RUSSIAN ENERGY: AMBASSADOR MEETS GAZPROM'S MILLER

C O N F I D E N T I A L SECTION 01 OF 03 MOSCOW 000583 SIPDIS SIPDIS DEPT FOR EUR/RUS WARLICK DEPT FOR EB/ESC/IEC GALLOGLY AND GARVERICK DOE FOR HARBERT/EKIMOFF/PISCITELLI DOC FOR 4231/IEP/EUR/JBROUGHER NSC FOR GRAHAM AND MCKIBBEN E.O. 12958: DECL: 02/09/2017 TAGS: EPET ENRG ECON PREL RS SUBJECT: RUSSIAN ENERGY: AMBASSADOR MEETS GAZPROM'S MILLER REF: MOSCOW 466 Classified By: Amb. William J. Burns. Reasons 1.4 (b/d). ¶1. (C) SUMMARY. In a February 8 meeting with the Ambassador, Gazprom CEO Alexey Miller praised recent moves on domestic gas price reform, and said gas price rises to FSU countries would move forward in tandem, and assets are a part of the payment mix. Miller stressed plans in play to develop Yamal (work has already started on the giant Bovanenko field),and said a tender would be held in May for foreign firms to bid as contractors on Shtokman. He said the Burgas-Alexandroupolis pipeline (BAP) deal would "without a doubt" help CPC expansion. Recent talk of a gas OPEC (OGEC) was "fanciful," given the predominance of piped gas on world markets. The Ambassador urged Miller's attention to the emerging PriceWaterhouseCoopers tax case (Reftel),which Miller agreed to look into. Unexpectedly, at the very end of the meeting, Miller produced and summarized a letter from U.S. oil major Chevron indicating interest in working with Gazprom in bidding on Yukos assets. END SUMMARY. . DOMESTIC GAS PRICE REFORM -------------- . ¶2. (C) Miller was pleased about recent GOR moves to raise domestic gas prices over the next five years. For Gazprom especially, the changes will mean the company can finally pursue a "clear-cut strategy" for exploration, production, and transport. Lacking long-term contracts for gas supplies within Russia - a vestige of the GOR's ability to set prices only one year out - the gas industry had been unable to properly plan for future production and transportation needs. The new regime will allow "mid-term contracts" that will help Gazprom make production plans while passing risks off to consumers since the gas would be "sold before it is produced." . ¶3. (C) The current "super-low" domestic tariffs made it impossible to profit from domestic sales, resulting in profits being generated exclusively from export sales. Scheduling prices to reach netback parity by 2011 will make the export and domestic markets (which represent two-thirds of Gazprom's production) equally profitable. This would "triple" Gazprom's profits and would be good for independent producers as well, and will make the Russian economy more efficient and competitive. Independent producers will get equal treatment and industrial consumers of gas in Russia will ultimately be treated in "similar and equal" ways to European customers. . ¶4. (C) Russia last year began experimenting with spot sales of gas on the domestic market, with Gazprom and independent producers permitted to sell 5 billion cubic meters (bcm) each on a free trading exchange. There has been no decision to limit the volumes on that free exchange, and one day it could represent 10-15 percent of Russia's domestic gas trade (roughly 35-50 bcm annually). So far spot prices have been higher than contract prices, but that could change as contract prices are scheduled to rise. The state has decided that while mid-term and long-term contracts and spot sales will ultimately dominate the domestic industrial consumer market (just as they do the export market) while, the household sector will be reserved for special treatment, with price rises much slower. . PRICE RISES IN THE FSU STATES -------------- . ¶5. (C) Miller argued that Russia clearly cannot disadvantage its own economy by subsidizing the production of goods in neighboring countries. Russia expected, and sees, modernization and conservation of energy emerging in states such as Ukraine that are living with rapid gas price increases, and has concluded "there is no reason such efficiency would not work in Russia". This will make the entire FSU more competitive. All FSU prices will reach market level one day, including Russia, where lower domestic tariffs were actually making the country less competitive relative to its neighbors. Even now, all FSU countries are being treated "fundamentally" the same, and where assets are being offered in lieu of cash, the listed prices are lower. It is all the same to Gazprom whether payment comes in cash or assets. MOSCOW 00000583 002 OF 003 . DEVELOPMENT PLANS INCLUDE YAMAL... -------------- . ¶6. (C) Looking ahead, Miller observed that western speculation about a future gas production shortfall was grossly exaggerated. In fact, Gazprom has a plan for the nation's gas balance to 2030, and at least until 2013 those plans are firmly and absolutely covered by "concrete" field development schemes. After reviewing overall gas demand for the last few years, Gazprom is basing its future plans on a "maximum demand" scenario, not a conservative scenario. This year and next Gazprom will is working to improve its forecasting ability, but until that process is complete Gazprom will continue basing its plans on this maximum demand scenario. Fields on the Yamal Peninsula are Gazprom's first priority, especially the giant Bovanenko field, where work has already begun. . ...AND SHTOKMAN... -------------- . ¶7. (C) Regarding Shtokman, Miller emphasized several times that Gazprom has the rights only to the license for using the subsoil resources. As soon as the gas/oil is out of the ground, nothing precludes various business deals with foreign firms at any point in the chain of production, refining or liquefaction, or transport. This means western firms cannot book reserves, but there's plenty of other business to be done together. Gazprom is open to such deals, and that is what is behind the recent re-opening of talks with foreign firms. Gazprom plans to hold its first tenders in May for foreign firms to bid as contractors, and letters to this effect had been sent to Chevron, ConocoPhillips, Total, and Norsk Hydro. (Note: He did not mention Statoil but presumably meant to.) All the companies had "confirmed" (NFI) except Chevron who was expected to "confirm" soon. (Note. Chevron told us later that neither Chevron nor Norsk Hydro had received letters as of February 8.) . ¶8. (C) Miller defended last year's shelving of the offer to partner with western firms to develop Shtokman. Western had not put sufficient assets abroad on the table, given the huge resources Shtokman has to offer -- and current price trends. "Swapping assets" was Gazprom's original intention, but no worthy assets were on offer and those offered were "far, far too low" in value, and only a few producing assets had been proffered. Gazprom had been willing to consider a "balance" of producing and non-producing assets, but no package met Russian requirements. Western firms seemed overwhelmed at the scale of what they would have to surrender in return for a piece of Shtokman. More volumes had come to light in 2006 at Shtokman, which made it all the more difficult for western companies to meet Gazprom's requirements. . ...AND SAKHALIN -------------- . ¶9. (C) Miller admitted that Gazprom's view of Sakhalin differed now that it is a shareholder in Sakhalin 2. Piped gas doesn't have much future in the eastern half of Russia due to a low population, but LNG is obviously going to be a big story. Piped gas for export is a possibility, but then the key concern must be the interests of the producer, whereas with LNG clearly the interests of the consumer are paramount. . CPC and BAP -------------- . ¶10. (C) Miller offered little new on the recent news that Russia, Bulgaria, and Greece had signed an agreement on the Burgas-Alexandropolos Pipeline (BAP) in which GazpromNeft, Rosneft, and Transneft would collectively hold 51% of the shares. Progress on such a route would "without a doubt" help achieve resolution of the expansion of the Caspian Pipeline Consortium (CPC). Both are clearly important contributions to world markets. . MIDDLE EAST TRAVELS AND "OGEC" -------------- . ¶11. (C) Miller said he will accompany President Putin on his MOSCOW 00000583 003 OF 003 upcoming trip to the Middle East including Saudi Arabia, Jordan, and Qatar. Miller intends to tie this in with a stop in Turkmenistan to attend the presidential inauguration. As for recent talk of a "gas OPEC" ("OGEC"),Miller dismissed it as fanciful. Gas is fundamentally different than oil, and piped gas cannot conceivably support an OGEC's purported purposes. All the talk is just meaningless speculation, and the motives behind the media stories about OGEC were suspect. "Why is this story raised? Who is it for?" . PRICEWATERHOUSECOOPERS -------------- . ¶12. (C) The Ambassador raised the recent tax cases against PWC, and urged Miller's attention to the matter. Miller professed ignorance but had nothing but the highest praise for PWC's work for Gazprom over many years, and promised to look into the situation. . YUKOS -------------- . ¶13. (C) In an unexpected closing, Miller produced a letter from U.S. oil major Chevron and read from it, summarizing that the firm was offering to work with Gazprom in the upcoming auctions for some of Yukos' assets. This letter was proof of at least two things - first that U.S. firms could do business with Gazprom without booking reserves after the recent Shtokman decisions, and second that U.S. firms were willing to buy into Yukos assets. The Ambassador did not comment in response. (Note: Gazprom did not inform the Embassy of its intentions to release a press statement about the meeting, or to publicly refer to this letter.) . COMMENT -------------- . ¶14. (C) Miller was confident, which is understandable since Gazprom is on a roll. Miller's logic for raising domestic gas prices was sound, and his explanation of raising prices to FSU customers only slightly defensive. Miller's test of our view of the radioactivity of Yukos assets -- both by raising it with the Ambassador and by issuing the press release -- previews Gazprom's intentions to bid on the assets and the general desire (dating back at least to December 2004) to legitimize the Yukos affair. BURNS