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Cablegate: Romania: Romgaz Tries to Adapt to Changing Energy Market

VZCZCXRO6467
PP RUEHIK
DE RUEHBM #0801/01 3371247
ZNR UUUUU ZZH
P 031247Z DEC 09
FM AMEMBASSY BUCHAREST
TO RUEHC/SECSTATE WASHDC PRIORITY 0122
INFO RUEHZL/EUROPEAN POLITICAL COLLECTIVE PRIORITY
RHMCSUU/DEPT OF ENERGY WASHDC PRIORITY

UNCLAS SECTION 01 OF 02 BUCHAREST 000801

SENSITIVE

DEPT FOR EUR/CE ASCHIEBE AND EEB/ESC

SIPDIS

E.O. 12958: N/A
TAGS: ENRG ECON EINV PGOV RO
SUBJECT: ROMANIA: ROMGAZ TRIES TO ADAPT TO CHANGING ENERGY MARKET

BUCHAREST 00000801 001.2 OF 002


Sensitive but Unclassified; not for Internet distribution.

SUMMARY

1. (SBU) One of the top two gas producers in Romania, state-owned
Romgaz, echoed in a November 20 meeting the previous public
statements by OMV/Petrom and other private players on the domestic
market that the regulated price of domestic gas suppresses
production in Romania. Until now Romgaz has maintained a public
silence on this point. Concerning investment plans, Romgaz hopes to
obtain additional on- and off-shore exploration concessions, develop
new underground gas storage areas, and begin producing electricity.
The proposed liquefied natural gas (LNG) terminal in Constanta also
ranks high among Romgaz's priorities. End Summary.

REGULATED DOMESTIC GAS PRICES IMPEDE PRODUCTION

2. (SBU) The regulated price of domestic gas is among the biggest
challenges facing Romgaz. While gas imported from Russia is sold at
one of the highest prices paid by any European country (currently
280 USD per thousand cubic meters (mcm)), by regulation domestically
produced gas may be sold for no more than 160 USD per mcm. In a
November 20th meeting with EconOff, Romgaz Deputy Director General
Lucian Stancu stated that the company has developed economic models
to show the correlation between gas prices and the amount of gas
that could be produced domestically, but the Ministry of Economy has
never even asked for the information. Stancu admitted that Romgaz
was uninterested in exploiting smaller and/or unconventional
reserves (i.e., gas found in coal beds, shale formations, or other
non-conventional reservoirs) given the expected low rate of return
on investment. These fields would only become economical if either
the gas could be exported or if the domestic wellhead price could
approach the Russian import price, neither of which yet seems
feasible.

3. (SBU) While Romgaz could in theory export domestic gas, the lack
of infrastructure to do so and political pressure to use Romanian
gas at home make this unlikely. Instead, Romgaz would like to tap
into foreign markets by exploring outside of Romania's borders. To
this end, the company has recently developed joint ventures to
explore for gas in Slovenia and Poland. Romgaz also hopes to
develop activities in the Caspian Sea, building on the expertise
gained in the region when it was part of the Soviet Union. In
private, Romgaz officials hope the European Commission will force
Romania to eliminate its regulated gas pricing system, but Stancu
admits that this would be politically unpopular, especially among
poorer consumers in the midst of a severe recession.

LOOKING FOR GAS IN NEW PLACES

4. (SBU) Romgaz is well aware of the country's potential for
unconventional gas and that current technology could increase yields
from existing fields. At the same time, Romgaz points to the high
costs it faces in the application of new technology. According to
Stancu, insufficient infrastructure results in well services costing
at least twice what they would elsewhere; the price Romgaz pays to
drill one well would easily cover drilling two wells in the United
States. Negotiating with service companies to lower fees in return
for higher volume is a tactic that Romgaz has attempted, so far
without notable success.

5. (SBU) Offshore, Romgaz plans to bid for exploration and
production licenses in blocks near Romania's maritime border with
Ukraine in the bidding round that the National Agency for Mineral
Resources will conduct in May 2010. Lacking the technical expertise
for offshore operations on its own, Romgaz is contemplating a joint
venture with an international oil company but has not decided
whether it will seek the joint venture before bidding or after
obtaining the concession. Romgaz will also likely bid on the few
remaining onshore blocks in the upcoming bid round.

GAS PRODUCER BECOMES ELECTRICITY PRODUCER?

6. (SBU) Romgaz presents a clear case of regulations driving
rent-seeking market behavior. According to Stancu, Romgaz is in the
process of taking over a gas-fired power plant in Iernut (central
Romania) under a debt-for-equity swap arrangement with state-owned
thermal power producer Termoelectrica. The acquisition is
economical due to the huge disparity between domestically regulated
gas and unregulated electricity prices. Per kilowatt hour of
energy, electricity sells at double the cost of gas, according to
Stancu. Romgaz plans to use this plant as a peak-load generator to
cover the electricity deficit in central Romania. Romgaz believes
it can avoid the regulatory requirement that gas used for power
generation be part of a blended basket comprised of both domestic
and imported gas. If Romgaz integrates the plant onto its balance
sheet as an asset and uses some of the electricity produced for
internal consumption, it is not bound by the basket rules and can

BUCHAREST 00000801 002.2 OF 002


sell excess production (which will be most of what the plant
produces) to the market.

7. (SBU) With regard to the long-standing proposal to consolidate
state-owned energy companies into one or two integrated "national
energy champion(s)," Stancu believes Romgaz has enough political
clout to remain independent of the new company. State-owned, but
profitable and independently operated from the city of Medias 208
miles from Bucharest, Romgaz has little interest in subsidizing
inefficient and loss-making producers elsewhere in the
state-dominated energy sector. Despite initial plans to include
Romgaz in the energy holding company, Stancu said he had received
assurances from the Ministry of Economy that this proposal was
definitively off the table.

LNG IMPORTS AND MORE GAS STORAGE ARE FUTURE GOALS

8. (SBU) While unclear on the precise economics, Stancu confirmed
that diversifying Romania's gas import capabilities to include an
LNG option made sense. U.S. contractor Granherne is conducting an
LNG import terminal feasibility study for Romgaz with funding from
the U.S. Trade and Development Agency (USTDA). To avoid problems
with Turkey over importing gas through the crowded Bosporus Straits,
Romgaz hopes the terminal will be fed by Caspian Sea gas transported
across the Black Sea, compressed in Georgia or brought via tankers
with onboard compression capability. Romgaz believes that using LNG
to feed electric power plants could help make the economic case that
the terminal is warranted. If the LNG could be sold for less than
pipeline Russian gas, this would also inject a new element of
competition into the market. As additional cross-border
interconnections are built, LNG imported into Romania could also be
used for gas swaps with neighboring countries.

9. (SBU) Romgaz also wants to improve its gas storage capacity.
Over the last several months, Romgaz has invested in existing
underground facilities to improve the gas extraction rate from 20
million cubic meters (MMcm) per day to 25 MMcm per day. While
Romania had enough gas stored during the Russian supply cutoff last
January to last through the winter, the limit on extraction capacity
still stressed the system and forced cutoffs to some industrial
consumers. Romgaz currently has 2.9 billion cubic meters in
underground storage, part of which will be drawn down over the
course of the winter. The company is also studying a project with
Gazprom to develop an underground storage facility in Margineni, in
eastern Romania.

COMMENT

10. (SBU) Romgaz's shares of both the domestic market and
production have declined compared with Petrom ever since the latter
was acquired by Austrian-owned OMV. While Romgaz has remained
profitable, Petrom's increased nimbleness as a private company has
undermined Romgaz's position as the clear market leader. Despite
this, the Romanian Government is broadly opposed to further
privatization in "strategic" sectors like energy, especially when it
comes to crown jewels like Romgaz. While this ensures that
important strategic priorities like Nabucco and Black Sea LNG remain
important, ultimately it means that Romanian consumers must pay a
price for over-regulation, underinvestment, and relative
inefficiency in this state-owned sector. End Comment.

GITENSTEIN

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