RS OIL STATE OF PLAY

UNCLAS SECTION 01 OF 02 SARAJEVO 001661 SENSITIVE SIPDIS STATE FOR EUR/SCE HYLAND, FOOKS, STINCHCOMB E.O. 12958: N/A TAGS: ECON ENRG PREL RS BK SUBJECT: RS OIL STATE OF PLAY REF: 07 SARAJEVO 678 ¶1. (SBU) Summary: According to the Republika Srpska Government, the Russian Zarubjezneft rehabilitation of the Brod refinery is progressing, despite many internal delays, and the refinery should be producing gasoline by the end of October 2008. (Reftel) As part of the Brod privatization deal, Zarubjezneft also purchased the largest chain of retail gas stations in the RS, PETROL RS. Despite commitments to invest in improvements to the old gas stations, Zarubjezneft has not yet invested a Euro in their rehabilitation. In other industry news, the RS Government is deliberating on a law to control the price of gasoline in the consumer market by limiting the profit margins for wholesalers and retailers. The first biodiesel plant, funded with U.S. investment by American citizen locals, opened in Srbac in the northern RS on September 28. RS President and PM Milorad Dodik attended the ribbon-cutting ceremony and used the factory opening to declare that the RS is a safe place for foreign investment. With regard to legislative reform, the RS continues to work on updating its own energy legislation, instead of pursuing a joint energy strategy with the Federation which would go much farther in enticing foreign companies to take a chance on investment in BiH. End Summary. BROD REFINERY -------------- ¶2. (SBU) The Russian firm Zarubjezneft began discussions with the RS Government in 2006 to purchase its oil and gas assets (Reftel). Bosniak members of the Council of Ministers, however, stalled the agreement when they raised concerns about sub-EU-quality oil coming from Russia into the BiH market. The lower quality gasoline that will be produced, once the old processing line at the Brod refinery is rehabilitated, will not meet EU-environmental quality obligations due to the high sulfur content in the Russian oil that is difficult to refine. The Council of Ministers finally approved the agreement in March 2007 once the refinery agreed to bring its petrol products up to EU standards by July 31, 2010. Republika Srpska Assistant Minister for Energy Dragana Kalabic claims, however, that Brod will only require six months to improve the old processing line to remove the sulfur content and bring the gasoline up to EU standards. (Note: At present, the largest percentage of gasoline in BiH comes from Croatia where it is refined to EU standards. End note) ¶3. (SBU) Kalabic explained that once the Brod refinery is up and running at the end of October, it will be able to supply gasoline to the RS, the Federation as well as Brcko district (although with lower quality gasoline compared to what they receive now from Croatia)) essentially the whole country ) and still have excess product for export. She claimed Brod would sell its products based on free market principles without preferential pricing for RS wholesalers (Note: This was an earlier concern raised by Bosniak politicians in Parliament. End note.) PETROL RS ) ANOTHER RUSSIAN ASSET -------------- ¶4. (SBU) General Manager of PETROL RS, Drago Djukic, said that PETROL RS is still the biggest petrol retailer in the RS with 78 gas stations out of over 350 existing stations. He explained that the new Russian owners have committed to invest in refurbishing the old gas stations, but have not yet done so. He also predicted that retailers will receive better prices for gas once the Brod refinery is generating fuel again, as compared to prices they currently pay for imported gasoline. When asked about the problem with non-EU quality gas coming from Brod, Djukic confirmed RS Assistant Minister Kalabic,s statement that further improvements to the refinery,s old processing line should in six months bring the sulfur content of the fuel down to EU standards. Djukic explained that although there are already penalties for poor quality gasoline, the fines are extremely low and do not prohibit wholesalers and retailers from selling poor quality gas. CONTROLLING PRICES? -------------- ¶5. (SBU) Kalabic also discussed RS plans to pass a law that would control the price of petrol in the retail market, in response to the high price of oil in the world market and increasing concerns from consumers. She explained that the RS is mainly concerned with uncontrolled profit margins between wholesalers, retailers and the customers. She said that a price margin ceiling, either as an exact amount that SARAJEVO 00001661 002 OF 002 would change based on crude oil price fluctuations or as a percentage, would be an ideal regulation. Kalabic expects this regulation to be included in the next changes to the RS Law on Gas, which could happen sometime later this fall. (Note: The RS Government had already pressured retailers to adhere to maximum profit margins on certain consumer products in order to control inflation before the October 5 municipal elections. End note.) SYSTEM ECOLOGIJA ) FIRST BIODIESEL FIRM IN BIH -------------- -- ¶6. (SBU) System Ecologica, a biodiesel firm in the northern RS, held a ribbon-cutting ceremony on September 28 which RS President Kuzmanovic and RS Prime Minister Dodik attended. It was opened by Best Inc., which is a U.S. firm founded by American-Bosnian dual citizen locals Nenad Kokanovic and Borivoje Vukadinovic. Company director Biljana Kokanovic announced to the media that the company will produce daily 100 tons of biodiesel from vegetable oils and fats and will employ 20 workers. Although the company is currently importing raw materials, the owners intend to purchase raw materials from local farmers once their storage facilities are ready in 2009. Dodik took the opportunity of the factory opening to state that this is an excellent example proving that the RS is safe for foreign investors ) though the amount of true foreign investment is really questionable. In terms of customers, BiH is a brand new market for biofuels, and it may be a challenge to find wholesalers or retailers to purchase the fuel. Drago Djukic, General Manager of PETROL RS, the largest gas station retailer in the RS had not heard of the biodiesel company and did not know of any other companies selling biofuels in the area. RS Minister of Energy Kalabic noted that the RS Government will soon be purchasing a new fleet of eco-commuter buses that will run on biofuel. With enough volume, these eco-buses will provide System Ecologica sufficient income to increase production and search for new buyers. EU OIL AND GAS LAW CONSISTENCY -------------- ¶7. (SBU) Most of the oil and gas industry is regulated at the entity level. The RS is currently trying to bring its laws into compliance with EU standards, including the Law on Gas, Law on Energy, Law on Fuel and Law on Electricity. Although her priority is not harmonizing the new laws with the Federation Government, Kalabic noted that she has good contacts with her Federation counterparts and talks with them daily. According to Kalabic, it is the job of the BiH Minister of Foreign Trade and Economic Relations to make sure the RS and the Federation laws are harmonized. She mentioned that the Law on Gas is currently under scrutiny by the EC experts and still needs to be brought into compliance with EU regulations. Although there were earlier discussions on establishing a state-wide Law on Natural Gas, Kalabic explained that the RS is leaning towards establishing an agreement between the Federation and the RS, making a new law unnecessary. (Note: Dr. Johann Hess, Head of the Economic Assistance Section at the European Commission, later explained that in contrast to Kalabic,s assertions, that the EC has one main point of contact at the State level ) it is not in the business of examining entity-level legislation. End note) COMMENT -------------- ¶8. (SBU) Despite many previous unfulfilled commitments on Brod, we have recently heard our fair share of positive signs that the Brod refinery will definitely be producing gasoline by the end of this month, or at the latest, the beginning of next month. Once production is online, we will follow closely the revenue generated from the finished products, the status of the promised investment into PETROL RS, as well as Kalabic,s statement that Brod will start producing EU quality petrol products within six months. It is disappointing that the RS Government (as in many other matters) continues to work in its own world, ignoring the possibility of developing a state-wide energy sector strategy with the Federation. ENGLISH