Russia and China's $25B Handshake on Energy

Having discussed the Byzantine workings of Russia’s energy players in previous articles and also the direction that China has taken recently in securing strategic reserves, it was only a matter of time before the Dragon and the Bear came to an accord together. During a visit to China this week, Russian Deputy Prime Minister Igor Sechin has succeeded in bringing together a massive deal for Russian oil producers in Siberia.

On Tuesday (Feb. 17), Russia and China signed an intergovernmental agreement on the construction of a branch of the East Siberia-Pacific Ocean (ESPO) oil pipeline toward China. Under this agreement, Russia will supply 15 million metric tons (300,000 barrels per day) of crude oil annually for 20 years to China; in return China via state owned China National Petroleum Company (CNPC) will extend a total of $25 billion in loans to Russian state-controlled crude producer Rosneft and pipeline operator Transneft at 6% per annum in exchange for the long-term oil supply. Transneft plans to start building a Chinese leg of the East Siberia-Pacific Ocean later this year and to commission it in 2010, Russia’s monopoly pipeline operator said in a statement on Tuesday.

“The construction of the leg should be synchronized with the construction of the first line of the ESPO pipeline,” the statement quoted the company’s vice president, Mikhail Barkov, as saying. Barkov also said that China’s $10 billion loan to Transeft would primarily be invested in the construction of the Chinese leg. “In addition, there are projects that will contribute to the functioning of the entire eastern pipeline and this leg in particular,” the Transneft official said.

The pipeline’s first leg was launched in October 2008 in the reverse direction, running westwards. The construction of the pipeline, designed to bring Russian oil to the lucrative Asia-Pacific market, is due to be completed later this year, which will enable ESPO to pump its first oil eastwards. The terms of the agreement stipulate that China will extend a $15 billion loan to Russian state-run oil giant Rosneft against the guarantee of oil supplies, while Transneft’s $10 billion would be granted with the infrastructure as collateral. Currently Rosneft, which is expected to be the main oil exporter via the pipeline, supply’s around 10 million tonnes of oil a year to China by railway under the terms of a deal signed in 2004.

The ESPO was originally conceived in the mid-'90s by now-disgraced Yukos Chairman, Mikhail Khodorkovsky, as a private pipeline. Following the “collapse” of Yukos, state-owned Transneft picked up the baton and began construction of the first leg in 2006, which was completed last year. The pipeline is supplied via spurs from the Tomsk Oblast and Khanty-Mansi Autonomous Okrug oil fields in Western Siberia, Transneft’s existing Omsk-Irkutsk pipeline has also been connected, allowing Rosneft to pump up to 22 million tons of oil annually into the pipeline, whilst smaller competitor Surgutneftegas will contribute around 8 million tons.

Anglo-Russian or Russo-Anglo (depending on which side of the political fence you sit on) TNK-BP is also involved in this project, having begun supplying oil to the pipeline in October 2008. TNK-BP in a joint venture with Rosneft has extensive operations in the Verkhnechonskoye field, which has proven reserves of 409 million barrels of oil equivalent.

“The first shipment of VC crude into the ESPO marks an important event for TNK-BP and for the industry.” commented Chief Operating Officer Tim Summers at the launch. “We are establishing a major new production center in East Siberia. Application of world-class technology and the timely launch of the ESPO pipeline allowed us to begin commercial development of this project, which has been deemed uneconomic for the past 30 years. The beginning of regular commercial shipments from VC to the ESPO marks the emergence of East Siberia as a new and important oil and gas province in Russia”.

So win-win all round? Certainly for the Chinese in the long term; as we have argued in previous articles, China is on a spending spree on commodities, particularly in the energy sector where it seems almost desperate to secure strategic reserves. Russia also gains, in that with the recent devaluation of the ruble, access to funding in capital markets has been harder to come by, especially for Russia’s energy firms. Do we in the West gain from this? That remains to be seen. This may well help to stabilise geo-political issues in the region whilst also contributing to oil price stability in the long run.

Comments

[bosun.j:]

Oh no! Whatever are we to DO! A multi-billion deal and Wall St Banksters aren't going to benefit! What is the world coming to!?!

Feb 18 05:01 PM

[avd:]

Heh, as far as I remember Khodorkovsky wanted to build the pipeline directly to China. It was cheaper. Khodorkovsky was not a big fan of massive investment. He got Yukos from Yeltsin for cheap. And he wanted to keep it cheap. But state-controlled companies deemed it would make the project too dependent on Chinese. So they decided to extend the pipeine to Pacific to reach for more markets. And if the Chinese still want the piplene, then ask them for some financing.

Feb 18 08:40 PM

[HaavBline:]

The Russians has been playing the Chinese and the Japanese with this pipeline for more than a decade. At one point the Chinese got disillusioned with the Russians and turned their focus to Africa (Sudan, Angola).

It takes a deep financial crisis for China to finally nail it, if everything will happen according to Russian "plan".

Feb 18 09:46 PM

[Moon Kil Woong:]

HaavBline: Very good insight. This is tired old news. The funny thing is everytime Russia announces a deal for this they pull the rug out from under the winner. Last time Japan was the winner of this marathon multi-year fiasco. This time, I think Japan decided buying oil from the middle east is more stable and who needs more of the stuff right now. Pretty much every oil storage tank in the world is full.

This year there will be oil tankers moving in circles waiting for someone to buy the stuff.

With Russia's economic situation maybe they should consider selling the Urals to Japan, Korea, or China lol.

Feb 18 10:10 PM

[Paul Harper:]

Yep, the Japanes were the favourites for a Pacific terminus near Vladivostock, until they decided that oil rights in the Kuriles was of more importance ... oops
Have a feeling that the Pacific option will come to fruition, but will not be in the next few years.


On Feb 18 09:46 PM HaavBline wrote:

> The Russians has been playing the Chinese and the Japanese with this
> pipeline for more than a decade. At one point the Chinese got disillusioned
> with the Russians and turned their focus to Africa (Sudan, Angola).
>
>
> It takes a deep financial crisis for China to finally nail it, if
> everything will happen according to Russian "plan".

Feb 19 02:09 AM

[Ferdinand E...:]

Russian oil and gas to China and Japan makes all the economic sense in the world - to Russia, China and Japan.

This is a good article, but the last couple of lines remind me of something that Milo said in 'Catch 22' about people not understanding advanced economic theory - or whatever he called it. Swedish environmentalists and other stupidoes do not want Sweden to allow the Russians to put a pipeline on the bottom of the Baltic and terminaling in Germany. What these know-nothings do not understand is the favorable effect that an increased availability of gas in Germany will have on the electricity price in Sweden. On the other hand, I don't see anything good for the electricity price in Europe if more Russian gas and oil goes to Asia.

Feb 19 09:45 AM

[CLH:]

China is buying oil at the bottom while Americans buy gold at the top.

Feb 19 12:51 PM

[searcher:]

CLH: more truth than poetry.

Feb 19 04:50 PM