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Reference ID Created Released Classification Origin
07MOSCOW2393 2007-05-23 09:34 2011-08-30 01:44 CONFIDENTIAL Embassy Moscow

DE RUEHMO #2393/01 1430934
O 230934Z MAY 07

C O N F I D E N T I A L SECTION 01 OF 07 MOSCOW 002393 
E.O. 12958: DECL: 05/18/2017 
Classified By: Econ M/C Pamela G. Quanrud.  Reasons 1.4 (b/d). 
1. (C) Summary.  On April 19-20, Embassy Moscow hosted energy 
officers from regional Embassies and Washington DC-based USG 
officials at the 2nd Asia Energy Officers Conference.  The 
conference focused on the still nascent oil and gas linkages 
between energy-rich Russia and energy-hungry Asia.  Russian 
and foreign energy companies and leading think-tankers 
briefed attendees on the complex issue of putting together 
Russian supply and Asian demand.  The key themes were a 
growing Chinese-Russian rivalry for energy dominance in 
Central Asia; the rising importance of gas decision-making 
(relative to oil); Russian foot-dragging holding back 
consummation of regional ties; uncertainty over some 
resources and infrastructure (particularly pipeline routes); 
and the ubiquitous and lumbering Russian energy giant Gazprom 
as the linchpin to solving (or blocking) key projects.  End 
2. (C) Alistair Ferguson and Shawn McCormick provided an 
overview of Russia's looming gas imbalance and a harsh 
assessment of Gazprom's ability to deal with what could 
become a crisis.  Gazprom's modus operandi is to "lie, cheat, 
and steal" about gas numbers and Gazprom "manages demand out" 
of the equation rather than finding new supply.  TNK-BP 
estimates that Russia operated at a 4-5 bcm/y deficit in 
2006, and that will grow to about 10-12 bcm this coming 
winter.  Russia will do all it can to meet export 
commitments, and there is a definite recognition of 
interdependence with Europe. 
3. (C) One significant thing that has changed since the last 
Asian Energy Officers conference in December 2005 is that it 
is apparent now that Russia is unable to follow through on 
strategic decisions.  Promising 30-40 billion cubic meters of 
natural gas to China by 2020, for example, means that 
geotechnical work must be underway now, yet Gazprom stands in 
the way of projects in the east.  To move West Siberian gas 
to China through the so-called Altai route would drain gas 
from Europe, as production has reached a plateau and is 
insufficient to supply both markets.  Since it is unlikely 
that Gazprom will walk away from its base European markets, 
the company will look elsewhere for new reserves.  Developing 
the big fields on Yamal, in TNK-BP's estimation, is much more 
difficult and expensive than estimated, and at the earliest a 
2015-2020 proposition. 
4. (C) As a result, Central Asian gas, as well as gas 
produced by independents (non-Gazprom companies), is 
absolutely critical to Russia's gas balance.  At the same 
time, China's growing inroads to its west present the Central 
Asian countries with a chance to play the two superpowers off 
each other.  The gas balance problem is "not a crisis yet," 
but Gazprom's growing needs present companies like TNK-BP 
with opportunities and TNK-BP will not "wait until it is a 
crisis."  In fact, TNK-BP is sufficiently confident in the 
ultimate outcome -) that it will be able to produce and 
market additional gas -- that it is budgeting $300 million on 
Kovykta development annually despite having no resolution to 
its impasse with Gazprom over development of the field. 
5. (C) TNK-BP, angry over the indecision over development of 
Kovykta, vowed to attack Gazprom head-on since Gazprom simply 
"cannot control it all."  With gas sector reform slowly 
strengthening in Russia, gas prices gradually rising, an 
electricity crisis looming, and the hastily-passed export 
monopoly law even coming under increasing fire, 2007-8 marks 
a moment of opportunity to break through the Gazprom barrier. 
 Gazprom is at the "zenith of its power" at the moment, but 
Gazprom really has no strategy other than increasing its 
market capitalization while its motivations are almost 
entirely driven by politics and vested interests rather than 
business fundamentals.  This is temporarily Gazprom's 
strength but also its longer-term weakness.  As long as 
Gazprom is happy only with "domination and bulldozing," 
domestic supply problems will grow and will threaten exports, 
MOSCOW 00002393  002 OF 007 
and powerful authorities will increasingly recognize that 
Gazprom is retarding rather than promoting growth in places 
like East Siberia.  At that point, the vested interests in 
Gazprom could be upended while business fundamentals come to 
trump politics.  If not, Gazprom will simply grow weaker, or 
at least more dysfunctional. 
. (C) Erik Houlleberghs, Peter Lundh, and Ed Verona provided 
an overview of energy demand in the Russian Far East and 
Asian markets and a brief summary of the Sakhalin 1 project, 
but most of their presentation was a thesis on how to move 
forward with Gazprom in Russia's east.  There is no doubt 
about Asian demand, and projects such as Sakhalin-1 are 
proving that Russian supply is sufficient to meet it. 
ExxonMobil (EM) sees Russia's gasification strategy in the 
east quite differently than does TNK-BP, however.  The 
Russian government has undertaken a series of complementary 
policies and legislative initiatives to develop the gas arena 
in the east.  These include the federal gas export monopoly 
law (passed); a program (under final approval) establishing 
an integrated production, transportation and supply system in 
the east; a program (draft) on natural gas production; and a 
separate program (draft) on a gas transportation system, 
including for export.  This would all go towards establishing 
a Unified Gas Supply System (UGSS) in the east that roughly 
replicates what Russia has in the west. 
7. (C) The problem with Russia's plan is that it is 
impossible to carry out.  From 2009 to 2017 the plan calls 
for bringing on-stream no less than eleven huge new sources 
of gas to meet its commitments.  These fields are spread 
across virgin territory the size of the continental U.S., and 
the projects will require enormous investments on a shocking 
scale.  EM by contrast sees few of these projects coming 
on-stream until at least 2015 or 2020, with the exception of 
the Kovykta gas project and obviously Sakhalin-1 and -2. 
Sakhalin-1, in which ExxonMobil and Rosneft are partners, has 
made good progress.  Unlike most of the agreements Russia and 
China have signed on energy, the Heads of Agreement that 
Sakhalin-1 signed with China,s CNPC includes a detailed 
price formula.  China has finally realized it must pay world 
prices for gas, at least from Sakhalin-1, and is moving away 
from its obsession with using coal as a basis for setting 
import prices in favor of LNG as the price-setter.  Since gas 
is essentially a peak-shaving fuel for China, it can afford 
to pay relatively high prices for it.  Sakhalin-1's proposed 
gas pipeline to China can serve as the basis for Russia's 
eastern UGSS.  To ExxonMobil,s chagrin, however, Sakhalin-1 
export rights are still uncertain. 
8. (C) All this leaves Russia with a giant need for foreign 
partnerships in the east, but this will be difficult given 
the inherent conflicts of interest Gazprom brings to the 
table.  Nevertheless, on the oil and gas fronts at least, 
international companies will be able to establish such 
partnerships with Gazprom and other Russian majors.  For 
example, despite some internal vested interests that would 
ordinarily compel Gazprom to want to divert Sakhalin-1 gas 
into Sakhalin-2's LNG facility, Gazprom might be satisfied 
with its Sakhalin-2 role and honor Sakhalin-1's PSA rights to 
export the LNG as it sees fit.  It helps that EM's 
calculations show fairly definitively that piping 
Sakhalin-1's gas to China is more profitable to all 
stakeholders than sending it anywhere as LNG.  On the other 
hand, Gazprom is loath to allow other companies to export gas. 
9. (C) In a separate conversation with Beijing Econoff, 
Verona stated that it is critical for China to finalize an 
agreement for Sakhalin-1 gas as soon as possible.  By doing 
so, it may be able to preempt Gazprom's involvement in the 
project.  Verona said that China's unwillingness to cross 
Gazprom is clearly influencing its measured steps to date in 
negotiating for the gas. 
10. (C) The survivors of Russia's 2008 political transition 
will have an impact on whether such partnerships succeed. 
MOSCOW 00002393  003 OF 007 
Whatever happens, Russia's remaining dependency on Europe 
will continue to reduce Russia's freedom to act, while 
Central Asia will turn its attention to the east even more, 
fostering opportunities for cooperation and competition with 
Russia.  Kazakhstan, for example, may find it easier to ship 
gas east than west in the face of Russian opposition to 
trans-Caspian routes.  Kazakhstan has grand plans to develop 
a petrochemical industry and simply does not have enough gas 
to satisfy every direction on the compass, and China -- 
unlike Europe -- is just over the border.  Given EM's view 
that a trans-Caspian gas pipeline is &unrealistic,8 EM 
wondered if USG rhetoric about it was meant to cause Russia 
anxiety and questioned why the West complains when Russia 
takes the same tack by talking of a gas OPEC. 
11. (C) Alf D'Souza and Bibigul Baitluoeva characterized the 
Putin energy era as one of ensuring stability, safeguarding 
unity and control, restoring state capitalism, reacting to 
the perceived inequities of the Yeltsin era, and seizing the 
commanding heights of the economy.  They labeled 
ConocoPhillips' strategic deal with Lukoil as a model of how 
much the international oil companies (IOCs) can get these 
days -- about 20-25 percent of equity and "not much control." 
 As for Sakhalin Island, D'Souza compared the region to the 
North Sea at the early stages of its exploration and 
development.  At that time the North Sea was thought to 
contain around 4-5 billion barrels of recoverable oil, about 
the same as is already proved in the known Sakhalin fields. 
12. (C) Shell's Sakhalin-2 project is now 80 percent complete 
and, thanks in part to project financing that the Japanese 
partners insisted upon, it represents a level of transparency 
not seen elsewhere in Russia.  This despite some Russian 
fears that the field's operators were giving themselves 
kickbacks.  Shell confessed it had shot itself in the foot by 
not keeping all parties informed -) those conducting 
negotiations with Gazprom to swap shares of Sakhalin 2 for 
Shell's access to a West Siberian gas field and those 
preparing to announce Sakhalin-2 cost overruns at the same 
time.  Nonetheless this made the Russians that signed the 
alliance look dumb, the authorities suspicious, and led to 
the campaign to replace the foreigners' majority control with 
Gazprom's.  "When you are under attack in Russia, you are 
alone," D'Souza added. 
13. (C) D'Souza went to great lengths to defend Sakhalin-2's 
performance, pointing out that most of the authorities' 
claims of regulatory violations by Sakhalin-2 were unfounded. 
 For example, it was unrelated pipelines from the Soviet era 
that were leaking and not Sakhalin-2's; dead fish that had 
upset Russian and some western television audiences were the 
result of natural spawning; and in the end the consortium had 
to pay only $1 million in fines compared with the audacious 
estimates by some authorities of $50 billion or more. 
D'Souza also defended the recent deal with Gazprom (to sell 
the latter 51% of Sakhalin-2), which "was not expropriation." 
 Instead it is
a fair deal that avoided arbitration.  Shell 
will remain technical service provider for upstream and LNG 
and the western partners will retain a proportionate role in 
governance.  He admitted the deal has taken a while to 
complete because it is highly legalistic but noted that such 
steps are essential since "forgiveness is not a Russian 
trait".  All partners have now received their funds for the 
sale (totaling $7.45 billion). 
14. (C) D,Souza also pointed out Sakhalin 2 required 100,000 
different licenses and permits and boasted that the project 
had consumed 18 million man hours without any deaths or 
accidents.  He criticized the environmental groups that had 
stirred up trouble on Sakhalin for making "a deal with the 
devil" because the attention they had drawn had resulted in 
Gazprom taking majority control of the project.  D,Souza 
believes Gazprom will produce a much poorer environmental 
record than Shell has thus far.  He noted, however, that the 
environmental groups had played a useful role by keeping 
Shell honest. 
MOSCOW 00002393  004 OF 007 
15. (C) Rosneft's Vice President for Finance, Peter O'Brien, 
boasted that Rosneft has enjoyed five years of oil production 
growth at more than 8 percent, although he did not specify in 
how many of those years growth was through acquisition 
(Yuganskneftegaz, Anglo-Siberian, Severnaya Neft) rather than 
organic growth.  Rosneft is hiring experts from throughout 
the sector to remain the industry leader in growth, overtake 
Lukoil in production, and become competitive internationally 
with a market capitalization capable of supporting further 
acquisitions.  Looking forward, Rosneft will continue to grow 
thanks in large part to its strategy in Eastern Siberia and 
the Far East (Sakhalin and Kamchatka).  Rosneft is partnering 
with nearly every international major in one project or 
another, and with most Asian oil and gas companies as well. 
Rosneft characterizes its partnership with ExxonMobil in 
Sakhalin-1 as highly successful.  The company hopes to get 
into the retail sector of several Asian countries ultimately 
and has also begun thinking about upstream activity in 
16. (C) While eastern production accounts for only 5 percent 
of Rosneft's output now, by 2015 it will grow to 20 percent 
even accounting for a higher production level company-wide. 
With Rosneft's Vankor field, the company plans to be the 
major user of the East Siberian-Pacific Ocean (ESPO) 
pipeline, shipping 500,000 b/d or more by 2020.  Rosneft and 
Transneft will have a "tariff discussion" to come to 
agreement on a fee structure that works for both parties. 
That discussion will focus on Transneft's cost of capital 
prior to taking out loans or on Transneft simply acquiescing 
to the need to pay off its loans more slowly, because to date 
the pipeline seems too expensive.  O'Brien said that even the 
Prime Minister has taken an interest in why ESPO is so 
expensive.  Other East Siberian exploration will be spurred 
by the combination of ESPO and the recently enacted tax 
differentiation for east Siberian fields. 
17. (C) O'Brien characterized the tax relief (for the first 
25 million tons of a new East Siberian field) as a huge 
development incentive, equating to over a billion dollars for 
each field at current prices.  Rosneft sends 180,000 b/d of 
crude to China by rail currently and notes that China's 
desire to get into Russia's upstream is an important lever to 
ensure that higher exports will secure world-level prices in 
the future.  The "price at the end of the pipe" is a major 
concern so such leverage should help. 
18. (C) Separately, USG officers visited Rosneft's Science 
and Technology Center in Moscow.  Here Rosneft monitors and 
directs production, water-flooding programs, and other 
factors and calculates the most commercially favorable 
production profile for its fields.  While the tour is largely 
a packaged presentation that Rosneft's public relations firm 
has prepared for dignitaries, it nonetheless demonstrated a 
competent, technically serious, and very young company that 
wants to advertise its sudden emergence into the ranks of the 
supermajors.  In side conversations, Rosneft admits that at 
least 70 percent of its personnel came with the acquisition 
of Yuganskneftegaz's center and that most of the technology 
and reservoir management techniques were developed by Yukos' 
team of western reservoir engineers who delivered the 
production miracle to Yukos earlier this decade. 
Vladimir Milov 
19. (C) Vladimir Milov, president of the Institute for Energy 
Policy and former Deputy Energy Minister, offered his opinion 
on a wide range of topics, including the growing 
Chinese/Russian rivalry in Central Asia and energy relations 
between the two countries.  He said that the Chinese have 
always wanted to buy an equity stake in a big Russian company 
and thought they had extracted a promise from the Russians to 
allow them to buy into Yuganskneftegaz when it was taken from 
Yukos.  Rosneft ended up with this asset and the Chinese have 
MOSCOW 00002393  005 OF 007 
not forgotten this "broken promise." 
20. (C) On Central Asia, Russia is clearly worried about 
Turkmenistan sending gas to China because Gazprom needs to 
lock up these volumes for itself.  The current agreement 
between Russia and Turkmenistan is only good through 2009. 
Moscow has spent the last 15 years squeezing resources out of 
its Central Asian partners.  As a result, Moscow's 
competitive advantage over Beijing in the region is being 
threatened.  Because of its need for gas, Gazprom will 
undoubtedly muscle into TNK-BP,s giant Kovykta gas project 
in East Siberia.  The volumes can go to meet some of the gas 
volumes Putin committed to China during a trip to Beijing 
last year.  The Sakhalin-1 project looks to be safe from 
Gazprom's predatory tendencies for the time being, he 
thought.  It is likely that ExxonMobil (the operator of the 
project) and Gazprom will work out a way to export the gas. 
International Energy Agency (IEA) 
21. (C) Yo Osumi, head of Asia-Pacific, Latin America, and 
Sub-Saharan Africa at the IEA, gave a detailed presentation 
on Asian energy demand going forward.  While China, India and 
other Asian giants are clearly going to continue leading the 
globe in energy demand growth, there are more alternatives at 
their disposal than some realize.  China's growth has been 
and can continue to be fueled by coal overall, but China will 
clearly welcome Russian oil. Muted Chinese demand for gas to 
date has left the country so far ambivalent about piped gas 
vs. LNG.  Japan's interest in ESPO must stem definitively 
from a policy desire for diversification since Japanese oil 
demand is set to decline in coming decades.
South Korea and, 
to a lesser extent, Japan could face strong needs to seek out 
Russian LNG (or in the case of South Korea, piped gas) in the 
future as gas demand grows and LNG contracts come up for 
renewal in the face of some Asian supply problems (primarily 
in Indonesia). 
22. (C) India has had good luck with domestic gas discoveries 
recently but will continue to be a magnet for LNG and 
pipeline gas imports looking forward, although much depends 
on domestic energy price reform.  IEA's recent criticism of 
Russia for not investing enough in gas development in the 
face of a growing call on Russian gas hit Chinese 
policymakers "square in the eye" and forced them to examine 
Russian gas from a new perspective.  Meanwhile, the Chinese 
have always had a major footprint in Central Asia and IEA 
believes Chinese imports of major volumes of Central Asian 
gas is a likely scenario. 
23. (C) In closing, Osumi stressed that diversification is 
everyone's energy policy goal, but that the key to success in 
this part of the world will be negotiations over pricing, the 
fate of coal use in China, and developments in the "LNG vs. 
piped gas" arena.  "Avoidance of captivity," whether for a 
consumer or producer, will also be determined by internal and 
external politics and, sadly, the seemingly permanent 
corruption in the region. 
Carnegie Center 
24. (C) The Carnegie Moscow Center pulled together an array 
of experts to discuss emerging Russian-Asian energy linkages. 
 Their emphasis was on the nature of the decision to 
construct the ESPO pipeline, different perceptions of China's 
role in the energy equation, and the importance of Central 
Asian gas. 
-- Konstantin Simonov, General Director of the National 
Energy Security Fund, emphasized that the ESPO pipeline is a 
political, not a commercial, project.  Whether it terminates 
in China or on the Pacific coast will be a reflection of 
friends Russia chooses at the time.  Russian society is "very 
flexible" about China and not as fearful of it as many think. 
 With so few resources identified to fill ESPO in the east, 
the pipeline really should be called WESPO since it will 
MOSCOW 00002393  006 OF 007 
require oil from West Siberia.  This is a policy of 
"diversion, not diversification," he said. 
-- Tatiana Mitrova of the Center for International Energy 
Markets Studies at the Russian Academy of Sciences argued 
that China and Russia do not understand each other yet on 
energy trade.  Russia sees the flows through ESPO, and 
possibly the promised gas volumes, to China as a maximum but 
China views them as a "starting point."  This conflict will 
grow and will exacerbate pricing negotiations.  Agreements to 
date are nothing but declarations, whereas actual business 
deal-making will be exceptionally difficult.  Timing is 
another huge issue as China and other markets opt for 
alternative sources of fuel.  Russia's obsession with adding 
value to the economy by exporting products rather than raw 
materials is another stumbling block since Russia's would-be 
fuel customers do not want Russia to add value before the 
products cross the border.  The G8 approach to energy 
security, focusing as it did on diversification for both 
consumers and producers, makes Russia's turn to the east a 
fundamentally strategic rather than commercial issue. 
-- Vasiliy Mikheev of the Institute of World Economy and 
International Relations argued that Russia's recent 
statements about its strategic foreign policy direction have 
been misconstrued by the West.  The West has mistakenly 
focused on Putin's message in Munich, for example, 
interpreting it to mean that Putin was only criticizing those 
who would limit Russia's competitiveness.  In fact Putin 
raised ten points of cooperation with the West as well.  It 
is through this sort of prism that Russia views who is 
helping and who is hurting Russia, and energy security is 
part of that prism.  On the issue of Russia-China relations, 
Mikheev argued that China is both a cooperator and a 
competitor with Russia.  It would be a psychic shock for 
Russia to see China on Russian soil developing oil or gas, as 
Russia is not prepared to accept China as an equal the way it 
does the U.S., the EU, or Japan.  China on the other hand is 
not satisfied with the level of mutual trust with Russia. 
Central Asia, meanwhile, will play Russian and Chinese 
competition off one another. 
-- Vladimir Milov pointed out that much of the hype about 
eastern Russian hydrocarbon riches is overblown.  Proved 
reserves are tiny compared with western Russia, high taxes on 
production that work in western Russia where sunk costs make 
such a government take possible will not work in the east, 
and the only projects in the east showing "signs of life" are 
the two PSA projects run by westerners.  Milov argued for 
focusing less on energy as an economic linchpin for eastern 
Russian development in favor of more focus on overall 
transportation links with the Asia-Pacific world.  While some 
fear this might split Russia in two, Milov believes it would 
instead ground eastern development in economic and geographic 
reality as opposed to the centrally-planned energy projects 
that are little more than a political way to glue the country 
together.  Regarding Central Asia, Milov believes that all 
the states want transit independence and customer diversity 
after years of "broken promises" from Russia on transit and a 
blatantly self-interested Russian position on the Energy 
Charter Treaty.  Russia is taking a short-sighted view of 
Central Asia but still has a firm grip on those states. 
Russia will have to change its strategy in the face of 
Chinese inroads to Central Asia, however. 
25. (C) Asked in closing what advice they would give the USG 
on taking a policy position towards emerging Russia-Asia 
energy trade and geopolitics, participants offered the 
following advice: 
-- China is really the key, not Russia.  The U.S. must decide 
what China represents in energy matters --friend or foe? 
Then, the U.S. should develop a strategy of cooperation with 
China and only then incorporate Russia into the equations. 
-- Take a firm position, reflected recently by the NSC to 
some audiences, that demonstrates that the USG is 
strategically interested in Russia having a presence in the 
Pacific Rim.  U.S. advice to all on how to achieve that 
MOSCOW 00002393  007 OF 007 
integration will be much appreciated. 
-- Be gentle in handling developments in the energy 
geopolitics of the region and avoid over-reacting.  Do not 
regard ESPO as merely a commercial or a political exercise -- 
it is both.  Russia will continue maneuvering on ESPO until 
it finds enough reserves to fill it and will continue to play 
China, Japan, South Korea and the U.S. off against one 
another as it seeks the most comfortable partnership at the 
moment.  Recognize that Central Asian gas is being pulled in 
four directions and that
there is not enough to fill all or 
even most of them.  The USG should take a position on Central 
Asian gas to China. 
26. (U) This cable was cleared by all conference participants. 


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