SCENESETTER FOR VISIT OF SPECIAL ENVOY GRAY

C O N F I D E N T I A L SECTION 01 OF 02 MOSCOW 002019 SIPDIS DEPT FOR EUR/RUS, FOR EEB/ESC/IEC GALLOGLY AND WRIGHT, AND FOR COORDINATOR FOR EURASIAN ENERGY STEVEN MANN EUR/CARC, SCA (GALLAGHER, SUMAR) BRUSSELS FOR SPECIAL ENVOY GRAY DOE FOR FREDRIKSEN, HEGBORG, EKIMOFF DOC FOR 4231/IEP/EUR/JBROUGHER E.O. 12958: DECL: 07/15/2018 TAGS: EPET ENRG ECON RS SUBJECT: SCENESETTER FOR VISIT OF SPECIAL ENVOY GRAY Classified By: Ambassador John R. Beyrle for Reasons 1.4 (b/d) -------------- OVERVIEW -------------- ¶1. (C) Your visit is an opportunity to stress our shared interest in a productive and efficient Russian energy sector. Russia is the world's largest producer and exporter of energy. We believe a Russia that does business in multiple markets in well-regulated and modern jurisdictions will be less able to use its energy riches for political aims. Subject to regulatory oversight, partnered with established Western multinationals, and under the microscope of Western financial markets, Russian companies, whether state-owned or not, will be less able to contravene accepted international business principles. -------------- DECLINING PRODUCTION -------------- ¶2. (SBU) Due to excessive state control, an onerous tax regime on the oil sector, heavily subsidized domestic gas prices, and under-investment in exploration and production, both oil and gas production are virtually stagnant and predicted to remain so in the near- and medium-term. Meanwhile, export capacity will likely decline as a rapidly growing economy fuels a surge in domestic demand (Russia's car market just surpassed Germany's to become Europe's largest). ¶3. (C) Recent moves, publicly pushed by Putin himself, to lower the tax burden on the oil sector, to force third-party access to Gazprom's pipelines, and to raise domestic gas prices should all help move production in the right direction. Although these policies would only affect the long-term, you should applaud them as helping secure future additional energy supplies, and encourage a continued focus on these and other reforms intended to boost production. -------------- PIPELINES -------------- ¶4. (SBU) Russian pipeline policy is to diversify away from transit states. The Russians claim that this policy is commercially driven, but the transit states in particular see political motives. Gazprom (along with its German and Dutch partners) is building the Nord Stream gas pipeline to send gas directly to Europe, bypassing Poland and Belarus. It is promoting the South Stream gas pipeline as an alternative to Nabucco. The GOR has also negotiated a slew of agreements with individual European states in a successful "divide and conquer" strategy. The GOR also seeks to divert oil from the Druzhba pipeline and instead send it to market directly on tankers from the Baltic Sea. ¶5. (C) Regardless of its diversification plans, Russia will be dependent on transit through Ukraine for the foreseeable future, especially for gas. Some 80% of Russian gas exports to Europe transit Ukraine. The annual price negotiations with Ukraine (which resulted in a brief shutoff of gas in early 2006) regularly result in public charges that Russia is politicizing the gas trade. These tense negotiations are likely to get worse given expected price rises of over 100% to Ukraine as part of Russia's goal of charging Ukraine "market" prices by 2011, and could become a highly contentious issue if Ukraine were to be offered a NATO Membership Action Plan in December. ¶6. (SBU) Another key consideration for Russian policy is Central Asia. Given stagnant production, Russia cannot fulfill its European contracts and its various gas pipeline ambitions without Central Asian gas (and that may soon be true about oil, too). President Medvedev has recently been on a tour of Central Asian capitals to strengthen ties and help ensure continued gas flows north. ¶7. (SBU) While Russia's politicization of the gas trade grabs MOSCOW 00002019 002 OF 002 the headlines, lost in much of the analysis is an appreciation of Russia's dependence on European consumers. Russia is as dependent on Europe as a gas customer, perhaps more so, as Europe is on Russia as a gas supplier. Some 75% of Gazprom's revenues come from sales to Europe. At the Russia-EU Summit in Khanty-Mansiysk at the end of June, the leaders agreed to begin negotiations on a new Partnership and Cooperation Agreement. The negotiations are expected to be long and difficult, with energy being the key issue. It is very much in Russia's interest to be seen as a reliable supplier of gas to Europe (as well as a reliable non-OPEC supplier of crude to global markets.) ¶8. (C) Our efforts at diversification should avoid setting this up as a U.S.-Russia competition (which strengthens hardliners),by clearly demonstrating that our support for particular projects is based on their commercial viability. On the proposed South Stream and Nord Stream gas pipelines, and the proposed Burgas-Alexandropoulis oil pipeline, our efforts should be aimed at strong competition regulation in Europe, while welcoming the additional supplies of energy. -------------- TNK-BP -------------- ¶9. (C) Your visit also presents another opportunity to raise the TNK-BP dispute. The TNK-BP saga sends very negative signals about how this economy operates. We need the GOR to worry more about Russia's international reputation. By now, the GOR has heard our concerns about the TNK-BP case many times, and responds consistently that it is "staying out of a commercial dispute." President Medvedev's public positions on the economy provide the opening for you to communicate our concerns about the importance of a level playing field -- for TNK-BP, and in the energy field more broadly. Medvedev has emphasized the rule of law, a campaign against corruption, protection of property rights, and greater economic freedom as necessary requisites for economic modernization. You should express our strong support for Medvedev's vision and note that the world is watching the TNK-BP dispute to see if the GOR's actions will match its rhetoric. BEYRLE