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Reference ID Created Released Classification Origin
07MOSCOW1149 2007-03-16 15:28 2011-08-30 01:44 CONFIDENTIAL Embassy Moscow

DE RUEHMO #1149/01 0751528
O 161528Z MAR 07

C O N F I D E N T I A L SECTION 01 OF 05 MOSCOW 001149 
E.O. 12958: DECL: 03/15/2017 
Classified By: Amb. William J. Burns.  Reasons 1.4 (b/d). 
1. (C) Summary.  Deputy Secretary of Energy Clay Sell visited 
Moscow March 11 - 14 to participate in the bilateral Energy 
Working Group (EWG) and to meet with U.S. energy companies as 
well as Lukoil and Gazprom.  At the EWG, there was a good 
exchange of views on information exchanges, energy 
efficiency, oil spill prevention, and each country's 
investment climate.  The Deputy Secretary met with Lukoil's 
CEO Vagit Alekperov to discuss Lukoil's successful 
cooperation with ConocoPhillips, with Alekperov also raising 
Lukoil's projects in Iraq and Iran.  Gazprom's Deputy CEO 
Alexander Medvedev waxed philosophical about the rectitude of 
the state's new role managing key sectors, Gazprom's efforts 
to diversify markets, the need for promoters of the "southern 
gas corridor" to include Russia in the game, and he 
criticized Shell's management of the Sakhalin 2 project. 
Energy Minister Khristenko proposed conducting a small, 
bilateral seminar to discuss each countries energy policies. 
Sell stressed the benefits of Russia's making a decision on 
its openness to foreign investment.  Khristenko agreed that 
making such a decision soon is in the GOR's best interest and 
predicted passage of the Law on Strategic Sectors this year. 
End Summary. 
2. (C) Sell co-chaired the EWG with his Russian counterpart 
Deputy Energy Minister Ivan Materov.  Sell agreed with 
Materov that it had been too long since the two sides met 
(about two years) but that much good had happened in the 
intervening period.  Sell pointed out, and Materov agreed, 
that the work of the group going forward should be based on 
the principles laid out at the St. Petersburg and Gleneagles 
G-8 Summits.  On information exchanges, the U.S. side noted 
that DOE's general counsel had reviewed and commented on the 
protocol dealing with transmission of statistical data and 
analyses and that DOE had sent the comments to the Russian 
side and is waiting for the Ministry's reaction.  Materov's 
colleagues noted that internal approval for over half of 
DOE/EIA's suggestions for exchange of facts and energy 
indicators had been approved but that the ministry is still 
reviewing the propriety of releasing a handful of the 
requested items.  Materov agreed with Sell that information 
exchange is essential for clarity and functioning markets, 
observing that Russia has trouble forecasting oil market 
movements, for example.  Sell and Materov agreed to aim for a 
signing of the information exchange protocol by the end of 
3. (C) The Russian side said that the bilateral work on 
energy efficiency is a natural follow-on to the G-8 
Gleneagles commitments and the topic will get attention at 
the next summit in Germany.  President Putin stressed energy 
efficiency and the ministry expects to finish drafting a law 
on energy savings in March.  The GOR will also try to push 
legislation on renewables and other alternative sources of 
energy.  Materov said that it was "critical to work with you" 
in writing laws and regulations in this sphere. Specifically, 
Russia is working on a federal program on energy consumption 
to 2015 that aims to reduce energy consumption per unit of 
GDP by nearly 40% from 2006 levels.  The GOR also 
specifically hopes to implement a program similar to the 
U.S.' Federal Energy Management Program (FEMP) to reduce 
energy consumption in federally-funded governmental 
facilities.  For these and other energy efficiency programs, 
Russia needs international technology and management 
expertise, needs to share experiences, and needs a dialogue 
to help shape its legislation and regulations in this sphere. 
 Further, the Russian side indicated that they were pleased 
with the cooperation on oil spill prevention and that it 
should continue. 
4. (C) Regarding investment climate issues, Alan Hegberg, 
Deputy Assistant Secretary for Policy and International 
Affairs, relayed to the Russian delegation the changes to the 
U.S.'s energy economy over the last thirty years, especially 
regarding deregulation of the gas and electricity industries. 
 These changes are on-going and are market-based and rely on 
new innovations.  The Russian side acknowledged Hegburg's 
arguments that success in building an energy economy requires 
MOSCOW 00001149  002 OF 005 
long-term dedication, market-based incentives for 
competition, technological innovation, energy efficiency, 
self-sustaining investment, non-discriminatory opportunities, 
transparency and financial discipline, and integration into 
the world economy.  Ma
terov replied that the GOR was 
committed to the same approach, but needed to finally 
transform the Soviet-era legislative and regulatory base into 
a modern one.  The current debate on a strategic sectors law 
was an example, drawn largely from U.S. experience, of Russia 
attempting to build that bridge to modernity. 
5. (C) At the close, Sell mentioned that in an earlier 
meeting Energy Minister Viktor Khristenko had proposed the 
idea of a bilateral energy forum to debate/discuss each 
country's national energy strategy.  Khristenko's idea was 
that he and Energy Secretary Bodman would open the meeting. 
Sell indicated that he would relay the message to Secretary 
Bodman, while Materov noted that "debates bring governments 
6. (C) On March 12, Sell met with Lukoil CEO Vagit Alekperov 
who said that his company was looking at opportunities 
globally, including expansion in the U.S.  Lukoil wants to 
complete the value chain of bringing West Siberian oil to 
U.S. consumers' gas tanks through its retail network in the 
U.S.  Sell said that the ConocoPhillips (CP)-Lukoil 
partnership should serve as a model for future investment and 
that the U.S. is open to Russian investment.  Alekperov 
agreed and pointed to the personnel exchange with CP and the 
fact that Lukoil is taking on some CP management techniques 
and senior managers as examples of increased cooperation. 
Lukoil is in extremely good shape financially as it has the 
largest reserves of any private company in Russia, plans to 
double production over the next decade to be as big as 
ExxonMobil by that measure, and it is the only company that 
has replace reserves for 15 years running.  Lukoil plans to 
invest around $10 billion annually divided 70/30 
7. (C) Alekperov admitted the oil business in Russia is 
intensely political.  The decision has been made that big 
fields -- both onshore and offshore -- should be developed by 
national companies (like Lukoil), not necessarily just state 
companies (i.e. Gazprom and Rosneft).  He hopes Lukoil will 
be given this opportunity and that CP has success in its 
pursuit of Shtokman, an outcome that he believes could 
further his own attempts to strike a strategic alliance with 
Gazprom for offshore ventures.  That said, Alekperov has 
doubts about the economics of Shtokman due to the field's 
difficulties.  He admitted nonetheless that an element of 
capriciousness remains in the debate over access to large 
fields and that "different visions" are in play regarding 
what the rules should be.  He said that Gazprom is not 
impossible to deal with since Gazprom usually admits its 
weakness once ensconced in a deal but when first negotiating 
Gazprom will always act as "older brother".  Sell stressed 
the need to draw on the technical capability of international 
oil companies on an equity basis to develop challenging 
fields such as Shtokman. 
8. (C) Regarding the strategic partnership with CP, Alekperov 
emphasized that it has the political support of not only the 
Kremlin leadership but society as a whole.  He observed in 
the same vein that Lukoil is the only Russian company 
currently partnering successfully with almost all major U.S. 
oil companies, with USG agencies such as OPIC (the Vysotsk 
oil products terminal), with the EU (building a possible oil 
terminal at Wilhelmshaven in Germany), with the Caspian 
countries, and with many others.  Lukoil is all about 
business, not politics, he emphasized, although he admitted 
that sometimes "crude oil smells a lot like politics". 
9. (C) Alekperov made a strong pitch for his company to 
develop Iraq's West Qurna (WQ) field.  Lukoil would need 30 
months to launch the project from the date of signing.  WQ 
could sustainably produce 500,000 b/d, production that would 
help develop the economy to stabilize the political situation 
and the new oil law should make this a possibility.  Due to 
the work Lukoil has already done, should another company win 
MOSCOW 00001149  003 OF 005 
the rights to the field it would take three times as long to 
develop WQ.  Sell pointed out that we want to see a stable 
Iraq that is able to make responsible use of its natural 
resources.  The case for Lukoil's involvement was compelling 
and, if the Iraqi chose to go that way, we would be 
10. (C) Alekperov also sought Sell,s reaction to Lukoil,s 
work in the Anaran project in Iran.  Alekperov said that 
Lukoil is a junior partner to Norsk Hydro, that the project 
is at the exploration stage, and that Lukoil has been 
compliant with U.S. sanctions and has kept its relationship 
with ConocoPhillips in mind when deciding on steps towards 
this project.  Lukoil has clearly chosen not to  pursue its 
work with Iran in a manner that would threaten its business 
interests in the U.S. market, even if complying with U.S. law 
would mean losing out on a lucrative opportunity in Iran. 
Lukoil can continue in it current holding pattern on Anaran 
for six to twelve months but after that there will be plenty 
of other firms, including perhaps Russian firms, willing to 
take on the Anaran project. Sell emphasized that a way 
forward with Iran is difficult for both countries. 
11. (C) Sell stressed the importance of the government to 
move forward on the subsoil law to clarify the rules for 
foreign investment.  Speaking expansively, Alekperov noted 
the tendency not just in Russia but throughout the world for 
resource-rich countries to adopt nationalist and 
protectionist measures in key sectors.  He implicitly 
criticized these countries as typified by complacency born of 
wealth, highlighting Kazakhstan as one of the worst.  In 
Russia, at least there is a lot of diverse opinion, which is 
healthy since "if things had been decided quickly, everything 
would now be owned by Gazprom".  He predicted that a better 
version of the subsoil legislation or amendments to the 
existing law would be produced by September and did not 
particularly see impending Duma elections this winter as an 
obstacle to passage.  He reiterated how important the 
survival of private companies in the Russian energy sector 
is, noting that Gazprom and Rosneft are simply not capable of 
developing enough resources to keep Russia's oil and gas 
production steady.  Alekperov closed by emphasizing that 
Lukoil will become more internationalized - Lukoil is too 
"outstanding" a company and with production that will one day 
exceed ExxonMobil's, Lukoil cannot be a "local" company. 
12. (C) Alexander Medvedev, head of Gazexport and Deputy CEO 
of Gazprom, covered a range of topics with Sell at a meeting 
on March 13.  Regarding gas price disputes with FSU 
countries, Medvedev said that the Belarus spat had not been 
accompanied by nearly as much western objection as the 
Ukraine spat a year earlier, despite the last-minute dea
with Belarus.  Russia hopes it is clear to the world that 
Russia's policies towards all gas consumers are equivalent - 
to move to market based pricing.  This includes its own 
internal customers now that the GOR has decided to increase 
domestic prices to netback parity by 2011 (except for 15 
percent of the market occupied by households, which will be 
liberalized more slowly).  The GOR and Gazprom are confident 
that this will benefit the Russian economy by introducing 
more energy-efficient technologies.  Sell replied that U.S. 
experience with deregulation had resulted in at least two 
major outcomes - more efficient technologies throughout the 
economy and more sustainable investment. 
13.  (C) Medvedev said the Bovanenko field on the Yamal 
Peninsula would require $40 billion to develop and that first 
production would be in 2011.  This field will be developed 
concurrently with the Shtokman field.  Chevron's recently 
signed deal with Gazprom Neft was a "good deal" and good 
project.  Gazprom is impressed with ExxonMobil's management 
of Sakhalin-1, which despite cost increases for such projects 
around the world did not suffer anything like the exorbitant 
cost overruns of Sakhalin-2 or Snovhit.  Gazprom is having 
other good experiences with U.S. companies these days, 
including with Aspen Technologies, which recently entered a 
deal with Gazprom's petrochemical subsidiary Sibur. 
14. (C) Regarding Shtokman, Medvedev said that Gazprom 
MOSCOW 00001149  004 OF 005 
intends to pick a maximum of three partners from the 
shortlist of five by May or possibly as late as June. 
Before, the valuation of Shtokman's reserves by the western 
firm had simply been too low, resulting in counter-offers by 
them that were insufficient.  Over time, the discount rate 
associated with Russia will decrease, leading to higher 
valuations by the west so that asset-swaps may be revisited. 
But for now, he said, the foreign firms acknowledge that 
Gazprom will own the reserves and that they will have to find 
alternative "values to book" from the project. 
15. (C) Waxing philosophical, Medvedev admitted that Russia 
has not had a long history of a consistent investment 
climate.  The state, however, is "back where it should be", 
running the industries that are genuinely strategic in their 
importance.  This is the only way to protect the people and 
the nation, as opposed to the 1990s when the nation's assets 
were handed out to a few individuals for much too low a 
price.  And Russia is not as bad as some countries, having 
decided not to renationalize but rather to create a sort of 
"semi-private" sector.  The next generation of Russians is 
"absolutely different" than the older generation but they 
still recognize the "historical mistake" of the 1990s and the 
rectitude of the state regaining its rightful role in 
managing key sectors to avoid abusing the people's trust 
through botched privatizations.  Even at Davos, which he 
attended with his namesake Deputy Prime Minister Dmitry 
Medvedev, notables had been commenting on the progress Russia 
had made in its legal structure, tax climate, registration 
rules, banking procedures, and so on.  And the senior 
Medvedev had promised the Davos audience that the rules about 
access to strategic sectors would be passed soon, and people 
are taking him at his word.  To Sell's question about what 
happens after the March 2008 elections, Medvedev predicted 
that whoever takes over will continue the policies under 
Putin.  Putin achieved a great deal and people recognize that 
16. (C) Gazprom is inefficient, he admitted, and needs much 
in the way of cost management and operational efficiency, 
problems that "will not be solved overnight".  But with 
upside in this area, commodity price upside, and reserves 
upside, Gazprom expects to grow its market capitalization to 
$1 trillion eventually, and Medvedev claims that objective 
analyses by western market analysts come in at around the 
same magnitude. 
17. (C) Gazprom and Russia do not understand some U.S. 
policies, Medvedev said.  Specifically alluding to the 
Nabucco pipeline and the southern gas corridor, he said it is 
a mistake to think such a corridor can be built without 
Russian gas.  Without Russia, there is no gas, and without 
Russia's markets in Europe there is no market, he argued. 
Gazprom made an agreement with Greece and Turkey regarding 
onward transit of gas from the Blue Stream pipeline and the 
three will soon decide on the feasibility of such a 
Russia-origin corridor.  Without Russia, the southern 
corridor "will fail, just as it is now frozen". 
18. (C) Sell asked Medvedev why Gazprom wants to remain 
dependent on European markets rather than diversify markets, 
such as through LNG to North America.  Medvedev replied that 
Russia is doomed to remain dependent on Europe but is also 
diversifying to North America and Asia.  This is important to 
the world since China or India, for example, have 
unsustainable economies without resolution of their resource 
scarcities.  Gazprom is basing all its moves on commercial 
rationale alone, "trying to avoid" politics in its 
19. (C) Medvedev, who had been the key negotiator in 
wrenching a 50% plus one share from the Sakhalin 2 
consortium, had special scorn for Shell's management of the 
project.  He repeated the distrust that stemmed from the 
unfortunate juxtaposition of the constructive deal Gazprom 
and Shell had struck in 2005 that was followed "the next day" 
by Shell's announcement of extreme cost overruns at Sakhalin 
2.  Noting that he had grown up on Sakhalin Island and knew 
environmental degradation there when he saw it, Medvedev 
offered the example of the Sakhalin 2 pipeline being built 
right through the middle of a national park when the federal 
license clearly said the pipeline must skirt the park's 
territory.  True, he admitted, the regional government had 
MOSCOW 00001149  005 OF 005 
given Shell permission to build it through the park, but 
"Shell is not from kindergarten" and knows better than to try 
and get away from such federal supervision by hiding behind 
local authorities who "have no right" to supersede federal 
power on such matters.  Asked why on earth Gazprom wanted 
into such a project if it had so many problems, Medvedev 
responded that Gazprom bought in at a proper discount to 
adjust for such problems and that Deloitte and Touche had 
verified that the price paid was a fair valuation.  With 
Shell, Gazprom is now embarking on a plan to overcome the 
ecological damage done by Sakhalin 2, he said. 
20. (C) In a lengthy private conversation with the Deputy 
Secretary and Ambassador, Minister of Industry and Energy 
Viktor Khristenko stressed the need to focus our energy 
relationship on pract
ical results.  Along those lines, 
Khristenko proposed "a joint seminar on national energy 
policies."  The proposal was short on specifics but would be 
modeled on seminars that Russia has with the EU and Japan and 
would follow up on the principles laid out at the St. 
Petersburg G-8 Summit.  The seminar could be a small 
gathering with Khristenko and Secretary Bodman, perhaps, 
opening the meeting.  Khristenko envisioned high-level 
private sector participation from both sides.  Sell said that 
this sounded like a good idea and that he would relay the 
message in Washington. 
21. (C) Sell said that the G-8 principles were a good basis 
to build on.  He encouraged Russia to move forward on 
building transparency in the energy sector, saying that it 
was Russia's choice to do what they want regarding 
restrictions on foreign investment but the key was making a 
prompt decision.  Khristenko said that the sooner the GOR 
defines strategic sectors the better.  He expects the Law on 
Foreign Restrictions to pass this year but would not be drawn 
out on the Subsoil Law.  Sell continued that energy 
efficiency was an area our two governments could do some good 
work.  Khristenko recognized this and noted that improving 
energy efficiency was one of the reasons the GOR decided to 
raise domestic gas prices to European netback levels by 2011. 
 Khristenko noted that the planned ramp-up in Russia's 
civilian nuclear power is part of the long-term strategy to 
rationalize energy use. 
22. (U)  The Deputy Secretary's delegation has cleared this 


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