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R 160126Z MAY 08
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UNCLAS SECTION 01 OF 03 ULAANBAATAR 000221 
 
SENSITIVE 
SIPDIS 
 
STATE PASS USTR, USTDA, OPIC, USGS, AND EXIMBANK 
STATE FOR EAP/CM AND EB/IFD/OIA 
USDOC FOR ITA 
 
E.O. 12958: N/A 
TAGS: EMIN EINV PREL ECON EFIN PGOV KPKO MG
SUBJECT: MONGOLIAN PM'S PLAN TO LOWER GAS PRICES BACKFIRES 
 
SENSITIVE BUT UNCLASSIFIED - NOT FOR INTERNET DISTRIBUTION. 
 
¶1. (SBU) SUMMARY AND COMMENT: In an effort to bolster his party's 
prospects in the run-up to June 29 Parliamentary elections, 
Mongolian Prime Minister Bayar embraced a plan to keep gas prices 
under control by allowing a Russian oil giant to set up 100 gas 
stations throughout Mongolia.  The plan has backfired, with 
opposition Democratic Party (DP) MPs, petroleum-industry leaders and 
many ordinary citizens calling it a sell-out to the Russians.  Under 
the plan, Russian state-owned oil products producer Rosneft would 
have the right to set up a distribution network along key Mongolian 
transport corridors, including the east-west Millennium Highway, in 
exchange for holding down gasoline and diesel prices at some 
unspecified level for an unspecified time.  If this proposal were to 
be approved, Rosneft, which provides more than 90% of Mongolia's 
fuel, would not only retain its near-monopoly on supply to Mongolia, 
but also become a leading distributor.  Such a proposal would 
require Parliament to amend Mongolia's Petroleum Law, which limits 
foreign participation in the sector.  The DP, eager to deny any 
pre-election success to PM Bayar's Government, which is led by the 
Mongolian People's Revolutionary Party (MPRP), has adamantly opposed 
any such amendment, arguing that other approaches are possible and 
that the proposal threatens Mongolian sovereignty and free markets. 
Mongolians' fear of Russian domination has trumped the lure of lower 
gas prices, at least for the moment.  END SUMMARY AND COMMENT. 
 
¶2. (SBU) On May 2, Mongolian Prime Minster S. Bayar submitted to 
Parliament his Government's plan for stabilizing gas prices, which 
have skyrocketed in recent months.  The plan focused on Russian 
state-owned petroleum product exporter Rosneft, which supplies more 
than 90% of Mongolia's gasoline and petroleum product needs.  At 
present, all of these imports come through private distribution 
companies owned and operated by Mongolian firms.  The PM's stated 
concern was that Rosneft would soon be raising prices by US$62-89 
per metric ton on three types of gasoline and diesel, respectively. 
These increases would raise Mongolian pump prices from the current 
US$1-1.30 per liter to US$1.10-1.50 per liter.  (Note: Because 
diesel prices would see the greatest increase, and because most 
transport and shipping methods - including trains and trucks -- use 
diesel, these price increases would be amplified in all products 
that require diesel-based shipping, especially meat, wheat and 
potatoes from the countryside, exacerbating already troublesome 
food-related inflation. End Note.) 
 
SOFTENING THE BLOW 
------------------ 
 
¶3. (SBU) Our GOM sources have made clear that the Bayar Government - 
a three-party coalition, led by Bayar's MPRP -- feared another hefty 
price increase for fuel.  Such an increase, on top of rising costs 
for food and other imports, would present a direct threat to the 
re-election prospects of MPRP Members of Parliament.   Following the 
latest fuel-price hikes by Rosneft, the GOM had attempted to soften 
the blow for consumers through a combination of subsidies and 
pressure on Mongolian distributors to absorb price increases. (Note: 
A source at one of Mongolia's largest fuel-distribution companies 
told us it had taken a major financial hit by following the GOM's 
"guidance" to keep prices fixed.  The promised GOM subsidies never 
fully materialized, the source added.  End Note.)  Eventually, it 
became too costly for the GOM to continue subsidies, and too costly 
for the private companies to absorb the cut in profit margin. 
Consequently, distributors began to pass higher costs on to 
consumers.  The popular outcry apparently prompted Bayar to direct 
his Minister of Industry and Trade, Narankhuu, to reach some sort 
deal with Rosneft to bring prices down. 
 
 
ULAANBAATA 00000221  002 OF 003 
 
 
QUID PRO QUO: CHEAPER GAS FOR DISTRIBUTION SYSTEM 
--------------------------------------------- ---- 
 
¶4. (SBU) Rosneft informed the GOM that it would consider lowering 
the price of its petroleum products exported to Mongolia by an 
unstated amount for an unspecified period, but only if the GOM let 
Rosneft build 100 gasoline stations along the North-South road that 
runs from the Russian to Chinese borders, and along the east-west 
Millennium Road that bisects Mongolia. (Note: Although there is no 
firm estimate of the amount of traffic carried on these routes, 
these are best maintained and most heavily trafficked highways in 
Mongolia.  End Note.)  PM Bayar accepted this plan and submitted it 
to Parliament. 
 
PROPOSAL WOULD REQUIRE AMENDING PETROLEUM LAW 
--------------------------------------------- 
 
¶5. (SBU) The Rosneft proposal has to be approved by Parliament 
because Mongolia's Petroleum Law prevents foreign-owned entities 
from selling more than 30% of all petroleum products sold in 
Mongolia, and no more than 10% of the sales volume for any 
particular petroleum product. In addition, the current law bars 
petroleum producers, such as Rosneft, from domestic distribution and 
sales.  In light of these prohibitions, the PM argued that unless 
the law was amended immediately, the GOM would be barred from 
putting its price reduction plan into immediate effect.  (Note: 
Finance Minister Ulan put a glossy spin on this telling donor reps 
at the UNDP's monthly meeting on May 15 (septel) that the GOM was 
thinking about "liberalizing" this and other sectors to encourage 
competition, improve service and reduce prices. End Note.) 
 
DEMOCRATS: YOU MUST BE JOKING 
----------------------------- 
 
¶6. (SBU) The response of the opposition Democrats was immediate and 
virulently negative.  The DP, which has centered its election 
campaign on refusing to approve any legislation for which the MPRP 
could claim credit, argued that Rosneft's proposal was nothing more 
than a campaign trick to lower prices in the run-up to elections. 
The opposition predicted that Rosneft would raise prices soon after 
the elections, leaving Mongolia with not only higher prices but the 
Russians in control of both production and distribution.  The DP 
argued that by ceding these rights to the Russians, the GOM wanted 
to return the petroleum-distribution sector to government control -- 
Russian Government control.  DP members have proposed a return to 
subsidies, as well as efforts to build refineries for the relatively 
small amounts of oil that Mongolia produces (and/or coal to fuel 
facilities).  They have made the case that even if this approach 
means prices will be high in the short run, Mongolia's independence 
and market economy must not be imperiled. (Note: The DP uses a 
similar argument to justify its refusal to support MPRP efforts to 
amend the Law on Mineral Resources.  End Note.) 
 
PUBLIC, INDUSTRY INCREASINGLY UPSET OVER PROPOSAL 
--------------------------------------------- ---- 
 
¶7. (SBU) The Mongolian public's response to the Bayar proposal was 
muted at the beginning but has become increasingly loud and harsh. 
Initially, petroleum-product importers and their supporters -- 
including importers of American-brand lubricants made by Cal-Tex and 
Exxon -- remained publicly quiet, fearing some sort of punitive 
backlash from the GOM or their Russian fuel suppliers.  As our 
sources explained, the GOM could ban imports, claiming pricing 
irregularities; impose spurious quality tests and ban imports while 
testing was done; or simply order customs to delay or stop shipments 
at the border, if  local distributors refused to play ball. 
 
ULAANBAATA 00000221  003 OF 003 
 
 
Privately, the distributors were lobbying furiously.  They were 
joined by several large banks that provided the industry with trade 
financing in excess of 10-15% of their annual loan turnover.  Adding 
to the chorus of boos were the Mongolian National Chamber of 
Commerce and Industry, the Employers Federation, and several trade 
unions, all of which feared that thousands of Mongolian workers 
would lose jobs to the Russian network. 
 
¶8. (SBU) But the GOM, adamant that the Rosneft deal must be done, 
told the distributors to stop complaining and accept what had to 
come.  In response, the local distributors took to the airwaves in 
protest.  On May 12, the CEO of Mongolia's largest petroleum 
distribution company (an MPRP member) gave a TV interview in which 
she accused the GOM of attacking Mongolia's business community and 
putting Mongolia's gasoline supply into Russian hands. 
 
¶9. (SBU) After the plan was announced, media organizations conducted 
man-on-the-street interviews to gauge reaction.  Many indicated that 
although they would like to see fuel prices stabilized, they are 
leery of further Russian involvement in Mongolia's petroleum sector. 
  Some doubted that the Russians would honor any deal, while others 
accused the PM of selling out to the Russians. 
 
COMMENT 
------- 
 
¶10. (SBU) Bayar and his MPRP have been harmed by their blundering 
approach on fuel prices.  Clearly, Mongolian fear of Russian 
domination has trumped the lure of lower gas prices.  It remains 
uncertain to what extent the MPRP will pay at the ballot box for 
this strategic mistake, but the Democrats will almost surely use 
every opportunity to raise the issue between now and June 29. 
 
GOLDBECK