China and Russian Oil: Shaping the Future of Chinese Energy Security?

2012-12-07 by Richard Weitz

Russia and China have made considerable progress in the last few years in increasing Russian oil deliveries to the PRC.

In April 2009, the two governments finalized a $25 billion loan-for-oil deal that they had accepted in principle during Putin’s visit to China in March 2006. Although they finally agreed on general terms for the arrangement in October 2008, it required months of additional haggling to overcome differences over the rate of the loan and other details.

Under its terms, the Development Bank of China lent Russia’s state-run energy companies the money they needed to build and operate a 67-kilomterer branch line, extending from the Skovordino refinery on the East Siberia Pacific Ocean (ESPO) oil pipeline to the Russian-Chinese border town of Xing’an in Heilongjiang province’s Mohe county.

The China National Petroleum Corp. (CNPC) also built a 1,000-km pipeline from Mohe to the refineries located in the Chinese city of Daqing.

Oil and gas cooperation between CNPC and Russia’s oil sector began since 2003. CNPC also provides oilfield services and engineering and construction services in Russia. Credit: http://www.cnpc.com.cn/en/cnpcworldwide/russia/?COLLCC=438345784&

Russia’s Transneft Corporation has already begun building the branch pipeline, while Russia’s Rosneft energy conglomerate has pledged to pump 300 million metric tons of oil through it during a 20-year period.

As a result, the crude oil that passes through the pipeline begins its week-long journey in the Russian town of Skovorodino in the far-eastern Amur region, enters China at the border town of Mohe in Heilongjiang Province, traverses Inner Mongolia, and terminates at northeast China’s Daqing City.

According to Yao Wei, general manager of the new “Branch PetroChina” pipeline, Pipeline Branch of Petro China Co., Ltd. (PBPC), the operator of the Chinese section of the pipeline, then moves the oil from Daqing’s Linyuan Station into the Pipeline Networks of Northeast China, where it proceeds to oil refineries in Dalian, Fushun and other cities.

Russia’s new ESPO pipeline to the Pacific will be the world’s longest, stretching over 4,700 kilometers. http://www.dw.de/russia-expands-oil-deliveries-outside-of-europe/a-14747000 

Roseneft’s oil supplies serve as collateral for a $15 billion loan, whereas the pipeline and related infrastructure will guarantee the $10-billion loan to Transneft. In 2008 and 2009, Russia provided China with 6.5 and then 7.8 percent of its total oil imports, making Russia the fourth largest oil supplier to the PRC after Saudi Arabia, Angola and Iran.

Depending on what happens with other suppliers and how much oil Russia continues to supply China by rail, the volume of Russian oil deliveries to the PRC could double. As a result, Russia could move up in rank and provide a greater proportion of China’s imported oil.

When completed in 2013 or 2014, the main Eastern Siberia-Pacific Ocean (ESPO) pipeline will extend more than 4,000 kilometers, making it the longest in the world.

The ESPO pipeline’s $25 billion cost also makes it the largest infrastructure project in post-Soviet Russia. But the Russian oil pipeline to China is only a branch of the larger ESPO. Most importantly, the oil sector is unique in the Russia-China energy relationship, and will not soon be realized in other energy sectors, such as that involving natural gas.

Some analysts have speculated that the pipeline would double the flow of Russian oil to China in the next few years. This forecast is extremely optimistic.

The aggregate volumes in the new pipeline could certainly be enormous.

According to their 2009 agreement, Russia will to deliver on average 15 million tons of crude oil annually from 2011 to 2030. This would equate to some 300,000 barrels per day for the next 20 years. According to Sergey Tsyplakov, the Russian trade representative in China, the annual amount of oil shipped through the pipeline could increase, depending on how rapidly Russia can increase its drilling capacity. Chinese customs officials estimate that, based on current world oil prices, even an additional 15 million tons annually would, everything being equal, add $8 billion each year to the bilateral Russian-China trade volume. Most of these funds will flow to the Russia government, either directly or through taxes and state control over the Russian energy companies. The Chinese government will also earn up to $1.5 billion its from tariffs.

The problem with presuming that the volume of Russian oil to China will soon double is that such projections presume that the Russian rail deliveries will continue.

In an ironic sense of timing, China began to receive these rail deliveries after the Russian state oil firm Rosneft acquired the largest unit of the Yukos oil firm in 2004. Its owner, Mikhail Khodorkovsky, had run afoul of then Russian President Vladimir Putin, who broke apart his company and put Khodorkovsky and his closest associates in prison. In return for 48.4 million tons of oil, China loaned Rosneft the $6 billion in needed to acquire the remains of Yukos.

Although Rosneft bought the Yukos unit at firesale prices, China did not do badly either, effectively prepaying $17 per barrel for the almost 50 million tons of oil. But this contract has now expired. Rosneft has declined to extend it due to its low oil sales price, which is now considerably below world market levels. Ironically, the contract expired at the time when Khodorkovsky underwent another trial on trumped up charges, which ended with a further extension of his sentence.

Although Chinese representatives expressed happiness that they now can import Russian oil via pipeline, in the long run Russia is likely to benefit most from the opening of its new west-east pipelines.

Although Russia is already one of the largest oil supplier in Asia, most of Russia’s 50,000-km oil pipeline network has been concentrated in West Siberia and carried oil toward Europe. Even the newer fields in East Siberia have tended to pump their oil away from Asia. In 2009, more than four-fifths of Russia’s crude oil exports went to Europe and Eurasia, while only 12 percent flowed to Asian countries.

Russia will export 15 million tons of oil to China annually. http://www.dw.de/russia-expands-oil-deliveries-outside-of-europe/a-14747000 

For years Russia energy mangers have been seeking to diversify their energy clients to reduce their dependence on any one market and enhance their bargaining leverage among possible customers. The ESPO represents Russia’s key hopes in this area since it is designed to send large volumes of oil, produced in West and East Siberia, to Asia-Pacific countries also hoping to reduce their dependence on Persian Gulf oil exports. In August 2010, Prime Minister Vladimir Putin said that Russia seeks to provide 30 million tons of crude oil to the Asia-Pacific region annually in the next few years, and 50 million tons yearly after that.

The ESPO is also important in that it will not require Russia to send all its oil to China.

Russia plans to refine much of its crude in the Russian Far East and then sell the oil to the highest foreign bidder or use it domestically. Customers in China will have to compete with potential Russian clients in Japan, South Korea, and other East Asian states for Russian oil sales. The Russian government has shown in the past that non-market factors can influence its decision. For example, Russian officials might be willing to deliver large volumes of oil at a discount to Japan for concessions over the Kuriles or to North Korea in exchange for concessions over its nuclear and missile policies.

The Chinese cannot even console themselves with the expectation that the completion of the long-awaited direct Russia-PRC oil pipeline will be complemented by increased Russian supplies of other forms of energy.

Government development plans for eastern Russia envisage a resurgence of scientific, technical, and industrial activity that will require the domestic consumption of large quantities of nuclear and hydroelectric power that might otherwise go to China.

Market conditions rather than a major transformation in Russia-China relations explained the recent deal.

It also reflects the Chinese energy policy of diversification and duplication to provide for maximum geopolitical flexibility.

At the time, the Russian government and its state-run energy firms were suffering from declining world demand and prices for Russian oil and gas, sharp falls in the share value of Russia’s heavily indebted energy firms on global stock markets, and surging unemployment and other manifestations of economic retraction in the Russian economy.

In addition, Chinese negotiators had achieved some success in securing oil and gas agreements with neighboring Central Asian governments, circumventing Moscow’s dominant position in the energy sectors of Kazakhstan and Turkmenistan by outbidding Russian energy representatives at times. China had also provided large loans to Moldova, Central Asian countries, and other former Soviet republics suffering during the global recession.

Against this backdrop, Russian negotiators made concessions they had long resisted concerning Chinese demands regarding the price for oil deliveries to China and the terms for the Chinese loans. They also expressed greater openness than previously to encouraging Chinese direct investment in eastern Russia and Central Asia.

Since then, Russian officials have been encouraging consideration of a similar relationship to accelerate plans to sell Russian natural gas to China, though without result.

"If everyone is thinking alike, someone isn’t thinking."

—General George Patton Jr.

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