US embassy cable - 05WARSAW1282

C O N F I D E N T I A L SECTION 01 OF 04 WARSAW 001282 
 
SIPDIS 
 
STATE FOR EUR/NCE TARA ERATH AND MICHAEL SESSUMS 
STATE FOR EB/CBED AMB. MANN AND ERIC JONES 
STATE FOR EB/ESC STEVE GALLOGLY AND MATT MCMANUS 
USDOC FOR 4232/ITA/MAC/EUR/JBURGESS AND MWILSON 
TREASURY FOR OASIA MATTHEW GAERTNER 
DOE FOR IA-42 ROBERT PRICE 
 
E.O. 12958: DECL: 03/15/2016 
TAGS: EPET, ENRG, EINV, PREL, PL 
SUBJECT: POLISH PIPELINE COMPANY FINALIZING A BUSINESS PLAN 
FOR ODESSA-BRODY-GDANSK, STILL LOOKING FOR CHEVRON SUPPORT 
 
REF: (A) WARSAW 1080 (B) KIEV 381 
 
Classified By: Economic Counselor Richard Rorvig, reasons 1.5 (b and d) 
. 
 
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Summary 
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1. (C) As promised, PM Belka met with his Ukrainian 
counterpart PM Tymoshenko early in her tenure to discuss 
practical steps the two sides could take to deepen their 
bilateral ties.  The two Prime Ministers agreed to form a 
bilateral committee to accelerate work on linking the 
Odessa-Brody oil pipeline to the Polish oil grid in Plock. 
The Polish pipeline company and its Ukrainian counterpart UTN 
will prepare a financial and business plan for the pipeline, 
and hope to secure the interest of Chevron or another Kazakh 
oil shipper.  Chevron reports it does not rule out becoming 
involved "eventually," but wants to avoid angering Russia, a 
goal Poland and Ukraine share.  The two delegations also 
discussed the potential for Poland to develop gas storage in 
Ukraine, Ukraine's interest in investing in a Polish steel 
mill and electricity exports.  End Summary. 
 
 
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Initial Poland-Ukraine Consultations 
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2. (U) On March 3-4, Polish PM Marek Belka paid an official 
visit to Kiev to discuss a wide range of economic cooperation 
topics, including the Odessa-Brody oil pipeline, Ukrainian 
electricity exports to Poland, and Kiev's interest in 
investing in the state-owned Czestochowa steel mill.  Polish 
papers report the two sides agreed to set up a special 
working group to extend the Odessa-Brody (OBG) oil pipeline 
to Plock in central Poland and on to the port of Gdansk. 
According to the Polish press, Ukrainian PM Tymoshenko 
stressed the importance of using the pipeline to ship Caspian 
and other oil to West European markets as a means of 
diversifying Europe's sources of oil.  An MFA official told a 
Polish paper that it will be essential to attract investors 
from Kazakhstan particularly Chevron. 
 
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Reversal in Principle, but Not Now: 
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3. (C) Halina Trymucha, Director of the Ministry of Economy's 
Energy Security Department, who participated in the meetings, 
and said the most important achievement was an agreement to 
form a committee to accelerate inter-governmental efforts to 
extend Odessa-Brody to Plock and Gdansk.  The Polish 
delegation was very pleased that Ukrainian PM Tymoshenko 
provided such strong statements endorsing the western 
orientation of Odessa-Brody. It is also very happy that she 
did not announce the GOU would reverse the pipeline 
immediately.  Trymucha reported both sides agreed they would 
work to build the necessary link to the Polish system, after 
which the pipeline would be reversed.  Trymucha said the 
minutes of the meeting agreed by the two heads of delegation 
suggested that the outer limit to complete the OBG pipeline 
would be three years, i.e., 2008. 
 
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Kazakhstan is Key: 
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4. (C) While the Polish Government is pleased with the 
renewed Ukrainian commitment to the project, Trymucha 
believes the participation of a Kazakh oil producer like 
Chevron or ConocoPhillips will be key to making the project 
work.  Cezary Filipowicz, the president of Sarmatia, the 
PERN-UTN joint venture formed to realize Odessa-Brody-Gdansk, 
explained that the companies had looked at shipping lighter 
Azeri crudes, but these have too many other good alternatives 
to use OBG on a cost-effective basis. Chevron and Kazakhstan, 
on the other hand, are looking for a new outlet for a large 
quantity of oil from Chevron's Caspian Pipeline Consortium 
(CPC) pipeline, which Chevron hopes will be expanded by 2007. 
The Director for International Agreements at the Polish 
Pipeline Company (PERN), Cezary Lewandowski, said Chevron is 
still the best fit for the project, in part because Chevron 
has done far more analysis than other shippers on the details 
of OBG.  He said Chevron also has the greatest potential 
interest in increasing returns for its CPC-blend by gaining 
direct pipeline access to European markets. 
 
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Chevron Still Watching: 
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5. (C) Luis Coimbra, Director of Chevron's Marketing 
Transportation Department, said his company is still watching 
Odessa-Brody carefully, and thinks Chevron may get involved 
"eventually," but needs to wait for the right time.  Coimbra 
thinks it could be useful for PERN and UTN to develop 
Odessa-Brody in such a way that it could facilitate oil 
exports through both the northern and southern Druzhba 
systems into Europe.  He suggested it would be useful for the 
new GOU to declare publicly that Odessa Brody can be used to 
export Russian Urals blend through the southern Druzhba 
(through Croatia) and CPC blend through the northern Druzhba 
through Poland.  Coimbra also reported that Kazakhstan may be 
willing to finance the construction of a 52 kilometer 
pipeline to connect CPC to OBG without having to tanker oil 
between Novorossysk (the current terminus of the CPC 
pipeline) and Odessa.  Coimbra cautioned, however, that a 
number of steps have to be taken for Chevron to be 
comfortable getting involved in OBG.  One of the most 
important steps is to persuade Russia (particularly pipeline 
operator Transneft) to agree to the project.  Coimbra also 
noted that Chevron is considering other options, which may be 
more commercially attractive.  He concluded by stating "OBG 
is not that important for us to be throwing mud in Russia's 
face at this time.  We are working with TNK-BP on the 
Burgas-Alexandropolous bypass and the Russians on CPC 
expansion." 
 
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Opening the Door to Russia: 
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6. (C) The Polish Government would like to find a way to 
involve Russia in the project in a constructive way. 
Lewandowski said that PERN is planning to leave 10 percent of 
the project open to Russian companies.  Trymucha noted the 
difficulty of getting the sequencing right, however, in 
approaching Russia.  Poland does not want to exclude Russia, 
but also wants to avoid giving Russia an effective veto over 
its development. 
 
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Financial Model by End of March: 
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7. (SBU) PERN's Lewandowski reports that PERN has been 
working closely with its Ukrainian counterpart, Uktransnafta 
(UTN), and expects to have completed work on a financial 
model by the end of March.  PERN has already prepared a basic 
business plan, which it will augment once the financial model 
is complete.  To enhance the plan's credibility, PERN hopes 
to attract a serious partner (preferably Chevron) to the 
project and release the plan as a joint product. 
 
8. (C) Tariffs will be an important part of the financial 
model, but will ultimately depend on the volumes of oil 
shipped.  Filipowicz said initial calculations suggest that, 
for smaller volumes of 9-12 million tons per year (MTA), OBG 
would have very high tariffs, of up to $15 per ton, compared 
to $3-5 for competing Bosphorus bypass pipelines like 
Burgas-Alexandropolous.  One of the key goals of the joint 
PERN-UTN working group will be settling questions related to 
the tariffs Ukraine will expect on the pipeline.  The two 
companies will also continue to look at ways to shave costs, 
including potential changes in routes.  In examining 
potential route changes, PERN's management is reluctant to 
endanger ongoing operational links with Transneft in the 
management of the Druzhba system, which is likely to minimize 
the potential for building a link to Adamowo instead of Plock. 
 
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Finding Money: 
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9. (C) Lewandowski said that the Polish Government will have 
to make a strategic decision in the second half of 2005r 
whether it wants private companies to develop this project, 
or whether the government will want to spend the money 
necessary to build the pipeline (at an estimated cost of $500 
million to extend the pipeline from Brody to Plock).  He 
confirmed that the European Investment Bank has volunteered 
that it would be willing to finance up to 500 million Euro 
($650 million) for the project, depending on the scope of the 
project.  This loan, however, comes with a number of 
conditions which Lewandowski said may make commercial 
financing easier.  Commercial banks will want to see that a 
significant oil shipper is committed to the project, however. 
 While he still expects the GOP to look to commercial 
companies to finance the project, Lewandowski said that it is 
possible that the GOP could decide that it is too important a 
project to let it languish should no clear sponsor step 
forward.  Lewandowski expected that this decision will have 
to wait for a government to be formed after this year's 
general elections (expected June 16), as, currently, the 
project lacks a committed senior sponsor in the GOP. 
 
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Gas and Electricity: 
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10. (C) Economy's Trymucha said Poland and Ukraine agreed to 
explore opportunities to develop gas storage for the Polish 
Gas Company (PGNiG) in Ukraine.  Poland is still smarting 
from Gazprom's cutoff of Belarus (which cut gas for a day to 
Poland) in February 2004, and has been looking to develop 
short-term storage options.  Western Ukraine has several 
natural formations which may fit the bill, and provide an 
early sign of tangible cooperation between Poland and the new 
GOU.  Trymucha noted that the Polish papers had widely 
reported a statement Belka made that the two sides would 
examine prospects for Ukrainian electricity exports to 
Poland.  Trymucha said that Belka is trying to play up the 
meeting's achievements.  The reality is that Poland looked a 
year ago at the prospect of buying electricity from western 
Ukraine, but decided it was simply too costly.  Poland is 
working first with the EU to ensure it joins the European 
electricity grid (UCT), which it is most likely to do through 
a connection through Silesia to the Czech Republic.  Poland 
will probably wait for UCT plans to link the EU's system to 
Ukraine by 2008 before investing in any projects to link 
systems over the border.  Trymucha said Poland could decide 
over time to import electricity from Ukraine if it developed 
problems meeting its Kyoto emissions targets in coming years. 
 
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Other Areas of Cooperation: 
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11. (SBU) Polish papers report that Ukraine expressed 
considerable interest in bidding on the privatization sale of 
the Huta Czestochowa steel mill.  A Ukrainian firm, Donbas, 
is reported to have submitted a lower bid than the Indian 
steel company, LNM, although the latter has until April 13 to 
better Donbas' offer.  At the end of February, Treasury 
Minister Socha told Econoff that Donbas had submitted a good 
offer, and had a good chance of winning the tender, although 
he noted price would be the most important factor in making 
the final decision. 
 
12. (U) Polish papers also reported that the two prime 
ministers agreed to develop a project with Russia to link 
their rail systems.  In cooperation with a consortium of 
investors, including the American firm DEC, Polish Railways 
(PKP) developed new technology in 2004 which allows rail cars 
to move from European track to Russian gauge track without 
offloading their cargo.  PKP hopes that this will allow 
greater traffic flows with Russia and Ukraine, starting with 
passenger service and eventually expanding to freight. 
 
Comment: 
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13. (C) The GOU's declaration of support for the westward 
orientation of the project is very important in reassuring 
potential shippers like Chevron.  Even more important, 
Ukraine and Poland refrained from "re-reversing" the pipeline 
until an alternative has been developed.  Finalizing the 
much-delayed business plan will be the next step, which 
should help illuminate the key questions both Poland and 
Ukraine need to address if this project is to be realized 
(e.g., tariffs and taxes).  Completing the business plan will 
make the project look both more commercial, encouraging 
potential shippers to take one more look, and less political, 
potentially opening the door for a face-saving end to Russian 
opposition.   Unfortunately, as history has shown, the 
remaining steps may not be easy for the parties to complete. 
Upcoming Polish elections may also slow the process of GOP 
decision-making, although the opposition parties generally 
support OBG as a means of increasing Poland's energy security. 
 
 
ASHE