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)

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OVERVIEW
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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.

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DECLINING PRODUCTION
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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.

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PIPELINES
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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

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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.

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TNK-BP
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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