VZCZCXRO2192
PP RUEHAG RUEHAST RUEHDA RUEHDF RUEHFL RUEHIK RUEHKW RUEHLA RUEHLN
RUEHLZ RUEHNP RUEHPOD RUEHROV RUEHSK RUEHSR RUEHVK RUEHYG
DE RUEHMO #3712/01 3570920
ZNR UUUUU ZZH
P 220920Z DEC 08
FM AMEMBASSY MOSCOW
TO RUEHC/SECSTATE WASHDC PRIORITY 1302
INFO RUCNCIS/CIS COLLECTIVE PRIORITY
RUEHZL/EUROPEAN POLITICAL COLLECTIVE PRIORITY
RUEHXD/MOSCOW POLITICAL COLLECTIVE PRIORITY
RHEHNSC/NSC WASHDC PRIORITY
RHMFIUU/DEPT OF ENERGY WASHINGTON DC PRIORITY
RUCPDOC/DEPT OF COMMERCE WASHDC PRIORITY

UNCLAS SECTION 01 OF 03 MOSCOW 003712 
 
SIPDIS 
 
DEPT FOR EUR/RUS, FOR EEB/ESC/IEC GALLOGLY AND WRIGHT 
EUR/CARC, SCA (GALLAGHER, SUMAR) 
DOE FOR HEGBURG, EKIMOFF 
DOC FOR JBROUGHER 
 
E.O. 12958: N/A 
TAGS: ECON ENRG EPET OREP PREL RS
SUBJECT: ROSNEFT AND LUKOIL TELL SENATOR LUGAR OIL TAX 
 
REFORM IS COMING 
 
REF: A. MOSCOW 3649 
     ¶B. MOSCOW 1295 
 
SENSITIVE BUT UNCLASSIFIED.  PLEASE PROTECT ACCORDINGLY.  NOT 
FOR INTERNET DISTRIBUTION. 
 
------- 
SUMMARY 
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¶1. (SBU) In separate meetings on December 17 and 18, Lukoil 
Executive V.P. Ravil Maganov and Rosneft V.P. for Finance 
Peter O'Brien told Senator Lugar that they strongly believe 
major oil tax reform is inevitable in Russia in order to stop 
the slide in production (reftels).  They both suggested, 
however, that their own companies' production levels would 
likely not decline in 2009.  Both said future production in 
Russia will be more logistically and technically difficult 
and thus more expensive.  O'Brien and Maganov predicted the 
oil price would recover in the medium-term, with Maganov 
citing $70 - $80 as optimal.  Neither described their 
companies as very interested or involved in ethanol 
production in the near future.  End summary. 
 
-------------------- 
TAX REFORM ESSENTIAL 
-------------------- 
 
¶2. (SBU) During his December 16 - 19 visit to Moscow, Senator 
Richard Lugar met separately with Lukoil Executive Vice 
President Ravil Maganov and Rosneft Vice President for 
Finance Peter O'Brien to hear their views on Russia's energy 
sector.  A main theme for both meetings was the need for the 
GOR to reform the tax regime on the oil sector in order to 
reverse the trend of declining Russian oil production.  Both 
Maganov and O'Brien noted that new production areas in Russia 
will be more difficult and expensive to tap.  They said the 
most promising areas for future production are in the 
logistically and technically challenging East Siberian and 
off-shore regions.  Given the capital requirements for 
developing such fields and the financial risks involved, they 
said, the GOR needs move toward a system of profit-based 
taxes. 
 
¶3. (SBU) O'Brien explained that a tax on profits reduces much 
of the inflation risk (higher costs of labor and inputs) 
borne by companies.  If companies don't know what their price 
structure is going to be in the future, but face high tax 
rates regardless, they will be very conservative with their 
investment decisions.  If companies know that they will only 
face a tax on profits, then they can deploy capital more 
aggressively. 
 
¶4. (SBU) Maganov told Senator Lugar that many positive steps 
have already been taken, and that he strongly believes more 
comprehensive reform is coming.  Maganov said that a recent 
GOR decision to raise the threshold at which companies pay 
the mineral extraction tax, from $9 per barrel to $15, has 
already resulted in $1.5 billion of savings for Lukoil.  He 
also praised a recent GOR decision that reduced the lag 
period for the application of export taxes -- from a tax on 
the oil price of the preceeding 60-120 days, to a tax on the 
oil price of the preceeding 30-60 days.  Maganov said the GOR 
is also considering a proposal on accelerated depreciation 
that would be worth some $300-$400 million for Lukoil.  His 
said he believes further tax reform will be approved because 
the government realizes that such reform would ultimately 
increase government oil revenues by boosting production. 
 
¶5. (SBU) O'Brien echoed Maganov's optimism on future tax 
reform, saying he is "very confident" that the government 
understands the importance of the issue and the clear 
long-term benefit to state finances.  He said the main 
impediment to tax reform right now is the Ministry of 
Finance's reluctance to take a short-term hit to the budget, 
especially given commitments to increase social spending. 
O'Brien welcomed the internal government debate, however, 
noting that decision makers are asking the right questions 
and weighing priorities.  O'Brien said another hindrance to 
tax reform is that many in the government and population 
can't bear to take actions (like tax cuts) that would raise 
 
MOSCOW 00003712  002 OF 003 
 
 
the value of private production assets that many believe were 
corruptly privatized in the 1990s. 
 
---------------------- 
OPEC, PRODUCTION PLANS 
---------------------- 
 
¶6. (SBU) O'Brien said that with tax reform, Russian 
production could quickly recover to remain level, and 
possibly increase slightly in the coming years.  In the 
long-term, O'Brien said, production could only increase if 
Russia welcomes investment by major interantional oil 
companies who have the expertise and technology to develop 
the challenging fields in new production areas.  As for 
Russia's suggestion at the OPEC meeting in Algeria that 
Russian companies will reduce production by 300,000 barrels, 
O'Brien explained that most companies other than Rosneft 
already have production declines in their business plans for 
¶2009.  He said that given lower oil prices and high taxes, 
even without the credit crisis, Russian companies have 
reduced projected capital expenditures for 2009.  Rosneft, 
however, plans to increase production by up to 1% in 2009 and 
possibly by 5% in 2010, as its large Vankor field comes 
online. 
 
¶7. (SBU) Maganov said if the government of Russia enacted a 
policy requiring Lukoil to lower production, that "as a 
Russian company," it would abide by the government's policy. 
Without directly suggesting that the government could force 
compliance using its monopoly control over the transportation 
network, Maganov noted the government's 100% ownership of 
Transneft.  Maganov said Lukoil does not expect its 
production to decline in 2009 and "it may even grow a 
little."  He said the company will reduce certain 
investments, including cutting its budget for service 
contracts by 15% in 2009, but it would not cut production 
activities that would cause production to drop in 2009.  To 
conserve cash, he said, Lukoil will cut new projects and 
international expansion plans.  He explained that Lukoil is 
assuming a 2009 average price of $50 for oil, but would like 
to build up cash reserves to "prepare for the worst," 
especially in light of frozen credit markets. 
 
--------- 
OIL PRICE 
--------- 
 
¶8. (SBU) Maganov predicted global oil consumption would 
resume its growth soon and push prices back to the $70 to $80 
per barrel range, which he described as optimal "for both 
consumers and producers."  O'Brien also predicted oil prices 
would rise again given increasing costs of oil production for 
most producers.  He said that although Rosneft can produce 
oil for about $20 per barrel on average, including capital 
expenditures to replace reserves, the production cost of the 
marginal barrel for many producers around the world currently 
exceeds the oil price.  He added that even for Rosneft, the 
capital expenditure portion of its expenses would rise as it 
seeks to develop new production areas. 
 
--------------------------- 
TRANSPARENCY AND EFFICIENCY 
--------------------------- 
 
¶9. (SBU) Both Maganov and O'Brien presented their companies 
as having made great strides toward greater transparency and 
operational efficiency.  Maganov claimed Lukoil is as 
transparent as all the major international oil companies, 
reporting its financial results using GAAP standards. 
Maganov praised Lukoil's strategic alliance with 
ConocoPhillips, which owns 20% of the company, stressing the 
benefits of exchanges of personnel that have helped modernize 
Lukoil management practices. 
 
¶10. (SBU) O'Brien also touted his company's improved record 
of transparency and efficiency, saying it is essential to 
gaining public trust and support for tax reform as well as 
gaining preferential access to international credit markets. 
 
------------------------ 
BIOFUELS AND GAS FLARING 
 
MOSCOW 00003712  003 OF 003 
 
 
------------------------ 
 
¶10. (SBU) Both O'Brien and Maganov told Senator Lugar that 
their companies are not focused at all on production of 
biofuels.  Both cited their companies' decades of reserves -- 
Maganov said Lukoil has 28 - 20 years, O'Brien said Rosneft 
has 30 years -- as why they see no urgency to diversify into 
biofuels or any other alternative energy supplies.  Maganov 
emphasized that Lukoil is an oil company, focused on 
developing oil.  He noted that biofuels not only require 
subsidies in most countries, but have indirectly caused mass 
hunger around the world by diverting food for fuel. 
 
¶11. (SBU) Maganov cited his company's efforts to cut down on 
gas flaring by using the gas for power generation.  O'Brien, 
too, noted Rosneft's development of power generation capacity 
(largely for its own use) run by the associated gas that it 
would otherwise flare.  He blamed state-owned Gazprom, which 
owns 100% of the gas transportation network, for hindering 
access to its pipelines.  He said given the lack of easy 
access to the gas transportation network and the government's 
plans to fine companies for flaring gas, oil companies have 
built power plants to use their associated gas production. 
 
-------------------------------------- 
RUSSIAN INTEGRATION INTO WORLD ECONOMY 
-------------------------------------- 
 
¶12. (SBU) O'Brien told Senator Lugar that he is convinced 
that Premier Putin and President Medvedev share a desire to 
promote liberal economic policies, even if they are not doing 
enough to implement them.  He suggested that Russia is "still 
working its way out" of the trauma of 1990s.  He agreed with 
Senator Lugar that integration into the global economy and 
the global financial structures is the best path for Russia, 
forcing better economic policies and greater transparency and 
accountability.  He lamented, however, that the financial 
crisis and the reaction of investors toward Russia means that 
progress on integrating Russia into the global financial 
system will be set back "at least" 2-3 years. 
RUBIN