RUSSIAN ENERGY COMPANIES HIT BY FINANCIAL CRISIS

C O N F I D E N T I A L SECTION 01 OF 03 MOSCOW 003125

SIPDIS

DEPT FOR EUR/RUS, FOR EEB/ESC/IEC GALLOGLY AND WRIGHT
EUR/CARC, SCA (GALLAGHER, SUMAR)
DOE FOR FREDRIKSEN, HEGBORG, EKIMOFF

E.O. 12958: DECL: 10/22/2018
TAGS: EPET ENRG ECON PREL RS
SUBJECT: RUSSIAN ENERGY COMPANIES HIT BY FINANCIAL CRISIS

REF: MOSCOW 1295

Classified By: Econ MC Eric T. Schultz for Reasons 1.4 (b/d)

--------------
SUMMARY
--------------


1. (C) Gazprom announced on October 22 that it may have
trouble refinancing some of its debts and obtaining needed
new loans. The announcement was the latest in a recent
string of news indicating Russia's oil and gas sector may be
seriously affected by deteriorating conditions in financial
markets. According to press reports, the GOR recently
responded to requests by four major Russian oil and gas
companies (including Gazprom) and provided them with $9
billion in loans to help them refinance existing debt.
Although the companies have all been relatively quiet about
the impact of the financial crisis on their future investment
plans and operations, it is becoming increasingly clear that
tight credit markets will result in a reassessment of future
capital expenditures by the industry. The financial crisis,
combined with declining oil prices and increased government
control over the sector will further hinder Russia's ability
to overcome stagnating oil and gas production (reftel). End
summary.

--------------
OIL AND GAS COMPANIES NOT IMMUNE
--------------


2. (SBU) As a part of a release of its first quarter results,
Gazprom announced October 22 that financial market conditions
are having an impact on the company's ability to refinance
existing debts and obtain new loans. The company said it
would be looking for additional financial support from the
government. The news was the latest in a string of recent
reports indicating that Russia's oil and gas sector is
feeling the effects of the global financial crisis despite a
year of record high oil prices. According to press reports,
the GOR pledged $9 billion of financial assistance on October
14 to four Russian oil and gas companies (including Gazprom)
that had requested support in an earlier letter to Premier
Putin. Lukoil President Vagit Alekperov indicated in a press
interview reported October 8 that his company, along with
Gazprom, Rosneft, and TNK-BP, had appealed to the government
for loans in order to refinance billions of dollars of
short-term debt coming due in coming months.


3. (SBU) In late September, business newspaper Kommersant
reported that Gazprom's oil arm, Gazpromneft, may reduce its
investment budget for 2008 and 2009 by 10 to 20 percent. The
paper also quoted the deputy chairman of gas company Itera as
confirming that Itera and other major oil and gas companies
that had been paying 7-8 percent interest rates on
ruble-denominated debt now had to pay 11-13 percent. In
response, VTB bank Deputy Chairman Vasily Titov was quoted in
the press as saying interest rates to "all corporate clients"
had risen in line with the bank's borrowing costs.


4. (SBU) More recently, there were reports that several of
the smaller Russian oil companies had requested tax relief on
their crude exports. The companies complained (as the larger
companies had previously) that they were losing money on
these exports because the export duty, which lags price
movements, is calculated on the higher prices of previous
weeks. The companies also reportedly claimed that they could
not redirect their exports to the domestic market because the
projected export revenues had been used as collateral for
loans.


5. (SBU) State-owned oil pipeline monopoly Transneft has
reportedly delayed the start of the construction of the BPS-2
(Baltic Pipeline System 2),citing difficulties receiving
financing. (Note: Some investment analysts actually cheered
this move as value-additive given the dubious economic
justification of this "Belarus bypass" project. End note.)
Transneft has also reportedly sought government funds to
support its $10.2 billion 2009 investment plans (up from $7.9
billion in 2008),including for the hugely over-budget East
Siberian-Pacific Ocean (ESPO) pipeline.


6. (C) Believing that many oil and gas companies are indeed
facing financial difficulties, Energy sector consultant Jerry
Rohan (protect) pinned the blame on the companies themselves.

MOSCOW 00003125 002 OF 003


He told us recently that instead of reinvesting their
windfall profits into their businesses, they used them for
dividend payments and unwise acquisitions. Counting on
continued high oil prices and access to easy credit, they
borrowed heavily for capital expenditures and, in some cases,
to cover regular operating transactions. Now, they are
having trouble raising new cash to refinance those loans and
do not have the cash reserves to pay them off as they come
due.

--------------
INVESTMENTS TO SUFFER?
--------------


7. (SBU) Despite the news reports and widespread analyst
sentiment, the major oil and gas companies have been largely
quiet about the potential impacts of the financial crisis on
their investment and operational plans and forecasts.
Gazprom's cautionary note in its first quarter results was
the first time the company admitted potential problems with
financing. In fact, Gazprom head Alexei Miller, when
recently proclaiming "astronomical" results for his company
(prior to the October 22 official release),downplayed the
impact of the crisis, predicting it would not negatively
impact the company.


8. (C) Although all the major companies are reportedly
reviewing their future investment plans, none has posted any
information on their investor or press websites indicating
downward revisions. On the contrary, some have recently
projected increased capital expenditures. Following its
recent board meeting, TNK-BP announced an increase in its
2008 capital expenditures from the previously approved level
of $3.5 billion to $4.4 billion. COO Tim Summers (protect)
indicated to us recently that the 2009 level would be similar
but also admitted that given the rising cost of debt, the
company was having to rely more on cash than it would like to
finance its expansion plans. Press reports later quoted
Summers as saying the company's 2009 capital expenditures
would be between $3.5 billion and $4.5 billion. On September
28, press cited Gazprom's Deputy CEO as claiming the
company's investment program calls for rising investment
expenditures over the next two years, reaching $51 billion in

2010.


9. (SBU) Many analysts are skeptical that the sector can
maintain these planned investments. A UBS analyst warned in
a recent note to clients that he believes major Russian oil
companies are facing "severe liquidity problems" that will
cause them to seek expensive new financing, or tax cuts, or
to forego capital expansion. The analyst suggested the
government will be unlikely to cut taxes at this time and
that financing will be difficult, leaving the companies
likely to delay planned investments.


10. (C) Leonid Grigoriev, President of the Institute for
Energy and Finance also told us recently that he believed
energy sector investments will be delayed because of a lack
of credit. Vladimir Konovalov, Executive Director of the
Petroleum Advisory Forum (the association of western oil
companies),told us he believes companies will be forced to
slash investments as the credit crunch compounds the effects
of high input costs and onerous taxes in an era of falling
oil prices.


11. (C) Alf D'Souza (protect),Vice President of Government
Relations at Shell Russia, told us October 9 that he thinks
the Russian oil companies are "desperate for cash." He said
an upcoming board meeting of Salym Petroleum, Shell's JV with
British firm Sibir (owned by Russian oligarchs),was delayed
because the oligarchs are dealing with their
financial/liquidity problems. He said the Salym JV was not
in trouble itself, but that the effect of the crisis on
Sibir's owners may have an impact on Salym. (Note: A Sibir
press release later described certain asset sales that UBS
interpreted in its analysis as a "pure cash injection" to
help one of Sibir's oligarch owners avoid margin calls. End
note.)

--------------
GOVERNMENT TO THE RESCUE?
--------------


12. (SBU) As indicated by the GOR's $9 billion package to the
four major oil companies, the state may be able and willing

MOSCOW 00003125 003 OF 003


to support the sector as needed, at least in the near term.
The GOR has already stepped up by temporarily using a shorter
lag to calculate oil export taxes, saving the sector some
$5.5 billion.


13. (C) Alfa Bank's chief strategist Ron Smith told us
recently that despite the government's reduced "room for
maneuver" given dropping oil prices, he believes "the sector
is too critical for the overall economy" for the government
to allow any hiccups in operations. He wrote in a recent
note to investors that Gazprom's "surging cash flows" should
cover its investment needs in the near-term, and government
financing should provide a safe back-up source of funds. He
repeated both these sentiments in his October 23 note,
downplaying Gazprom's own cautionary statement.


14. (C) Deputy Speaker of the Duma Valery Yazev, a member of
the energy committee and dinosaur leader of the
Gazprom-financed Russian Gas Union (the gas industry trade
association) reportedly told the press recently that he
didn't expect any changes to major Gazprom, Rosneft, or
Transneft projects, believing the government will provide
needed financing for its favored champions.


15. (C) Government assistance would likely bring greater
government influence and control. Several major oil
companies recently reduced gasoline prices, for example,
following government complaints that pump prices have not
fallen in line with the decline in oil prices. D'Souza said
he believes the government is in fact eager to provide cash
to companies and is "licking its chops" to take further
control of the sector. Rohan noted that the government would
largely be loaning back to the companies money it
"effectively confiscated in the first place,8 referring to
the punishingly high tax rates the companies face on oil
exports at prices above $25 per barrel.


16. (C) BP Russia President Richard Spies (protect) told us
October 21 that the big companies should be able to cover
much of their investment needs through cash-flow, but that
all companies still need access to credit markets to cover
temporary shortfalls and other financing needs for their
operations. He said in that regard, the frozen credit
markets will affect all companies. He added, however, that
their bigger worry is the declining oil price and the onerous
tax regime. If the government is to help, it needs to
rethink its overall policy toward the sector.

--------------
SECOND-ORDER EFFECTS
--------------


17. (C) Another concern for the sector may be what D'Souza
called the "second-order" effects of the credit crunch. He
suggested that many sub-contractors and suppliers to the oil
and gas sector may also be having credit problems that could
threaten their existence. He said the companies who own a
field or project would then have to save their contractors or
look for new ones, both costly propositions.

--------------
COMMENT
--------------


18. (C) Slower economic growth and a declining oil price
could induce the GOR to take steps to reduce the tax burdens
on the oil sector, to accelerate the elimination of gas price
subsidies, to be more welcoming to foreign investments, and
generally to reduce its role in the energy sector. A more
likely scenario, however, is that government support for the
sector will result in even greater control and that the
declining economic conditions will result in the government
(or certain well-placed players) squeezing even more cash out
of the sector. Add into this mix lower oil prices and higher
interest rates, and the near-term future of the Russian
energy sector is one in which the country produces less oil
and gas and invests less in upstream developments, resulting
in less production in the future even if prices begin to rise
again after a global recession. End comment.
BEYRLE