RUSSIA ENERGY: THE BATTLE OF KOVYKTA -- MORE THAN

C O N F I D E N T I A L SECTION 01 OF 02 MOSCOW 002563 SIPDIS SIPDIS DEPT FOR EUR/RUS WARLICK, HOLMAN, AND GUHA DEPT FOR EB/ESC/IEC GALLOGLY AND GARVERICK DOE FOR HARBERT/HEGBURG/EKIMOFF DOC FOR 4231/IEP/EUR/JBROUGHER NSC FOR KLECHESKI E.O. 12958: DECL: 05/18/2017 TAGS: EPET ENRG ECON PREL RS SUBJECT: RUSSIA ENERGY: THE BATTLE OF KOVYKTA -- MORE THAN MEETS THE EYE Classified By: Econ M/C Quanrud. Reasons 1.4 (b/d). ¶1. (C) Summary: Rumors are rife that TNK-BP will lose its license any day now for the development of the Kovytka gas field, but a more complicated story may be playing out instead. Senior TNK-BP management says the company has offered Gazprom good terms to get the gas monopoly into the project and offered to send Kovytka gas to the Russian domestic market (rather than export it to China). For its part, BP has put overseas assets on the table as part of a package deal. Gazprom, however, seems intent on a simple acquisition, which TNK-BP suggests is part of a focus on capturing Kovykta's cash flows rather than entering into a more complicated, but potentially more mutually profitable deal. TNK-BP thinks Gazprom is executing a strategy intended to take back something that the Kremlin feels was unfairly privatized in the 1990s. TNK-BP's Board is meeting now on the deal, and Gazprom's CEO Miller and BP's Hayward will meet into the evening. Shifting alliances may be in play: TNK-BP believes that Board Chairman and First DPM Dmitry Medvedev and Miller are under attack from PA Deputy Head Igor Sechin-linked players within Gazprom itself, the latter are reportedly responsible for the Rosprirodnazor regulatory attacks on Kovytka. End Summary. ¶2. (C) On May 24, Econ M/C met with senior TNK-BP management to discuss what looks like the end-game on Kovykta. The company is in intense discussions with Gazprom and has put forward, "very concessional offers" in an effort to resolve the impasse over development of the multi-trillion cubic meter field. BP's partners in TNK-BP (Mikhail Fridman, Viktor Vekselberg, and Len Blavatnik) flip-flop daily about whether to hold out or sell the asset. The driving force behind this week's events is the threat by Rosprirodnazor's Oleg Mitvol to pull the Kovykta license from Rusia Petroleum -- majority-owned by TNK-BP -- as early as June 1. A regional court threw out TNK-BP's appeal against Rosprirodnazor's right to revoke the license earlier this week. ¶3. (C) Our contact continued that Gazprom Chairman (and first DPM) Dmitry Medvedev and CEO Miller are under attack from those in Gazprom linked to Igor Sechin, the deputy head of the Presidential Administration and Chairman of Rosneft. Mitvol, who infamously brought the environmental charges against Shell's Sakhalin-2 project, is only the visible part of this attack. Medvedev's enemies are accusing him of being ineffective and responsible for a host of "failures," including ruining the Sakhalin-2 deal (i.e. having paid too much to acquire it) and for not reacting quickly enough to Russia's looming gas imbalance problem. (Comment: Gazprom is not alone in this -- a well-connected source tells us that Rosneft's President Sergey Bogdanchikov is under fire from the FSB for being "ineffective" as well.) ¶4. (C) In a May 25 meeting with EUR/RUS Director Mary Warlick, Kris Sliger, TNK-BP's EVP for Strategy said that the politics surrounding Kovykta are more important now than the economics. No one should expect to earn anything more than single digit rates of return on high-profile Russian projects like this. In fact, Kovykta is not that lucrative for TNK-BP, as there are far better places -- both in Russia and abroad -- to put the marginal dollar right now. The TNK-half of TNK-BP likes venture capital rates of return and as such is not fired up about Kovytka (or about the long-term prospect of owning a relatively low-return "commodity company" like TNK-BP). They do, however, like the potential cash flow this project and TNK-BP could provide. (Comment. Western TNK-BP officials have told us on several occasions over the past few months that the Russian partners would exit the investment sometime this year.) ¶5. (C) TNK-BP appears to be backing off some redlines they have previously set as well as adding new sweeteners. For example, TNK-BP tabled a proposal to send Kovykta gas to the domestic market -- something many in Gazprom have long sought -- rather than exported to China. In addition, BP management has offered attractive overseas deals as part of a package with Kovykta. Gazprom is instead looking for a relatively MOSCOW 00002563 002 OF 002 straight forward buy-in, and the two firms have been in intense negotiations to find a middle ground. Shawn McCormick, head of TNK-BP's government relations department, told us his company is holding a Board meeting today to discuss the way forward. BP's new CEO Tony Hayward is in Moscow for the meeting. ¶6. (C) TNK-BP speculates Gazprom is being driven by many considerations, some of which date back more than a decade. Gazprom appears to want in on the cash flows from Kovykta (a simple concept to understand) rather than becoming enmeshed in a more complicated, global deal. The impasse also appears to be about rectifying perceived past wrongs stemming from the 1990s privatizations. This argument holds that Sidanco -- the company that obtained the Kovykta license in the 1990s and later sold it to TNK -- should never have gotten control over the field to begin with, and certainly not for the song that they paid. ¶7. (C) Comment: The fact that BP CEO Hayward is in town tells us that BP and Gazprom are working hard to come to some sort of deal prior to the threatened withdrawal of the Kovykta license. We know that lengthy negotiations between the two companies are happening almost every day. The contours of any deal are a matter of pure speculation at this point. But if we had to bet, Kovykta could well be wrapped into a broader redistribution to Gazprom, which could surprise us with a market valuation that BP could defend to its shareholders, as Shell was able to do in the Sakh II case. The apparent internal attacks on Miller/Medvedev and Bogdanchikov tell us that there is more than a Gazprom/Rosneft rivalry in play and that alliances and feuds have crossed company lines, and alliances seem to be shifting rapidly, especially in light of the election cycle. BURNS