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Cablegate: Rs Oil State of Play

VZCZCXRO5707
RR RUEHAG RUEHAST RUEHDA RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA RUEHLN
RUEHLZ RUEHPOD RUEHROV RUEHSR RUEHVK RUEHYG
DE RUEHVJ #1661/01 3011500
ZNR UUUUU ZZH
R 271500Z OCT 08
FM AMEMBASSY SARAJEVO
TO RUEHC/SECSTATE WASHDC 9161
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE

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

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