RUSSIAN OIL AND GAS SECTOR RETRENCHES

C O N F I D E N T I A L SECTION 01 OF 03 MOSCOW 000853

SIPDIS

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

E.O. 12958: DECL: 04/02/2019
TAGS: EPET ENRG ECON PREL RS
SUBJECT: RUSSIAN OIL AND GAS SECTOR RETRENCHES

REF: A. MOSCOW 403

B. MOSCOW 367

C. 07 MOSCOW 3125

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

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Summary
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1. (SBU) Russian oil and gas companies are cutting back on
capital expenditures and trimming costs where possible as
they try to ride out the financial crisis and adjust to lower
oil prices. Even state-owned Gazprom and Rosneft, despite
having held to earlier investment plans through the end of
2008, have now announced 2009 expenditure cuts. Under
pressure from the GOR to maintain employment, no company has
announced major layoffs as a cost-cutting measure. Despite
support from a weak ruble and dropping prices for inputs, we
will likely continue to see the sector retrench absent a
major uptick in oil prices or a credit thaw. End summary.

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FACING REALITY
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2. (SBU) Until late October 2008, despite widespread
expectations that the Russian oil and gas sector would have
to make painful adjustments to new financial and economic
realities, no company had officially announced major cutbacks
in expenditures or investments (ref C). As the crisis wore
on, however, and GOR officials themselves began to publicly
accept its impact, the major oil and gas companies (Rosneft,
Lukoil, TNK-BP, and Gazprom/Gazpromneft) slowly changed their
tune. The private major companies, Lukoil and TNK-BP, were
the first to announce revisions to their original 2009
investment and spending plans.


3. (SBU) In 2008, Lukoil had $12 billion of capex
expenditures (capex) and expected to spend another $11
billion in 2009. In late October 2008, however, Lukoil
suggested 2009 capex would be cut to $7.5 - $9 billion. In
February, the company again cut its capex forecast for 2009
to just $6.5 billion. In March 2008, TNK-BP expected 2009
capex of $4.5 billion. By December 2008 the figure was cut
by 30% to just $3.3 billion and in January 2009 it was cut
again to $3 billion.


4. (SBU) In contrast, state-owned Rosneft and Gazprom were
steadfastly sticking to ambitious capex plans until early

2009. Vlad Konovalov, head of the Petroleum Advisory Forum,
an association of international oil companies in Russia, told
us recently that the divergent stances of the private and
state-owned companies indicated to him that the state
companies are being directed by the GOR and not by economic
considerations.


5. (SBU) By February and March 2009, however, even the state
giants had to acknowledge that their plans would have to be
scaled back. As of February 2009, Rosneft was still
suggesting 2009 capex would increase by 11% in ruble terms
(implying a 15 - 20% cut in dollar terms). By March, Rosneft
had shifted its guidance, saying 2009 capex would equal 2008
capex in ruble terms (a 25 - 30% cut in dollar terms).
Gazprom has been the most reluctant to revise its spending
plans downward. In March 2008, Gazprom planned to increase
its capex in 2009 by 40% to 700 billion rubles and again by
another 20% in 2010 to 850 billion rubles. Through January
2009, Gazprom was publicly and privately (refs A and B)
claiming it was moving ahead with all investment plans and
did not expect to change them in light of the financial and
economic crisis. By February 2009, however, Gazprom admitted
it would have to prioritize spending, and proposed 2009 capex
of under 500 billion rubles. Gazpromneft, Gazprom's oil
subsidiary, provided reduced capex guidance ahead of its
parent, in December 2008. At that time, Gazpromneft
announced various capex reduction scenarios depending on the
oil price. At $70 per barrel, 2009 capex would drop 25%; at
$50 per barrel, capex would be cut 35%; and at $32 per
barrel, Gazpromneft expected to cut 2009 capex by 45%.

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GOR PRESSURE TO AVOID STAFF CUTS
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6. (SBU) Even as the GOR has apparently allowed the state
giants to reduce capex plans it has kept the pressure on all
companies in the sector to maintain employment and avoid
staff cuts wherever possible. While several oil and gas
companies have reported minimal reductions in staff, none has
announced major layoffs. According to analysts who sat in on
a conference call in March, Rosneft has suggested it "may cut
several thousand" of its approximately 106,000 employees, but
it has not yet taken any official action. Both Gazprom and
Gazpromneft recently announced headquarters staff reductions,
but those cuts amount to only a few hundred of Gazprom's
several hundred thousand employees.


7. (C) TNK-BP COO Tim Summers (protect) told us recently that
the GOR is applying "tremendous pressure" on his and other
companies to avoid layoffs. He said TNK-BP would "try to
comply" but that his company has already cut 450 staff in
Moscow and will leave another 150 vacancies unfilled.
Summers said he had heard that Gazpromneft, in response to
government pressure, had canceled a major order for American
drilling equipment in order to avoid laying off the
additional staff needed to operate the less efficient current
equipment.

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BUT COST-CUTTING THE PLAY OF THE DAY
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8. (SBU) While avoiding layoffs for now, the companies are
taking other measures to save money. Summers told us TNK-BP
has switched how it pays its vendors, changing its policy
from payment within 30 days to payment within 60 days, a move
he explained would save his company millions of dollars. He
added that TNK-BP will be "extremely prudent" in managing
cash this year. According to Summers, 2009 and 2010 will
"weed out the inefficient."


9. (SBU) Rosneft has publicly announced a major cost-cutting
initiative, including reducing bonuses, but has revealed no
further details. According to press reports, the major oil
and gas companies are also considering cuts in charitable
contributions. The major companies reportedly spent a
combined $1.5 billion per year over the past two years in
charitable giving, but that figure is expected to drop in

2009. Dividend payments are also reportedly under review at
all the major companies as they balance the need to maintain
investor interest and the need to conserve cash for
operations and investments.

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WEAK RUBLE AND LOWER INPUT COSTS WILL HELP
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10. (C) Despite the gloomy outlook for the oil and gas sector
in general, two factors will help the companies' bottom lines
-- rapid deflation in the price of oil and gas sector inputs
and ruble depreciation. Summers told us that the prices of
many inputs used by the oil and gas sector have dropped by
30% recently, and are likely to continue to drop in the
near-term.


11. (C) Summers also told us that the sector has recently
benefited from changes in the exchange rate, which are tied
directly to the oil price. He explained that when the oil
price goes down, the ruble weakens, and expenses in dollar
terms drop, partly off-setting the fall in prices. Rosneft
CFO Peter O'Brien told us recently that the weak ruble is a
major contributor to Rosneft's bottom line as its expenses
are largely in rubles and its earnings in dollars.

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COMMENT
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12. (SBU) The size and geographic dispersion of the oil and
gas sector means cutbacks in expenditures will have major
impacts across Russia. In addition to billions of dollars in
purchases from vendors and in salaries to staff, in many
small towns they provide needed funds for schools, roads, and

MOSCOW 00000853 003 OF 003


hospitals both directly as part of their "social obligations"
and indirectly through tax payments. Given the sector's
massive debts and given continued global economic
uncertainty, the situation will likely get worse before it
improves. Absent a major change in the credit environment or
a sharp increase in oil prices, we would expect to see
further cuts in capital and operational expenditures
announced later in 2009.
BEYRLE