ENERGY DEPUTY SECRETARY SELL'S TRIP TO MOSCOW:

C O N F I D E N T I A L SECTION 01 OF 05 MOSCOW 001149

SIPDIS

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DEPT FOR EUR/RUS WARLICK, HOLMAN, AND GUHA
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E.O. 12958: DECL: 03/15/2017
TAGS: EPET ENRG ECON PREL RS
SUBJECT: ENERGY DEPUTY SECRETARY SELL'S TRIP TO MOSCOW:
HYDROCARBON WRAP-UP


Classified By: Amb. William J. Burns. Reasons 1.4 (b/d).


1. (C) Summary. Deputy Secretary of Energy Clay Sell visited
Moscow March 11 - 14 to participate in the bilateral Energy
Working Group (EWG) and to meet with U.S. energy companies as
well as Lukoil and Gazprom. At the EWG, there was a good
exchange of views on information exchanges, energy
efficiency, oil spill prevention, and each country's
investment climate. The Deputy Secretary met with Lukoil's
CEO Vagit Alekperov to discuss Lukoil's successful
cooperation with ConocoPhillips, with Alekperov also raising
Lukoil's projects in Iraq and Iran. Gazprom's Deputy CEO
Alexander Medvedev waxed philosophical about the rectitude of
the state's new role managing key sectors, Gazprom's efforts
to diversify markets, the need for promoters of the "southern
gas corridor" to include Russia in the game, and he
criticized Shell's management of the Sakhalin 2 project.
Energy Minister Khristenko proposed conducting a small,
bilateral seminar to discuss each countries energy policies.
Sell stressed the benefits of Russia's making a decision on
its openness to foreign investment. Khristenko agreed that
making such a decision soon is in the GOR's best interest and
predicted passage of the Law on Strategic Sectors this year.
End Summary.

ENERGY WORKING GROUP
--------------


2. (C) Sell co-chaired the EWG with his Russian counterpart
Deputy Energy Minister Ivan Materov. Sell agreed with
Materov that it had been too long since the two sides met
(about two years) but that much good had happened in the
intervening period. Sell pointed out, and Materov agreed,
that the work of the group going forward should be based on
the principles laid out at the St. Petersburg and Gleneagles
G-8 Summits. On information exchanges, the U.S. side noted
that DOE's general counsel had reviewed and commented on the
protocol dealing with transmission of statistical data and
analyses and that DOE had sent the comments to the Russian
side and is waiting for the Ministry's reaction. Materov's
colleagues noted that internal approval for over half of
DOE/EIA's suggestions for exchange of facts and energy
indicators had been approved but that the ministry is still
reviewing the propriety of releasing a handful of the
requested items. Materov agreed with Sell that information
exchange is essential for clarity and functioning markets,
observing that Russia has trouble forecasting oil market
movements, for example. Sell and Materov agreed to aim for a
signing of the information exchange protocol by the end of

2007.


3. (C) The Russian side said that the bilateral work on
energy efficiency is a natural follow-on to the G-8
Gleneagles commitments and the topic will get attention at
the next summit in Germany. President Putin stressed energy
efficiency and the ministry expects to finish drafting a law
on energy savings in March. The GOR will also try to push
legislation on renewables and other alternative sources of
energy. Materov said that it was "critical to work with you"
in writing laws and regulations in this sphere. Specifically,
Russia is working on a federal program on energy consumption
to 2015 that aims to reduce energy consumption per unit of
GDP by nearly 40% from 2006 levels. The GOR also
specifically hopes to implement a program similar to the
U.S.' Federal Energy Management Program (FEMP) to reduce
energy consumption in federally-funded governmental
facilities. For these and other energy efficiency programs,
Russia needs international technology and management
expertise, needs to share experiences, and needs a dialogue
to help shape its legislation and regulations in this sphere.
Further, the Russian side indicated that they were pleased
with the cooperation on oil spill prevention and that it
should continue.


4. (C) Regarding investment climate issues, Alan Hegberg,
Deputy Assistant Secretary for Policy and International
Affairs, relayed to the Russian delegation the changes to the
U.S.'s energy economy over the last thirty years, especially
regarding deregulation of the gas and electricity industries.
These changes are on-going and are market-based and rely on
new innovations. The Russian side acknowledged Hegburg's
arguments that success in building an energy economy requires

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long-term dedication, market-based incentives for
competition, technological innovation, energy efficiency,
self-sustaining investment, non-discriminatory opportunities,
transparency and financial discipline, and integration into
the world economy. Materov replied that the GOR was
committed to the same approach, but needed to finally
transform the Soviet-era legislative and regulatory base into
a modern one. The current debate on a strategic sectors law
was an example, drawn largely from U.S. experience, of Russia
attempting to build that bridge to modernity.


5. (C) At the close, Sell mentioned that in an earlier
meeting Energy Minister Viktor Khristenko had proposed the
idea of a bilateral energy forum to debate/discuss each
country's national energy strategy. Khristenko's idea was
that he and Energy Secretary Bodman would open the meeting.
Sell indicated that he would relay the message to Secretary
Bodman, while Materov noted that "debates bring governments
closer."

LUKOIL
--------------


6. (C) On March 12, Sell met with Lukoil CEO Vagit Alekperov
who said that his company was looking at opportunities
globally, including expansion in the U.S. Lukoil wants to
complete the value chain of bringing West Siberian oil to
U.S. consumers' gas tanks through its retail network in the
U.S. Sell said that the ConocoPhillips (CP)-Lukoil
partnership should serve as a model for future investment and
that the U.S. is open to Russian investment. Alekperov
agreed and pointed to the personnel exchange with CP and the
fact that Lukoil is taking on some CP management techniques
and senior managers as examples of increased cooperation.
Lukoil is in extremely good shape financially as it has the
largest reserves of any private company in Russia, plans to
double production over the next decade to be as big as
ExxonMobil by that measure, and it is the only company that
has replace reserves for 15 years running. Lukoil plans to
invest around $10 billion annually divided 70/30
upstream/downstream.


7. (C) Alekperov admitted the oil business in Russia is
intensely political. The decision has been made that big
fields -- both onshore and offshore -- should be developed by
national companies (like Lukoil),not necessarily just state
companies (i.e. Gazprom and Rosneft). He hopes Lukoil will
be given this opportunity and that CP has success in its
pursuit of Shtokman, an outcome that he believes could
further his own attempts to strike a strategic alliance with
Gazprom for offshore ventures. That said, Alekperov has
doubts about the economics of Shtokman due to the field's
difficulties. He admitted nonetheless that an element of
capriciousness remains in the debate over access to large
fields and that "different visions" are in play regarding
what the rules should be. He said that Gazprom is not
impossible to deal with since Gazprom usually admits its
weakness once ensconced in a deal but when first negotiating
Gazprom will always act as "older brother". Sell stressed
the need to draw on the technical capability of international
oil companies on an equity basis to develop challenging
fields such as Shtokman.


8. (C) Regarding the strategic partnership with CP, Alekperov
emphasized that it has the political support of not only the
Kremlin leadership but society as a whole. He observed in
the same vein that Lukoil is the only Russian company
currently partnering successfully with almost all major U.S.
oil companies, with USG agencies such as OPIC (the Vysotsk
oil products terminal),with the EU (building a possible oil
terminal at Wilhelmshaven in Germany),with the Caspian
countries, and with many others. Lukoil is all about
business, not politics, he emphasized, although he admitted
that sometimes "crude oil smells a lot like politics".


9. (C) Alekperov made a strong pitch for his company to
develop Iraq's West Qurna (WQ) field. Lukoil would need 30
months to launch the project from the date of signing. WQ
could sustainably produce 500,000 b/d, production that would
help develop the economy to stabilize the political situation
and the new oil law should make this a possibility. Due to
the work Lukoil has already done, should another company win

MOSCOW 00001149 003 OF 005


the rights to the field it would take three times as long to
develop WQ. Sell pointed out that we want to see a stable
Iraq that is able to make responsible use of its natural
resources. The case for Lukoil's involvement was compelling
and, if the Iraqi chose to go that way, we would be
supportive.


10. (C) Alekperov also sought Sell,s reaction to Lukoil,s
work in the Anaran project in Iran. Alekperov said that
Lukoil is a junior partner to Norsk Hydro, that the project
is at the exploration stage, and that Lukoil has been
compliant with U.S. sanctions and has kept its relationship
with ConocoPhillips in mind when deciding on steps towards
this project. Lukoil has clearly chosen not to pursue its
work with Iran in a manner that would threaten its business
interests in the U.S. market, even if complying with U.S. law
would mean losing out on a lucrative opportunity in Iran.
Lukoil can continue in it current holding pattern on Anaran
for six to twelve months but after that there will be plenty
of other firms, including perhaps Russian firms, willing to
take on the Anaran project. Sell emphasized that a way
forward with Iran is difficult for both countries.


11. (C) Sell stressed the importance of the government to
move forward on the subsoil law to clarify the rules for
foreign investment. Speaking expansively, Alekperov noted
the tendency not just in Russia but throughout the world for
resource-rich countries to adopt nationalist and
protectionist measures in key sectors. He implicitly
criticized these countries as typified by complacency born of
wealth, highlighting Kazakhstan as one of the worst. In
Russia, at least there is a lot of diverse opinion, which is
healthy since "if things had been decided quickly, everything
would now be owned by Gazprom". He predicted that a better
version of the subsoil legislation or amendments to the
existing law would be produced by September and did not
particularly see impending Duma elections this winter as an
obstacle to passage. He reiterated how important the
survival of private companies in the Russian energy sector
is, noting that Gazprom and Rosneft are simply not capable of
developing enough resources to keep Russia's oil and gas
production steady. Alekperov closed by emphasizing that
Lukoil will become more internationalized - Lukoil is too
"outstanding" a company and with production that will one day
exceed ExxonMobil's, Lukoil cannot be a "local" company.
.
GAZPROM
--------------
.

12. (C) Alexander Medvedev, head of Gazexport and Deputy CEO
of Gazprom, covered a range of topics with Sell at a meeting
on March 13. Regarding gas price disputes with FSU
countries, Medvedev said that the Belarus spat had not been
accompanied by nearly as much western objection as the
Ukraine spat a year earlier, despite the last-minute deal
with Belarus. Russia hopes it is clear to the world that
Russia's policies towards all gas consumers are equivalent -
to move to market based pricing. This includes its own
internal customers now that the GOR has decided to increase
domestic prices to netback parity by 2011 (except for 15
percent of the market occupied by households, which will be
liberalized more slowly). The GOR and Gazprom are confident
that this will benefit the Russian economy by introducing
more energy-efficient technologies. Sell replied that U.S.
experience with deregulation had resulted in at least two
major outcomes - more efficient technologies throughout the
economy and more sustainable investment.


13. (C) Medvedev said the Bovanenko field on the Yamal
Peninsula would require $40 billion to develop and that first
production would be in 2011. This field will be developed
concurrently with the Shtokman field. Chevron's recently
signed deal with Gazprom Neft was a "good deal" and good
project. Gazprom is impressed with ExxonMobil's management
of Sakhalin-1, which despite cost increases for such projects
around the world did not suffer anything like the exorbitant
cost overruns of Sakhalin-2 or Snovhit. Gazprom is having
other good experiences with U.S. companies these days,
including with Aspen Technologies, which recently entered a
deal with Gazprom's petrochemical subsidiary Sibur.


14. (C) Regarding Shtokman, Medvedev said that Gazprom

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intends to pick a maximum of three partners from the
shortlist of five by May or possibly as late as June.
Before, the valuation of Shtokman's reserves by the western
firm had simply been too low, resulting in counter-offers by
them that were insufficient. Over time, the discount rate
associated with Russia will decrease, leading to higher
valuations by the west so that asset-swaps may be revisited.
But for now, he said, the foreign firms acknowledge that
Gazprom will own the reserves and that they will have to find
alternative "values to book" from the project.


15. (C) Waxing philosophical, Medvedev admitted that Russia
has not had a long history of a consistent investment
climate. The state, however, is "back where it should be",
running the industries that are genuinely strategic in their
importance. This is the only way to protect the people and
the nation, as opposed to the 1990s when the nation's assets
were handed out to a few individuals for much too low a
price. And Russia is not as bad as some countries, having
decided not to renationalize but rather to create a sort of
"semi-private" sector. The next generation of Russians is
"absolutely different" than the older generation but they
still recognize the "historical mistake" of the 1990s and the
rectitude of the state regaining its rightful role in
managing key sectors to avoid abusing the people's trust
through botched privatizations. Even at Davos, which he
attended with his namesake Deputy Prime Minister Dmitry
Medvedev, notables had been commenting on the progress Russia
had made in its legal structure, tax climate, registration
rules, banking procedures, and so on. And the senior
Medvedev had promised the Davos audience that the rules about
access to strategic sectors would be passed soon, and people
are taking him at his word. To Sell's question about what
happens after the March 2008 elections, Medvedev predicted
that whoever takes over will continue the policies under
Putin. Putin achieved a great deal and people recognize that


16. (C) Gazprom is inefficient, he admitted, and needs much
in the way of cost management and operational efficiency,
problems that "will not be solved overnight". But with
upside in this area, commodity price upside, and reserves
upside, Gazprom expects to grow its market capitalization to
$1 trillion eventually, and Medvedev claims that objective
analyses by western market analysts come in at around the
same magnitude.


17. (C) Gazprom and Russia do not understand some U.S.
policies, Medvedev said. Specifically alluding to the
Nabucco pipeline and the southern gas corridor, he said it is
a mistake to think such a corridor can be built without
Russian gas. Without Russia, there is no gas, and without
Russia's markets in Europe there is no market, he argued.
Gazprom made an agreement with Greece and Turkey regarding
onward transit of gas from the Blue Stream pipeline and the
three will soon decide on the feasibility of such a
Russia-origin corridor. Without Russia, the southern
corridor "will fail, just as it is now frozen".


18. (C) Sell asked Medvedev why Gazprom wants to remain
dependent on European markets rather than diversify markets,
such as through LNG to North America. Medvedev replied that
Russia is doomed to remain dependent on Europe but is also
diversifying to North America and Asia. This is important to
the world since China or India, for example, have
unsustainable economies without resolution of their resource
scarcities. Gazprom is basing all its moves on commercial
rationale alone, "trying to avoid" politics in its
decision-making.


19. (C) Medvedev, who had been the key negotiator in
wrenching a 50% plus one share from the Sakhalin 2
consortium, had special scorn for Shell's management of the
project. He repeated the distrust that stemmed from the
unfortunate juxtaposition of the constructive deal Gazprom
and Shell had struck in 2005 that was followed "the next day"
by Shell's announcement of extreme cost overruns at Sakhalin

2. Noting that he had grown up on Sakhalin Island and knew
environmental degradation there when he saw it, Medvedev
offered the example of the Sakhalin 2 pipeline being built
right through the middle of a national park when the federal
license clearly said the pipeline must skirt the park's
territory. True, he admitted, the regional government had

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given Shell permission to build it through the park, but
"Shell is not from kindergarten" and knows better than to try
and get away from such federal supervision by hiding behind
local authorities who "have no right" to supersede federal
power on such matters. Asked why on earth Gazprom wanted
into such a project if it had so many problems, Medvedev
responded that Gazprom bought in at a proper discount to
adjust for such problems and that Deloitte and Touche had
verified that the price paid was a fair valuation. With
Shell, Gazprom is now embarking on a plan to overcome the
ecological damage done by Sakhalin 2, he said.

KHRISTENKO
--------------


20. (C) In a lengthy private conversation with the Deputy
Secretary and Ambassador, Minister of Industry and Energy

SIPDIS
Viktor Khristenko stressed the need to focus our energy
relationship on practical results. Along those lines,
Khristenko proposed "a joint seminar on national energy
policies." The proposal was short on specifics but would be
modeled on seminars that Russia has with the EU and Japan and
would follow up on the principles laid out at the St.
Petersburg G-8 Summit. The seminar could be a small
gathering with Khristenko and Secretary Bodman, perhaps,
opening the meeting. Khristenko envisioned high-level
private sector participation from both sides. Sell said that
this sounded like a good idea and that he would relay the
message in Washington.


21. (C) Sell said that the G-8 principles were a good basis
to build on. He encouraged Russia to move forward on
building transparency in the energy sector, saying that it
was Russia's choice to do what they want regarding
restrictions on foreign investment but the key was making a
prompt decision. Khristenko said that the sooner the GOR
defines strategic sectors the better. He expects the Law on
Foreign Restrictions to pass this year but would not be drawn
out on the Subsoil Law. Sell continued that energy
efficiency was an area our two governments could do some good
work. Khristenko recognized this and noted that improving
energy efficiency was one of the reasons the GOR decided to
raise domestic gas prices to European netback levels by 2011.
Khristenko noted that the planned ramp-up in Russia's
civilian nuclear power is part of the long-term strategy to
rationalize energy use.


22. (U) The Deputy Secretary's delegation has cleared this
cable.
BURNS