US embassy cable - 05YEREVAN2129

C O N F I D E N T I A L SECTION 01 OF 03 YEREVAN 002129 
 
SIPDIS 
 
E.O. 12958: DECL: 12/07/2015 
TAGS: ECON, ENRG, AM, RU 
SUBJECT: ARMENIA HOPES FOR A DEAL ON GAZPROM'S THREATENED 
PRICE INCREASE 
 
REF: A) KIEV 4897 B) CHISINAU 1476 C) YEREVAN 2118 D) 
     YEREVAN 1725 
 
Classified By: Amb. John M. Evans for reasons 1.4 (b,d). 
 
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SUMMARY 
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1. (C) Despite Gazprom's recent announcement that, as of 
January 1, 2006, it plans to double the price of natural gas 
exports to Armenia, the GOAM appears to be holding out hope 
that it will be able to negotiate a deal to minimize the 
impact of and/or delay the price increase.  According to 
press reports, President Kocharian discussed the matter with 
Russian Prime Minister Mikail Fradkov, who recently visited 
Yerevan, but no agreement was reached.  Deputy Minister of 
Energy Areg Galstyan told us that such a large increase in 
gas prices on such short notice would be a "colossal problem" 
for Armenia.  According to Galstyan, the price increase also 
would violate a verbal agreement that Kocharian had with 
Gazprom to maintain the current rate of USD 55 per thousand 
cubic meters for the next two years.  While the GOAM is 
working to minimize and/or delay the rate increase, the 
Deputy Minister appeared resigned to the fact that Armenian 
consumers eventually would have to adjust to paying world 
prices.  End Summary. 
 
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GAZPROM TO DOUBLE NATURAL GAS PRICE 
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2. (C) On November 29, Gazprom Deputy Chairman Aleksandr 
Ryazanov announced that, as of January 1, 2006, Gazprom plans 
to double the rate charged per thousand cubic meters of 
natural gas imported by Armenia from the current USD 55 to 
USD 110.  According to ArmRusGazprom's General Director Karen 
Karapetyan, Armenia will import 1.7 billion cubic meters of 
gas from Russia in 2005, up from 1.33 billion cubic meters in 
2004.  The Armenian press has speculated about a pending rate 
increase for months, but the timing of the announcement seems 
to have caught both the GOAM and the Armenian public by 
surprise.  The rate change coincides with proposed rate 
increases for many other CIS countries (refs A and B).  Rates 
for Armenia and Georgia, however, would be lower than the 
rates that, we understand from press reports, have been 
proposed for other CIS countries:  Moldova ) USD 160, 
Ukraine - USD 160, the Baltic States - USD 125.  During his 
visit to Armenia on December 2-3, Russian Prime Minister 
Fradkov claimed the price increase was not politically 
motivated and reflected changes in the world energy market. 
He called for understanding on the part of the Armenian 
government. 
 
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KOCHARIAN'S "DEAL" MAY NOT BE A DEAL AFTER ALL 
--------------------------------------------- - 
 
3. (C) On December 6, we discussed the proposed rate increase 
with Deputy Minister of Energy Areg Galstyan.  He appeared to 
have been surprised and disappointed by Gazprom's 
announcement because the GOAM was under the impression that 
Kocharian had struck a deal with Russia to fix gas prices. 
In October, President Kocharian told Assistant Secretary 
Fried that Armenia had obtained a fixed price of USD 55-56 
from Gazprom for three years and two years remained on the 
deal.  According to Kocharian, the fixed price was part of an 
agreement by which some Armenian debts to Russia were 
liquidated and Russia obtained shares in Armenia's gas 
monopoly, ArmRusGazprom.  (Note:  Gazprom controls 45 percent 
of ArmRusGazprom and the Russian gas company Itera controls 
an additional 10 percent.  End Note.)  Despite Kocharian's 
earlier comment to Fried that a deal is a deal, Galstyan told 
us that to his knowledge there was no written agreement.  He 
suggested that the GOAM was resigned to an eventual price 
increase to near world market levels, but believed the 
increase should be gradual and over time. 
 
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A POTENTIAL "NIGHTMARE" 
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4. (C) Galstyan told us that if there was no agreement and 
the price of gas increased to USD 110 on January 1, it would 
be a "colossal problem" for the government.  He explained 
that the GOAM had been working on the assumption that the 
three-year agreement would hold.  Following the advice of 
international experts (including USAID experts), the GOAM has 
been encouraging citizens to convert their residential 
heating to natural gas because it is more efficient than 
heating with electricity.  Furthermore, the GOAM has been 
working to improve collection rates on both residential and 
business energy services.  The proposed price increase would 
be a "nightmare" according to Galstyan, and would have a 
particularly devastating effect on the Armenian poor. 
 
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BOTH COMPANIES AND CONSUMERS WILL SUFFER 
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5. (C) Ironically, the price increase would negatively impact 
many Russian-owned energy companies in Armenia as well. 
Russian companies own approximately 55 percent of 
ArmRusGazprom, and RAO-UES recently acquired a controlling 
stake in the Armenian energy distribution network ENA (ref 
D).  The Hrazdan Power Plant, which relies on natural gas as 
an input, is also Russian-owned as a result of a 
debt-for-equity swap in 2002.  Hrazdan accounts for less than 
20 percent of local electricity production and USAID 
contractor PA Consulting estimates that if the entire gas 
price increase is passed through to retail customers, the 
average end-use electricity tariff in Armenia would increase 
by approximately 20 percent.  Acting Chief of Party for PA 
Consulting Armen Arzumanyan noted that the GOAM could use 
existing profit from plant revenues to minimize the impact of 
the price hike.  According to Arzumanyan, it will be more 
difficult to shield the approximately 500,000 consumers who 
use natural gas for residential heat and the many Armenians 
who use natural gas to power their cars.  These consumers, 
because they use natural gas directly, could conceivably see 
their rates double.  Deputy Minister Galstyan told us, and 
the Armenian Prime Minister and other GOAM representatives 
have publicly stated, that the GOAM will try to minimize the 
impact of any price increase on consumers. 
 
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PRESS SPECULATION ABOUT A DEAL CONCERNING IRAN 
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6. (SBU) On December 6, the Russian National News Agency 
(ANN) reported that Russia offered to lower the tariff 
increase to "an insignificant level" if the GOAM were to 
agree to limit natural gas imports from Iran.  The press 
report stated that the Armenian President and Russian Prime 
Minister had discussed such a deal during Fradkov's visit but 
failed to reach agreement.  Unidentified Armenian politicians 
were quoted in the local press saying that the proposal 
violated Armenia's economic sovereignty and was an 
inappropriate intervention in Armenian-Iranian relations. 
 
7. (C) Galstyan was unaware of this story until we brought it 
to his attention.  He questioned the credibility of the 
report and noted that limiting ties with Iran would leave 
Armenia even more vulnerable to Russian manipulation in the 
energy sector.  Recently, there has been an increase in 
cooperation between Armenia and Iran on energy issues (ref 
C).  He qualified his statement, however, by saying there 
were certain conversations during the Fradkov visit in which 
he did not take part. 
 
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GEORGIAN THREATS "NOT SERIOUS" 
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8. (C) Galstyan was aware of reports that Georgia has 
threatened to increase the transit rate on natural gas sent 
from Russia through Georgia to Armenia if Armenia is able to 
negotiate a price lower than Georgia's.  The Georgian 
government allegedly would design the transit rate increase 
so that Armenia's final price matched Georgia's.  Galstyan 
initially described such threats as "not serious" because 
they would mean increasing the transit rate from the current 
USD 6 per thousand cubic meters to USD 30 or more.  Later in 
the conversation, Galstyan said that charging such excessive 
transit fees for apparently political reasons would violate 
international norms and asked what the U.S. reaction would be 
if Georgia instituted such a policy.  He reflected that 
Armenia had been trapped when Russia stopped shipments of gas 
to Georgia when it closed its southern border following the 
Beslan school tragedy. 
 
9. (C) Galsytan said that the price of electricity Armenia 
exports to Georgia would rise if there was an increase in the 
cost of gas.  Export prices are based on the cost of 
electricity produced at the thermal power stations.  Seventy 
percent of the cost of that power is the gas itself.  Only 
internal consumers have access to the less expensive power 
produced by Armenia's nuclear plant and its various hydro 
sites. 
 
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COMMENT: NOT MANY OPTIONS 
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10. (C) The GOAM appears hopeful that it will be able to 
minimize the impact of the Gazprom price increase, but it is 
in a very poor position to negotiate.  While the GOAM may 
succeed in delaying the price increase, Armenia remains 
heavily dependent on Russian energy and Armenian consumers 
eventually will have to adjust to paying world-market prices. 
 The GOAM regularly expresses concern over Armenia's lack of 
energy independence and may use Gazprom's price increase to 
justify the continued operation of the unsafe Armenian 
Nuclear Power Plant or to explain the apparent deepening of 
energy ties between Armenia and Iran (ref C). 
EVANS