RUSSIA'S NORTH-SOUTH ENERGY STRATEGY: A KNIFE, A

C O N F I D E N T I A L SECTION 01 OF 05 MOSCOW 005231

SIPDIS

SIPDIS

DEPT FOR EUR/RUS, FOR EEB/ESC/IEC GALLOGLY AND WRIGHT
DOE FOR HARBERT, HEGBERG, EKIMOFF, PISCITELLI
DOC FOR 4231/IEP/EUR/JBROUGHER
NSC FOR WARLICK

E.O. 12958: DECL: 11/01/2027
TAGS: EPET ENRG ECON PREL RS
SUBJECT: RUSSIA'S NORTH-SOUTH ENERGY STRATEGY: A KNIFE, A
HAMMER, OR A BAND-AID?

REF: A. MOSCOW 875


B. ANKARA 2491

C. LONDON 3999

D. BRUSSELS 3195

E. KYIV 2671

F. MOSCOW 5069

G. KYIV 2611

H. MOSCOW 4691

I. SOFIA 1073

J. MOSCOW 4088

K. BAGHDAD 3254

L. MOSCOW 5162

M. TBILISI 2657

N. BAKU 1227

O. BUCHAREST 1205

P. SOFIA 1240

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


1. (C) SUMMARY. Russian activism in recent years to
strengthen the "north-south" energy corridor
suggests an intention to slice through the conceptual
"east-west" corridor, to reassert Central Asia's
dependence on Russian energy routes, and to repair
Russia's own fumbling gas balance. Russia appears to
be using several tools to build a stronger north-
south corridor: money; Russia's existing and new
pipeline routes; solidarity with Iran on energy
issues; and aggressive counter-measures against
"east-west"-oriented transportation routes.


2. (C) However, we doubt Russia can succeed in this
effort. Success would require an unlikely
combination of subservience by the Central Asian
countries, lethargic pursuit of east-west routes
by the West, Chinese apathy, and a reliable Iranian
partner. Everyone in the region understands the
game so there is little element of surprise left for
Russia to use. And, perhaps most importantly,
Russia has squandered the key element of trust in
nearly all its energy relationships in Eurasia.


3. (C) In our view, Russia will remain dependent on,
more than controlling of, Central Asian gas and will
continue to play an aggressive game of catch-up with
emerging alternative routes. On the oil front,
Russia has more cards to play but, with the Baku-
Tbilisi-Ceyhan (BTC) line in place and cross-Caspian
shipments looming, the horse is already out of the
barn. Against the backdrop of these Russian
weaknesses, the West has an opportunity to put the
burden on Russia -- via proposals to cooperate but
not dominate -- to declare whether Russia is only
interested in control, or can sometimes see its
self-interest in playing by everyone else's rules.
END SUMMARY.

DOMINATING CENTRAL ASIA IS NOT SO EASY
--------------


4. (C) Russia has been reminded recently that when
it comes to energy, Central Asia and the Caucasus
are not the roll-overs they once might have been.
Russia's activism in the last two years to
strengthen the "north-south" energy corridor has
been notable, but mostly reactive. Russia has
increased prices paid to Kazakhstan and Turkmenistan
for gas, driven by the emergence of China in the
region pulling resources eastward, by continued talk
of a trans-Caspian corridor, and, perhaps most
importantly, by Russia's primary need for this gas
(ref A).


5. (C) Yet the Central Asian countries remain
interested in independence and sustainable
sovereignty and are increasingly astute in their

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pursuit. Kazakhstan's Nazarbayev has managed to
appease Russia on energy while not precluding his
own options. Turkmen president Berdymuhamedov's
relatively bold moves to reach out in all directions
attest to a similar calculus, as demonstrated most
emphatically by his gas production and pipeline deal
with China. That both countries signed onto the May
2007 gas pipeline deal with Russia without negating
alternatives was an acknowledgment of geographical
reality, but the deal also demonstrated that Kazakhs
and Turkmen understand the need for alternatives to
help secure the highest price through the Russian
route.

EUROPE AWAKENING? TESTS FOR RUSSIA
--------------


6. (C) As the Chiefs of Missions conference in
Istanbul in September (ref B) concluded, reaffirming
Europe's interest in the sovereignty and
sustainability of the FSU countries and the New
Europe countries is a prerequisite to securing EU
activism on alternative energy corridors originating
from or through these countries. Perhaps
ironically, Russia's own energy mistakes and
diplomatic bludgeoning over the last two years
appear to be driving a more active European
consideration of energy realities in the region.


7. (C) Recent evidence (for example, refs C and D)
suggests Europe will engage more strongly,
presenting Russia with the challenge of taking on
more adversaries than bargained for or finding ways
to cooperate. South Stream and Blue Stream-2 are
clearly reactions to Nabucco and other evolving
southern corridor lines. But Russia is also
considering its options should Nabucco go ahead,
providing the opening for Europe to force Russia to
reveal its intentions at a time when Europe is
rigorously reviewing its tolerance of Russia's
ambitions in the European energy sector.


8. (C) Indeed, Russia's initial reactions to the
draft competition regulations the EU revealed on
September 19 ranged from stunned to indignant, and
the GOR is still trying to figure out its approach
to this new European resolve. This presents an
opportunity for the EU to test Russia's willingness
to play by the rules, perhaps with Nabucco as an
early case. Gazprom Chairman (and First Deputy
Prime Minister) Dmitriy Medvedyev's recent trial
balloon about eliminating middlemen in the Russia-
Ukraine gas trade (refs E, F and G) may provide
another opportunity to foster more rules-based and
transparent behavior on the foundation of economic
reality - in this case, the reality that increasing
gas prices everywhere makes middlemen too expensive.

CROSS-CASPIAN OIL PROBABLY A GIVEN
--------------


9. (C) With excess capacity in its own oil pipeline
system, Russia should in principle have great clout
in dominating Central Asian (primarily Kazakhstani)
oil flows. Instead, Russia failed to expand the
Atyrau-Samara line. And after pushing Caspian
Pipeline Consortium (CPC) negotiations to the
breaking point, Russia appears to have been forced
partly by Kazakhstani-Azeri progress on cross-
Caspian shipments to finally come to an (apparently
workable) agreement on CPC expansion (ref H).


10. (C) At the same time, for all its attempts to
dominate the Burgas-Alexandropolous pipeline bypass
of the Bosporus, a pipeline Russia views as a CPC
extension, Russia has punted the burden of filling

MOSCOW 00005231 003 OF 005


the pipe onto Bulgaria and Greece (ref I) while
retaining a majority interest, a business model that
could drive Kazakhstan to cross-Caspian routes as an
alternative. Meanwhile, the success of the BTC oil
pipeline was largely unexpected in Russia and has
brought some urgency to preventing expansion of this
corridor, but Russia has accepted (ref J) that
cross-Caspian tanker traffic will happen.

CROSS-CASPIAN GAS STILL UP FOR GRABS, BUT
DIFFICULTIES ON EVERY SHORE
--------------


11. (C) Russia may have had some success delaying
Kazakhstan's consideration of a cross-Caspian gas
pipeline but at the cost of paying substantially
higher prices to Kazakhstan, and Russia has not
been able to kill the idea of a cross-Caspian
route. Berdymuhamedov famously reserved the right
to examine cross-Caspian options immediately after
signing the May pipeline agreement with Russia and
Kazakhstan. Russia's own companies such as Lukoil
and TNK-BP have joined the parade of energy
companies courting Turkmenistan to explore for oil
and gas and have told us, as have western firms,
that they would examine all transportation routes
that are commercially sensible.


12. (C) Russia may be testing Iran as a partner for
dominating a north-south flow for Central Asian
gas, but an examination of prospects for such an
alliance would suggest that common Russo-Iranian
energy interests could well be offset by lack of
follow-through and trust. The recent summit of
Caspian states could be interpreted as
reaffirmation of common interests among the five
littoral states, but the fact that Putin and
Ahmadinejad also used the occasion to discuss
cross-Caspian pipelines suggests some anxiety.


13. (C) Russia and Iran clearly have a mutual
interest in preventing the cross-Caspian flow of
gas and they both win if either causes a north-
south flow. But news reports after the summit that
a deputy foreign minister of Azerbaijan refuted
Putin's insistence that all five states must agree
to a pipeline suggests that plucky self-interest
remains the watchword among the Caspian states
rather than solidarity. Recent rumors that Gazprom
may participate in a major way in the Iran-India
gas pipeline also seems unlikely given Gazprom's
squeezed financial situation.


14. (C) Russia and Iran undoubtedly recognize the
latent power that collusion on gas supplies could
give them over prices, but there is little record
of trust. Most analysts in Moscow believe that
Russia would never formally join a "gas OPEC,"
even if it would certainly consider ways of
achieving some of the clout such an organization
might afford. Finally, Iran is anything but a
reliable partner for Russia and it would be
difficult to imagine a rosy relationship on mutual
energy interests being completely carved out from
the myriad troubling geopolitical issues facing
the bilateral relationship.

THE IRAQ FACTOR
--------------


15. (C) A final consideration is Iraqi gas.
Russian companies have examined Iraqi prospects and
must know that Iraqi gas will be searching for
European markets sooner or later. Western industry
contacts in Moscow who have undertaken negotiations
with all the Iraqi factions tell us that Iraq could

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be exporting 10-12 bcm at a minimum into Nabucco
within 3-4 years of signing, provided the political
support of the U.S. and Baghdad is forthcoming.


16. (C) As ref K details, there is probably more
where that came from. Even if Russia senses a
window of opportunity to control or deny a
"southern corridor" before Iraqi exports come
online, it probably concurrently feels too weak to
do anything about Iraqi gas. That said, Lukoil
and others are increasingly frustrated at their
inability to pin down deals such as West Qurna,
so that their role as potential champions of
Iraq's oil and gas development remains
underexploited.

BEAST TO THE EAST: NEW FACTOR PULLING AGAINST RUSSIA
-------------- --------------


17. (C) China's thrust into the region means
diversion of resources along an eastern branch of
the east-west corridor at Russia's expense.
Some analysts here believe Russia was almost as
surprised by the Kazakhstan-China oil pipeline as
they were by BTC. Russia may have thought it had
locked in Kazakhstani gas by upping the price and
getting Nazarbayev to cease and desist his pursuit
of a cross-Caspian gas line, but instead Kazakhstan
turned to China as a potential gas export route.
Turkmenistan's deal for a gas pipeline to China
certainly has some Russian officials wringing
their hands.


18. (C) Some in the Russian elite fear that China
could conceivably dominate the "great game" in
Central Asia and in any Pacific energy strategy
Russia might develop (ref L),yet Russia has done
almost as much harm to itself on the eastern side
of Eurasia as it has on the western side over the
past few years. Russia has achieved nothing in 18
months of talking with the Chinese on bilateral
gas trade since Putin visited Beijing in March 2006
and struck two agreements on building gas pipelines.
Gazprom's takeover of the Kovykta project amplified
Chinese and South Korean reticence to place too
much trust in Russian energy and drove them to seek
alternatives including the Caspian countries.
Russia's clumsy attempts to play China and Japan off
each other on the East Siberia-Pacific Ocean oil
pipeline jaded the Asian countries towards Russia,
as our Japanese colleagues have confided to us.


19. (C) Looking forward, China could be considered
in some respects a pacesetter for, and an ally of,
those pursuing the east-west corridor. For where
once Russia may have thought it could rekindle the
Soviet-era reality that Central Asian molecules
went to mother Russia first before transiting
onwards to markets, Russia now finds itself racing
against Central Asia for the Chinese market ) and
against China for influence in Central Asia. And
while Gazprom may feel confident in its newfound
control of the East Siberian gas development and
export plan, the Kremlin's push to the east was
largely reactive -- to the Russian private sector's
preceding efforts to cut such export deals itself
and to China's activism in Central Asian energy.

CONCLUSION
--------------


20. (C) Russia can be counted on to aggressively
pursue its interests, which it perceives as
thwarting the east-west energy corridor, where it
can. But its leverage is declining in Central Asia
and the Caucasus as China enters the scene and as

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dependency on Russia for supply or transit declines
in relative terms (e.g., refs M and N). Russia's
leverage is perhaps growing in countries such as
Bulgaria or Romania (refs O and P) that are nexuses
where the southern energy corridor is colliding
with Russia's interests. But Russia's poor track
record of energy diplomacy and trust-building
throughout Eurasia has left it with few places to
attempt genuine strategic alliances, leaving Russia
to peddle influence the old fashioned way - through
ad-hoc marriages of convenience and likely through
graft as well. In that respect, Russia's north-
south thrust is less a weapon or a political
bludgeon than a reaction to injury (band-aid),
whether self-inflicted or not.


21. (C) Against the backdrop of these fundamental
weaknesses, deft diplomacy could harness Russia's
ambitions by posing it with a challenge - to signal
to the world, at a time when most are wary and
anxious of Russia's energy throw-weight, whether
Russia is interested only in control or is ready
to cooperate. While the Russian elite's often
groundless (and boundless) sense of aggrievement
will push the leadership to see neo-containment
behind every western action on the energy front,
the leadership has demonstrated, occasionally and
fitfully, that pragmatic self-interest can
sometimes win out.


22. (C) That means it is worth exploring whether
Russia can be brought into constructive
relationships -- which in turn means using our
leverage carefully and creatively. The EU is
doing that with new regulatory proposals, and
could do the same via a well-timed invitation
into Nabucco and carrying through on the idea of
eliminating middlemen in the Ukrainian gas trade.
Central Asia is doing that by introducing China
into the equation. China itself is doing that by
courting Russian gas while securing alternatives
in Central Asia and elsewhere to force Russia into
compromise on price. We presumably can have
influence in all these developments as well as by
accelerating Iraqi gas entering the southern
corridor. All of these could rope Russia in to
being a senior, but not dominant, part of Eurasian
energy stability, or they will smoke Russia out -
to Russia's own detriment.
Burns