor Georgiy Boos during a meeting with Putin.

Perhaps Lukoil's Gaidamaka is right to predict that the piped

oil will flow again, but perhaps with a Druzhba premium.

BURNS