Cablegate: Embassy Moscow

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TO RUEHC/SECSTATE WASHDC IMMEDIATE 1323
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C O N F I D E N T I A L SECTION 01 OF 03 MOSCOW 009482

SIPDIS
SIPDIS

DEPT FOR EUR/RUS WARLICK, HOLMAN, AND GUHA
DEPT FOR EB/ESC/IEC GALLOGLY AND GARVERICK
DOE FOR HARBERT/EKIMOFF
DOC FOR 4231/IEP/EUR/JBROUGHER NSC FOR GRAHAM AND MCKIBBEN

E.O. 12958: DECL: 08/29/2016

TAGS: EPET ENRG ECON PREL LH RS

1. (C) Summary: As is often the case in Russia's relations with its neighbors and former Soviet comrades, Moscow's decision to shut-off crude deliveries to Lithuania's Mazeikiu Nafta (MN) refinery in the wake of a July 29 oil spill along the Druzhba pipeline (Ref C) appears driven by a mix of geopolitical revenge and common-place commercial considerations. The good news may be that there is little more the Russians can do to worsen the situation (like cut off shipments from Primorsk to Butinge) and the refinery is unlikely to fold. The bad news is that refinery profits are likely to suffer until there is another shift in the oil delivery paradigm facing MN. End Summary .

FIRST THE REVENGE ----------------- .

2. (C) In the wake of the cutoff of Russian oil through the Druzhba pipeline to MN, we spoke to Shawn McCormick (protect), TNK-BP's government affairs rep, whose company is one of Russia's largest shippers. He said despite losing out to PKN Orlen in the MN bid, TNK-BP had offered to sell Orlen about 180,000 barrels per day (b/d) (going up to 240,000 b/d) last May-June, and that Transneft was fully on-board with this offer. Then in early July, Igor Sechin, Chairman of Rosneft (another Russian firm who lost out on the MN bid) and Deputy Head of the Presidential Administration, phoned German Khan, Executive Director at TNK-BP, asking if the oil delivery contract had been signed. Upon finding that it had not, Sechin "instructed" TNK-BP (via Khan) to withdraw its offer, which it did. In an August 29 conversation, Andrey Gaidamaka (protect), Lukoil's VP for Strategy, confirmed for us that Sechin was the interested party behind the cutoff in the Kremlin and that Lukoil and TNK-BP were still under pressure not to contract with MN for piped oil. .

3. (C) In August 22 conversations with Emboffs, Gintautus Siulys and Minijus Samuila of the Lithuanian Embassy characterized the shutdown of the pipeline as a political decision taken at a "very high level" to make Orlen drop its bid for MN, which awaits EU approval, expected in October. Despite all this, Siulys and Samuila seemed cautiously optimistic that the oil supply issue would be resolved soon in Lithuania's favor. Siulys suggested the Russians might ultimately back down out of fear the Lithuanians might shut down the rail link to Kaliningrad (supposedly to make repairs). As soon as Lithuanian officials began hinting at problems with the rail link, Siulys noticed a change in Russian behavior, adding, "in our experience with the Russians, we always do better when we negotiate out of a position of strength." He pointed out that not only do Russian civilians rely on the rail link, but the line is critical for supplying Russian military forces in the Kaliningrad Oblast. .

COMMERCIAL CONSIDERATIONS ------------------------- .

4. (C) Over the last several years, Russia has adopted a policy of avoiding export across transit states. Lukoil's Gaidamaka offered a pretty convincing explanation. Even though the Druzhba was clearly built more for political purpose than anything else, Gaidamaka explained that during the Soviet era the pipeline made more economic sense than it does today. Today, each country along the pipe charges a transit fee, making the route much less attractive for Russian shippers. Following the break-up of the Soviet Union and the extinguishing of the "friendship" in the "friendship pipeline," downstream consuming countries colluded, forcing shippers to sell into a monopsonistic market, which led to a "Druzhba discount" relative to other routes.

5. (C) Over the past several years, the GOR and Transneft have taken several steps to reduce the power of the downstream traders and have virtually eliminated the "Druzhba MOSCOW 00009482 002 OF 003 discount." The most important component of this effort has been the expansion of the Baltic Pipeline System (BPS), whose nameplate capacity Transneft just announced it plans to increase further from 1.2 to 1.4 million b/d. Before long, Gaidamaka predicted a "Druzhba premium" will emerge. This jives with what we have heard from numerous Russian oil companies -- it is simply cheaper to export out of Primorsk than out of Baltic ports because of Transneft's lower transit fees. .

6. (C) With piped oil stopped, rumors were rife that the Kremlin might "order" Russian shippers to stop tanker cargoes from Primorsk to Butinge to completely deprive MN of Russian oil, but these appear unfounded. McCormick says that there is "absolutely no pressure coming from the Kremlin to stop shipments of oil from Primorsk." Our Lithuanian Embassy contacts confirm that tanker shipments from Primorsk to the oil terminal at Butinge in Lithuania have not been interrupted, and they doubted that the GOR would intervene with private Russian shippers. Oil traders at Lukoil, Surgut, TNK-BP, and Gazpromneft confirm they have not received any order to stop shipments out of Primorsk, something Gaidamaka corroborated as well on behalf of Lukoil senior management. These and other international traders say that to stop such deliveries would require Russian firms to include in their crude sale contracts a clause forbidding on-sale of crude to Butinge, something they describe as "virtually impossible" -- western majors would never agree, and they are a crucial link in this chain. One trader said, "It would be a major violation of free trade and I'm very skeptical that it is feasible. If I see that Butinge offers the best price, I'll do my best to buy a Russian cargo and resell it to Butinge." .

TRANSNEFT AND MFA: FIXES ARE COMING, BUT CAN'T SAY WHEN ------------------------------------ .

7. (C) When we talked to Transneft this week, our contact stuck to the company's public line that shipments to Lithuania are a casualty of the July 29 oil spill on the Northern Druzhba pipeline. He said that experts from Rosteknadzor are investigating the spill, and had visited the site August 21-23 to &make clear what had happened and what needs to be done.8 Repairs are pending the outcome of Rosteknadzor's investigation. Arkadiy Sundeyev, Director of the MFA,s Office of Lithuanian Affairs, told us August 25 that he believed Rosteknadzor's pipeline investigation could be completed in a matter of weeks. He said this issue was not "political . . . We want to make the repairs and resume supplying oil as soon as possible." Traders with close ties to oil traders here confirm reports that Belarusian refineries normally supplied from the Northern Druzhba are still receiving oil. To that, our Transneft contact said that after the accident, Transneft restored some flow through &temporary fixes8 although the pressure had to be reduced so the amount of oil flowing is off sharply. .

COMMENT ------- .

8. (C) Given the history of this pipeline and MN, it is not surprising that revenge appears to be playing a significant role in the process of bringing the Druzhba back up to capacity, and we do not put it past Sechin to at least try and stop Russian shippers from supplying Primorsk. One interesting item of note in this case is the degree to which Sechin and his interests have been unable to stop Russian companies/traders from supplying the refinery, who follow Russian practice of f.o.b. (free-on-board) delivery. MN can just as easily, if more expensively, buy barrels from non-Russian sources, and the international oil majors' are reluctant to agree to contracts excluding Butinge -- both of these facts give Lithuania and Orlen leverage to fend off whatever Russian demands may actually be behind this situation. When conditions are right, Russia's ability to use energy as a weapon (even when the will may be there) is limited. .

9. (C) How this will all unwind is still not clear. The MOSCOW 00009482 003 OF 003 Rosteknadzor report will come before too long, and repairs will no doubt drag well into the fall. Despite Siulys, optimism that the Russians might back down over the rail line issue, we doubt there is much leverage to be found here, nor can the Russians credibly threaten to go around Lithuania to Kaliningrad via ferry, as suggested this week by Kaliningrad Oblast Governor Georgiy Boos during a meeting with Putin. Perhaps Lukoil's Gaidamaka is right to predict that the piped oil will flow again, but perhaps with a Druzhba premium. BURNS 2006-08-30

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