VISIT OF SE MORNINGSTAR: RUSSIA RECEPTIVE TO

C O N F I D E N T I A L SECTION 01 OF 04 MOSCOW 001658

SIPDIS

DEPT FOR EUR/RUS, FOR EEB/ESC/IEC GALLOGLY AND WRIGHT, FOR
S/EEE MORNINGSTAR
DOE FOR HEGBURG, EKIMOFF
DOC FOR JBROUGHER
NSC FOR MMCFAUL, JELLISON

E.O. 12958: DECL: 06/24/2019
TAGS: EPET ENRG ECON PREL RS
SUBJECT: VISIT OF SE MORNINGSTAR: RUSSIA RECEPTIVE TO
DIALOGUE; URGES CONSORTIUM TO MANAGE UKRAINE PIPELINES

Classified By: DCM Eric S. Rubin for Reasons 1.4 (b/d)

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SUMMARY
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1. (C) In June 17-18 meetings with visiting Special Envoy for
Eurasian Energy Morningstar, Russian interlocutors welcomed
greater cooperation and dialogue with the U.S., including on
two-way investment and global strategic issues such as the
future of LNG, pipelines, and energy diplomacy. SE
Morningstar made clear that we neither oppose nor support
either the proposed Nord Stream or South Stream pipelines;
that these are primarily European issues. He noted that some
countries support and some oppose the pipelines, but that
concerns about the pipelines should be addressed. He also
stressed that Nabucco does not threaten Russia's role as the
dominant supplier of imported gas for Europe. On Ukraine,
Russian Deputy Foreign Minister Denisov, Energy Minister
Shmatko, Presidential Special Representative for
International Energy Cooperation Yusufov, and Gazprom Deputy
CEO Alexander Medvedev all had the same central talking point
-- that the Ukrainian gas system needs to be managed by a
European-Russian consortium that could invest in upgrading
and modernizing it in order to ensure uninterrupted flows of
gas to Europe. In a group dinner, representatives of Western
oil and gas companies told SE Morningstar that their main
concerns in Russia were a tax system based on revenues rather
than profits and a regulatory framework that hindered foreign
investments in exploration and production. End summary.

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COOPERATION AND DIALOGUE WELCOME
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2. (C) In separate June 17 - 18 meetings with Energy Minister
Shmatko, Deputy Foreign Minister Denisov, Presidential
Special Representative for International Energy Cooperation
Yusufov, Gazprom Deputy CEO Alexander Medvedev, and Lukoil
Executive Vice President Maganov, visiting Special Envoy
Morningstar explained that we are interested in pursuing
dialogue and cooperation with the GOR and Russian entities on
a variety of broad issues of mutual interest. All Russian
counterparts welcomed this prospect. SE Morningstar
suggested that the energy policy sub-group of the proposed
Bi-National Commission (BNC) Energy Working Group could
discuss ways to increase two-way investment in the energy
sector and explore avenues for U.S.-Russian cooperation in
third countries as well. He said the two-sides could also
discuss broader strategic issues such as the future of LNG,
governance, and international pipelines.


3. (C) Energy Minister Shmatko agreed that a strengthened
bilateral dialogue would be important and noted his positive
discussions with Secretary Chu on technological cooperation.
Shmatko had a long list of potential issues for discussion
under the BNC, including Central Asia, the growing role of
East Asia, the Arctic, and energy efficiency. On energy
policy, Shmatko said he believed we should identify ways to
harmonize our policies on energy sector investments. He
suggested a "quid pro quo approach -- we give access to U.S.
companies and you give access to our companies." He cited
the Lukoil-ConocoPhillips partnership as a model, but
emphasized that we should not restrict our cooperation to
that model. Shmatko said we need a forum to discuss global
issues, including energy transit. He embraced an expanded
role for LNG in the gas trade as a means of "eradicating
political risk." He added that bilateral talks would also
help each side clarify what third parties are telling us
independently.


4. (C) DFM Denisov said he believed Russia and the U.S. are
"natural allies" on energy issues. He said the potential for
cooperation is great but, quoting Mao, added, "prospects are
bright, but the road is winding." Denisov said the MFA's
role will be to "look after the POLITICAL and diplomatic
matters related to energy" in order to facilitate such
cooperation, and that the MFA might provide SE Morningstar's
counterpart in the BNC sub-group. Denisov also welcomed the
prospect of greater Russian investment in the U.S. energy

MOSCOW 00001658 002 OF 004


market, and, like Shmatko, pointed to Lukoil-ConocoPhillips
cooperation, including in Iraq, as a successful model of
partnership.


5. (C) Lukoil's Maganov stressed that mutual respect and a
goal of mutual benefit is the best approach to working
successfully in any foreign country. Maganov praised the
Lukoil partnership with ConocoPhillips as exemplifying this
approach. He complained that the approach of Western
companies in Russia in the 90s was one of "we'll teach you
how to do it right," and that this approach did not sit well
with Russian counterparts.


6. (C) Special Representative Yusufov focused on the prospect
of LNG from the giant Shtokman gas field as a key to closer
future U.S.-Russian cooperation. He stressed that even
without production sharing agreements, there is plenty of
scope for U.S. participation in Russia, including in
Shtokman. He said "internal problems with the Shtokman
project will compel management to look for additional
partners," and added that the U.S. will be the main market
for Shtokman gas. He stressed that the U.S. market, for both
oil and gas, is key for Russia, and that "our cooperation
could rest on this."


7. (C) Gazprom's Alexander Medvedev said it was "important to
overcome the misunderstandings of the past" and find ways to
cooperate. Echoing Yusufov, he said the target for Shtokman
gas is the North American market and that Gazprom was looking
to collaborate with a U.S. company to make such deliveries
possible. Medvedev stuck to Gazprom's public claim that gas
from Shtokman would be available by 2013, but only "if a
final investment decision is made by March 2010."

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PIPELINES
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8. (C) SE Morningstar made clear to all his Russian
interlocutors that we neither oppose nor support either the
Nord Stream or the South Stream gas pipelines. He noted that
some European countries support these pipelines and some have
issues which should be resolved. Noting that Russia's
dominance of the European gas import market will not be
threatened, SE Morningstar also stressed that Russia should
not be concerned about the Nabucco gas pipeline, and
suggested Russia consider bidding on supplying the pipeline
with gas given that 50% is available for outside bid. SE
Morningstar explained that pipeline politics have muddled the
reality that the fate of any pipeline ultimately rests on
commercial realities.


9. (C) Noting that even a "pessimistic" forecast for European
gas demand calls for 100 bcm of additional imports by 2025
due to dropping domestic production, Medvedev declared "all
projects should go forward." He added that Gazprom does not
see Nabucco as a competitor, but that Gazprom is "not sure"
about its ability to provide gas for the pipeline. He said
"if it gets off the ground, we would likely participate.8
On South Stream, Medvedev claimed the pipeline is cheaper for
Gazprom than going through Turkey.


10. (C) SE Morningstar's official interlocutors did not
comment at length on pipeline specifics. Energy Minister
Shmatko only noted that Nabucco would represent just 5% of
European gas imports, to which SE Morningstar responded "so
why worry?" He also noted that if there was anything to
worry about, it would be what China is doing in Central Asia.
Shmatko added that Russia's plans for "sea routes" are based
on minimizing the "number of players" involved in the energy
trade.


11. (C) Nord Stream executives welcomed the "clarification"
on the USG position on their pipeline. They said the
pipeline is on schedule, but admitted that financing has been
"much more difficult" than expected. They said they believe
South Stream would also be built, but suggested the project
was about 5 years behind theirs.

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UKRAINE
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12. (C) All of SE Morningstar's counterparts had much to say
about Ukraine. Medvedev went into greatest detail, saying
Gazprom was "very worried" time may have already run out for
Ukraine to adequately fill its storage facilities and ensure
uninterrupted flows to Europe in winter. He explained that
only one-third of Gazprom's winter exports to Europe are
direct. The other two-thirds, he said, are "swaps," with
Gazprom supplying gas to Ukraine and Ukraine sending gas to
Europe from storage. According to Medvedev, "there is
literally not enough capacity in the transit pipeline for
Russia to directly supply Europe's needs in winter." He
added that Gazprom estimates that Ukraine currently needs 16
bcm of additional gas to fill its storage facilities and that
a maximum of 2.7 bcm a month can be pumped into storage. He
also said that Gazprom has continued to allow EU monitoring
of its dispatch center, but that Ukraine had ended this
access (a point EU Ambassador Franco had earlier made to
Ambassador Beyrle).


13. (C) Medvedev complained that Europe has not done enough
to resolve the Ukraine transit problem, instead telling
Gazprom that the problem is Gazprom's to solve. He then
described Gazprom's frustrations in dealing with Ukrainian
counterparts, who he accused of being inconsistent and
untrustworthy. Saying that Ukraine will continue to be a
problem because "it has gotten away with it in the past," he
compared Ukraine to a child -- "if you're not punished in
kindergarten, you will not learn to behave."


14. (C) Medvedev said Ukraine needs a European-Russian
consortium to "manage" its pipeline system and to provide the
capital to modernize and upgrade it. He said Gazprom "is
ready to play any role to help facilitate" a resolution to
the Ukraine transit issue, and that Gazprom's interest has
nothing to do with a desire to own the Ukraine's gas
transportation network. Without irony, he followed that
statement by pointing to Armenia and Belarus as models of
successful resolution of the payment recurring payment
problem because "they decided to sell their assets to make
their payments."


15. (C) All other Russian interlocutors, including Lukoil's
Maganov, as if having received the same talking point,
stressed the same on Ukraine -- the need for a
European-Russian consortium to take over the pipelines.
There was some disagreement in their messages, however, on
how we should approach the issue. Shmatko, blaming Ukraine
and claiming Russia is only interested in respect for
contracts, said the Ukraine situation has become "lose-lose."
He expressed his hope that Europe and the U.S. would "use
their influence" with the international financial
institutions to help Ukraine reform itself. Denisov, on the
other hand, specifically referred to the Ukraine problem as a
"family quarrel." He said Russia can "argue and be tough"
with Ukraine, but that at the end of the day, the two sides
are still family.

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CENTRAL ASIA
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16. (C) RELATIONS with Central Asia were also briefly
discussed during several meetings, with Shmatko suggesting
inclusion of this topic under the BNC. DFM Denisov said
Russia is very active with its Caspian partners, but that
bilateral interaction has been more productive than
multilateral interaction. Maganov said Lukoil is working
with ConocoPhillips in Turkmenistan (offshore oil and gas),
and was recently ready to sign a contract, but it "was
suddenly stopped" by the Turkmen side.


17. (C) For his part, SE Morningstar emphasized that U.S.
activities in Central Asia pale in comparison to those of the
Chinese, who will soon have large volumes of Central Asian
oil and gas flowing east. Apparently forgetting that Russia,
the current de-facto monopsony consumer of Turkmen gas
recently cutoff its purchases from the country, Yusufov

MOSCOW 00001658 004 OF 004


commented that Turkmenistan should not want to be beholden to
China as a monopsony buyer.

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IRAN
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18. (C) Commenting on the turmoil in Iran, DFM Denisov said
Russia "more dislikes than likes" Ahmadinejad, but sees him
as "at least predictable." He said Russia simply does not
know as much about Moussavi. Denisov added that, in his
view, "Iran belongs to the U.S. in the long-run," noting that
only the U.S. will have the capability to provide the huge
investments the country needs to modernize. On Iranian gas
sales to Europe, Denisov said he did not believe Iran would
be willing to send gas through Turkey, which it sees as a
regional competitor to its leadership. He said he believes
the more likely route for Iranian gas exports is via LNG and
to India.

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IOC PRIORITIES
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19. (C) SE Morningstar met collectively with representatives
of ExxonMobil, Chevron, ConocoPhillips, Shell, and BP. The
representatives emphasized their interest in investing in
Russia for the long-term, assuming the investment climate
develops appropriately. They had two main concerns: the
revenues-based (as opposed to profits-based) tax system and
the separation of exploration and production licenses. The
tax structure, they said, discourages the type of long-term
and large greenfield investments Russia needs. The
separation of exploration and production licenses, they
added, discourages exploration because it does not guarantee
production rights if a large field is found. They said
Russian production of oil and gas would soon decline without
appropriate reforms to the investment regime.


20. (U) SE Morningstar has cleared this cable.
BEYRLE