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07MOSCOW4088 2007-08-21 14:02:00 CONFIDENTIAL Embassy Moscow
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DE RUEHMO #4088/01 2331402
P 211402Z AUG 07
					  C O N F I D E N T I A L SECTION 01 OF 05 MOSCOW 004088 




E.O. 12958: DECL: 08/21/2017

Classified By: EconMinCounselor Eric T. Schultz. Reasons 1.4 (b/d).

1. (C) SUMMARY. In July 31-August 1 meetings, DAS Bryza's
discussions with MFA, western and Russian energy officials
centered on oil pipeline issues and Eurasian gas
developments. Transneft head Vainshtok criticized the
Caspian Pipeline Consortium, (CPC) and suggested it should
only be expanded to support the Burgas-Alexandropolos
pipeline (BAP). He also defended Russian oil cutoffs to
Lithuania and Belarus last year. Chevron head Ian MacDonald
said the key to resolving the dispute over CPC's expansion
lies in the agreement accepted by shareholders but still
awaiting Russian approval and noted that BAP's ownership
model is not currently attractive. The centrality of
Turkmenistan to Europe's future gas supply diversification
figured strongly in discussions. Most western companies
expect the State's hold over the energy sector will continue
but also predict a significant production crisis sometime in
the future. END SUMMARY.

Caspian Pipeline Consortium (CPC)


2. (C) Discussing the Caspian Pipeline Consortium,
Transneft President Semyon Vainshtok repeated oft-used
complaints to Bryza, calling CPC "technically bankrupt" and a
"cash cow" for the shareholders. Of some $600 million in
annual revenue, he said, $100 million goes to operations and
$500 million goes to the western shareholders to service debt
on their own loans. No money goes to Russia and the
consortium pays no taxes. Moreover the debt's interest rate,
at 12.66 percent, is too high in today's markets. "Why
should we let them pay these rates to themselves?", Vainshtok
asked. Transneft offers to the consortium's shareholders to
resolve the debt problem have so far been rebuffed, and
Vainshtok blamed shareholders that use CPC as a "cash machine
at the expense of Russia." He identified ExxonMobil, BP, and
Shell in this category, characterizing them as "bandits". By
contrast, he said, shippers such as Chevron seem interested
in resolving the financial morass and show more willingness
to consider lower interest rates and higher tariffs.
Transneft has offered to assist in refinancing CPC's debt via
Eurobonds but this was also rejected.

3. (C) Vainshtok also stated that Transneft has no qualms
about CPC's existence and the Russian state is not aiming for
more control or a greater share of the consortium but rather
wants the project to be profitable and better-managed.
Transneft does not view CPC as a competitor and, because its
tariffs are high compared with Transneft's, CPC "makes me
look good", Vainshtok emphasized. He complained about CPC's
governance structure in which a committee of shareholder
representatives makes key decisions, arguing it should be
more businesslike with a board, an executive cadre, and
company management. According to Vainshtok, President Putin
wants CPC to be a successful, prosperous enterprise and a
concrete example of cooperation with the United States and he
is well aware of the value President Bush places on it, but
Vainshtok said CPC sets a "bad example."

4. (C) Ian MacDonald, former head of CPC and now Chevron's
chief in Moscow, told Bryza separately that all shareholders
are ready to sign an agreement on refinancing CPC's debt and
raising the tariff to resolve CPC's financial straits if they
gain relief from Russia's aggressive attempts to take over
the consortium's governance and Russian approval for pipeline
expansion which would resolve CPC's financial problems.
Issues such as Transneft's new offer to refinance debt via
Eurobonds, while intriguing to some shareholders, are
essentially irrelevant since the financial issues have been
resolved in the agreement that has been awaiting Russian
approval for some time. MacDonald pointed out that, in
addition to some Kazakhstani shippers failing to deliver
volumes on time, CPC's financial condition was largely due to
the GOR's multi-year dithering over expansion.



5. (C) Regardless of CPC's financial situation, Vainshtok
added, it cannot be expanded until BAP makes some progress.
The Black Sea currently receives 107 million tons of oil

MOSCOW 00004088 002 OF 005

annually outbound through the Straits and it cannot handle
any more. Responding to Bryza's point that no one has
established a formal numerical limit on transit through the
Straits, Vainshtok praised U.S. support for Turkey's Vehicle
Traffic System (VTS) but said that Transneft's experts had
concluded that VTS data shows that the limit has been
reached. Any new oil entering the Black Sea will have a
negative impact on everyone. "We are mutually closed in", he
said. He recalled a recent accident in which a tanker lost
control in the Straits, backing up traffic for many days,
causing substantial losses. Although the Montreux Convention
does not allow discrimination by Turkey of ships transiting
the straits, he claimed that new regulations Turkey is
permitted to use managing traffic will result in
discrimination against Russian tankers, especially if the
additional oil entering the Black Sea to exit via the Straits
is non-Russian oil. "CPC means less for us," Vainshtok

6. (C) The solution is BAP. Vainshtok painted a scenario in
which CPC's expansion of roughly 35 million tons would go
largely to BAP, with an additional 5 million tons from
Tuapse. With Russian companies owning 51 percent of BAP, who
owns the other 49 percent is unimportant to Transneft and to
Russia, as long as the project is commercially profitable.
That way, he said, everyone will be operating on a "half and
half" basis -- "CPC gets to send half its volume wherever it
wants, and half to us."

7. (C) MacDonald separately told Bryza that Chevron would
support BAP under the right circumstances but that has not
been presented yet. Transneft, which is ostensibly to build
and manage BAP, clearly wants Chevron and other Kazakhstani
shippers to finance the pipeline. Yet, as MacDonald pointed
out, Chevron is not interested in 49% of BAP merely as a
financial investment, so currently the company sees BAP as a
pipeline to use as a customer, not an equity-holder.



8. (C) Vainshtok defended Transneft's cutoff of oil to
Lithuania last year, explaining that RosTeknadzor, one of
Russia's regulatory agencies, demanded that the main pipeline
be run at reduced pressure after the initial accident that
shut off Lithuania's (and part of Belarus') flow. The
reduced pressure meant that the oil could not be pumped
beyond Belarussian customers. Vainshtok complained that
"politicians and analysts" abroad criticized Russia's action
as a political act, yet when technical accidents happen at
Supsa (Georgia) or on BP's pipeline in Alaska, no one
criticizes them. In any event, Vainshtok said, Russia can
make $100 million/year more by shipping the crude through
Primorsk than through Lithuania. As for what Lithuania
should do, Vainshtok said that the Mazeikiu refinery can "buy
crude from anyone it wants" through ports.

9. (C) Vainshtok defended the previous oil cutoffs to Belarus
several months ago, saying that for at least two years,
Belarus had simply been stealing wealth from Russia. Under
the customs union, Belarus receives oil without export taxes
added from Russia and either sells it at world prices or
refines it and sells products, without sharing proceeds with
Russia. By December 2006, Belarus had "broken all contracts"
regarding oil supplies, according to Vainshtok and Russia had
to act. The world complained that Russia was an unreliable
supplier when in fact all its contractual commitments were
being met. Transneft had excellent relationships with
transit countries but Belarus had emerged as an
"extraordinarily dangerous situation," Vainshtok concluded
that Belarus mistakenly thinks that Russia will tolerate
Belarussian abuses, however, Russia is finding alternative



10. (C) In his meeting with Bryza, Ian MacDonald elaborated
on recent press announcements that Chevron is pursuing
acreage in Turkmenistan. Chevron wants to secure onshore
gas-prone acreage in Central Turkmenistan, including the
deeper horizons where Chinese companies are developing the

MOSCOW 00004088 003 OF 005

shallow portions. Chevron anticipates that gas resources in
these deeper horizons could be enormous, and believes that as
the world's leader in sub-salt geological reservoirs (such as
Tengiz in Kazakhstan), it should be in a good position to
help Turkmenistan develop them. Chevron has sent teams to
Turkmenistan in recent months, relations are good and
improving, and the company has brought Turkmen officials and
experts to the United States.

11. (C) MacDonald said Turkmenistan asked Chevron to
consider developing Serdar (Kapaz in Azerbaijan), the
disputed offshore field on the same geological trend as
Azerbaijan's AIOC fields. Chevron is willing to examine that
possibility, but has made it clear that a legal settlement of
Serdar/Kapaz' ownership needs to be reached between
Turkmenistan and Azerbaijan. MacDonald said it is almost
certain that the existing west-bound transportation corridors
starting in Baku would be used to carry any resources
produced from Serdar/Kapaz. Regarding transportation of
potential discoveries of large, new amounts of gas, Chevron
supports the concept that alternative routes should be
examined. Given the sensitivity of Turkmenistan's position
vis-a-vis Russia as Turkmenistan considers alternative
investors and alternative routes, MacDonald warned that it is
important to tread carefully in the diplomatic realm
especially regarding public rhetoric.




12. (C) At an Amcham-sponsored meeting, western energy
businessmen provided Bryza with a wide-ranging perspective on
internal and external energy developments. Among their
observations and recommendations were:

-- The consolidation of the energy sector in the state's
hands may or may not have been strategically planned, but the
authorities now in charge of the sector have developed what
appears to be a "Grand Ambition" which empowers them to
control the economy and to project power abroad.

-- The resulting political environment, has left much less
room for new ideas to solve problems or enhance efficiency.

-- Nonetheless, many sectors of the economy, including
retail, manufacturing and financial services are vibrant and
a middle class is developing. Foreign oil companies can work
with reduced ownership shares in deposits provided they have
budgetary control over projects. Even with the foreign
investment restrictions being considered, partnerships with
foreign firms can permanently change behavior by
demonstrating that business ambitions are better than
geopolitical ones, so protecting the "dual key" that gives
foreign minority investors some control over budgets and cash
flow is essential for companies going forward in Russia.
AmCham representatives suggested it would be useful to
establish and track some "benchmarks" on how Russia is doing
relative to other petro-states.

-- The geopolitical reality of the oil and gas world is that
Russia holds huge prizes for those who can run the gauntlet
of the Russian system. Observers are puzzled over what Total
is getting for its role in Shtokman but generally conclude
that the company must believe it is gaining first-mover
advantage and will be able to obtain a better deal with
Gazprom in the future.

-- It may be a good time for the West to identify the
relative progressives in Russia and find ways to reward them,
while taking meaningful steps to hobble the more
"neanderthal" elements. The members suggested this
distinction should be a consideration when viewing Russian
investments into the United States. Russian authorities
often use the U.S. CFIUS process to justify their own
restrictive attitudes toward foreign investment in anything
vaguely "strategic," so the U.S. open system should be better

-- Russia's presumed energy prowess is facing trouble in
coming years. Production is stagnating and will decline, the
state has proven incapable of building a tax and incentive
regime to prevent production crises in brownfields, and the

MOSCOW 00004088 004 OF 005

business model put forward for greenfields (aka Shtokman and
some East Siberian fields) is unsuitable for the frontier
regions. Most western companies expect production crises
sometime in the future, followed by fixes to the broken
system, but all this will take time to play out. Electricity
reform in Russia is "all screwed up" because Gazprom is
replacing much-wanted foreign investors in acquiring spun-off
power facilities.

-- There are some demonstrable improvements in transparency
and corporate governance in the sector, largely due to the
obligations and better governance that have come with Initial
Public Offerings and other linkages to global markets.
Russian accession to the WTO would bring greater integration
and improve the future business climate. However, corruption
and collusion remain problematic in Russia despite periodic
GOR/Kremlin moves to address them.



13. (C) The Director of the Third Department for Countries
in the CIS at the Ministry of Foreign Affairs, Maxim Peshkov
told Bryza that Russia is well aware of USG "lobbying" for
various alternative pipeline routes in the region, including
cross-Caspian and cross-Afghanistan routes from Turkmenistan.
Peshkov said Russia doubts either will work because of
insufficient gas resources in Turkmenistan. A cross-Caspian
gas route is also hindered by the lack of delimitation of
borders in the sea and because the PriCaspian gas route
(onshore along the coast northwards from western
Turkmenistan) is cheaper than a cross-Caspian route. Bryza
emphasized that the U.S. approach to pipelines in the region
is not politicized but rather aimed at building markets.
Competition is a fundamental principle of free markets, as
are alternative energy sources. The USG believes a
cross-Caspian route is economically viable and competitive
with alternatives and business will ultimately decide which
is best.

14. (C) Pehskov asked whether a problem with the "southern
corridor" might be Turkey's insistence on a role as a gas
broker rather than a simple transit state. Bryza replied
that contractual solutions are being found on this issue and
cited the recent contract Turkey signed in which Turkey will
get 15 percent of the gas and transit the rest. Peshkov
wondered whether the relatively cheaper route for Turkmen gas
through Iran might throw a wrench in USG promotion of the
southern corridor, and noted that Russia finds dealing with
Iran very frustrating. Bryza replied that Iranian
involvement would clearly pose problems, but based upon our
discussions with Europeans working in Iran the USG has little
doubt that dealing with Iran may well be fruitless.
Agreements Iran signs, such as the recent one with Turkey to
transit Turkmen gas, therefore may be little more than a
statement of intention.

15. (C) Regarding Europe, Peshkov emphasized that Russia
has tolerated theft by transit states such as Ukraine and
Belarus for too long and is now building alternative routes.
This will benefit energy security for consumers and provide
diversification and increasingly independent routes. Bryza
responded that Europe clearly wants diversified supplies,
which is not the same thing as Russia merely moving its
"molecules" to different Russian-owned routes. What Europe
might consider as diversification is ownership of some of
Russia's upstream gas, but Gazprom's monopoly status is a
huge hindrance. In the end the customer pays for everything
including upstream development. Since Russia needs immense
upstream gas investment, the current situation is probably
not sustainable and will drive Europe to other gas sources.
Pehskov responded that interdependence between Russia and
Europe is the glue that holds the system together so which
companies operate the fields is not that important.

16. (C) On oil pipelines, Pehskov agreed that the CPC
pipeline players should find a solution to the current
standoff. Bryza stressed that the USG has long supported
Bosporus bypasses and would support Burgas-Alexandropolos if
the business community endorses it. He noted that so far it
seems most companies would be willing to support BAP if the
business structure works. Pundits like to say BAP is a

MOSCOW 00004088 005 OF 005

strategic loss for the West, but it is quite the opposite --
it is a gain for all energy consumers and energy shippers
including Russia. Peshkov said that the viability of a
Samsun-Ceyhan route still has too many uncertainties and that
more work is needed "by the Turks" to make it attractive.
Regarding oil shipments across the Caspian, Peshkov said that
Russia is not opposed but would insist on double-hulled
tankers to protect the environment. Bryza replied that the
United States would have no problem with such a development
as it is our understanding that this is what shipping
companies in the Caspian plan. To Pehskov's observation that
cross-Caspian oil transport is economically "very tight",
Bryza explained the economic attractiveness of expanding
Baku-Tbilisi-Ceyhan that would play into commercially sound
cross-Caspian transport.



17. (C) The visit provided the opportunity to hear broad
views across a range of energy issues touching on Russia.
While little new on oil pipelines was forthcoming, the MFA's
non-interference stance on trans-Caspian shipments was
encouraging. Vainshotk's explanation of the Lithuania and
Belarus cutoffs offered nothing new but were the most frank
explanation yet of Russia's motivations. On gas, Peshkov's
observations suggest Russia is micro-analyzing every aspect
of the southern corridor and probing for its weak spots. A
clear message from western businessmen, echoed indirectly by
the Foreign Ministry, is the centrality of Turkmenistan to
the future of Europe's gas diversification. As such, we are
well advised to heed calls for adept diplomacy that focuses
on embedding our companies upstream as a useful prerequisite
for an organically-evolving gas corridor that does not go
north. A special effort between Baku and Ashgabat on
settling the Kapaz/Serdar ownership dispute would augment
such a corridor, as would encouraging the two countries to
reach a bilateral settlement on delimitation.

18. (C) After years of consolidating the sector at home,
Russia's "grand ambitions" abroad seem to be taking a visible
shape - Russia is building as completely independent an
export infrastructure as possible for its own production
while making itself the transit state for Central Asian
supply. Meanwhile, like a judo master, Russia will deflect
as many attempts as possible by independent actors to access
Russia's traditional and new export clients. As the western
businessmen observed, however, Russia is facing internal
energy challenges that could weaken its power, if not its
ambitions. As we promote alternative pipelines and
alternative sources of supply, timing, deft diplomacy, and
concrete achievable steps are our best bet.

19. (U) This cable has not been cleared by DAS Bryza.