Sino-Mongolian oil deal undercuts Russian role
By Alicia J Campi
Mongolian Petroleum Authority chairman G Ulziiburen announced in mid-March that Mongolia had made an agreement with PetroChina - a subsidiary of China National Offshore Oil Corporation - to exchange crude oil drilled in Mongolia with end-products processed in Inner Mongolia Autonomous Region.
Delivery was to reach 10,000 tons of fuel this April, lessening the present import cost for Mongolia by US$100-$170 per ton. Chairman Ulziiburen promised the government would continue to seek cheaper sources of fuel in hopes such policies soon would reduce prices.
After expansion upgrades are made in May to the Zamyn-Uud
railroad switch-loading yard on the Sino-Mongolian border, it is planned that monthly imports will increase to 20,000 tons by September.
The imported Inner Mongolian oil will be of a higher quality - equivalent to Euro-3 standard. Mongolia's current consumption of fuel imported from Russia is equivalent to the more polluting Euro-2 standard and sold under the brand name AI-92. This Inner Mongolian refined fuel is sold under the new Mongolian brand name MONGOL-93 and was released at gas stations in April.
Twenty percent of Mongolia's imports today are petroleum products. Mining Minister Davaajav Gankhuyag, a well known supporter of resource nationalism, was reported in March as commenting, "In order to get rid of petroleum supply from one route [Russia], we are negotiating with third parties that brings some positive results."
This is not, however, a new Mongolian oil strategy. Back in 2009, Dashzeveg Amarsaikhan, then-chairman of the Petroleum Authority, stated, "We shall have more leverage once we manage to diversify our sources and reduce captive dependence on one supply source. The government is clear about this and has been working to achieve that objective. Things will get better once we extract enough oil at home and also have a refinery here."
Mongols have claimed for years that the Russian supply has been interrupted for political reasons, such as in May 2011, and that these products are increasingly expensive and fail to meet soaring consumer and industrial demand. Although Mongolia is sensitive to Chinese activity in the mineral sector, it is willing to let China become a significantly larger supplier of oil products, at least in the short term, to break the back of its dependency on more expensive Russian petroleum products.
This temporary strategy may work in China's favor to ease the bilateral tension generated by Mongolia's increasing concern over the large volume of Chinese investment in its minerals. While certainly a more positive development from China's point of view, Mongols are clear that they see the future of their petroleum supply in creating their own refinery infrastructure.
For decades, Mongolia was over 90% dependent on Russian imported petroleum products, mainly acquired from Rosneft. In 2012, it imported a total of 1.2 million tons of oil, of which petroleum products comprised 1.1 million tons - 64% of which was imported from Rosneft. As of the first three months of 2013, imports from Rosneft have been decreased by another 30%, so, in the first quarter of 2013, Mongolia has imported 50% of its monthly supply from Switzerland's Gunvor Group (the world's fourth-largest crude oil trader and which obtains much of its crude oil from the Russian Federation), South Korea's SK Energy and Hyundai Oilbank, in addition to the China, at prices that average US$100-$200 per ton cheaper than Rosneft.
So far, however, these lower prices have not been reflected at the gas pump. In fact, Speaker of the Mongolian Parliament Zandaakhuu Enkhbold, back from a March trip to the United States, complained that Mongolian consumers pay more for gasoline than Americans.
Historically, petroleum production and drilling with a small refining operation were initiated by the Soviet Union in the 1960s, although the first find was in 1947. Petroleum operations ceased in 1969 because of well pressure decline, the refinery destruction by fire, and the discovery of giant oil fields in western Siberia. With the collapse of communism, the Petroleum Authority in 1991 began granting foreign exploratory licenses in order to obtain technical and financial assistance from Western companies and purposefully barred China from such licenses in its oil sector.
The trend over the years, however, has been for the private Western companies to sell out to Chinese state-owned enterprises, with the Mongols powerless to stop it. Exploration studies first were carried out by British Petroleum and Philips Petroleum between 1990 and 1993. Through Mongol Gazryn Tos (MGT), the state-owned petroleum company, the Mongolian government signed a production sharing contract (PSC) in 1993 with SOCO International of Fort Worth, Texas and its first exploration well was drilled in Dornod province near the Chinese Manchurian border in 1994.
Later, PSC agreements were concluded with two other Texas-based US oil companies - Nescor Energy of Austin and Medallion Petroleum of Houston - to work with existing production capacity in the southeast Gobi desert and the Tamsag Basin in the northeast.  SOCO partnered with Huabei Oilfield Services of China, which provided drilling services, and trucked its crude to China before finally selling out completely in 2005 to SOE PetroChina Daqing Tamsag (PCDT) - much to Mongolia's shock.
Nescor Energy, between 1994 and 1997, conducted exploration and appraisal operations in the southeast Gobi with a US Trade Development Agency grant, and, in February 1997, the Mongolian government gave up to Nescor its 50% stake in these fields, which covered 13 million acres (5.5 million hectares).
The next year, a joint venture of Gulf Canada and ROC Oil (Sidney, Australia) acquired all Mongolian rights and assets of Nescor Energy. Crude then was exported by truck, pipeline and train into China. In January 1999, Gulf Canada withdrew from the venture due to the oil price downturn.
Later in June 2001, ROC Oil sold out its interests to Dongsheng, a subsidiary of Sinopec. This action and the PCDT buyout enabled China to take control of Mongolia's oil sector, a result that has made Mongolian policymakers uncomfortable ever since. With so much Chinese investment in the oil sector and with China being the major customer for Mongolia's exported crude, the Mongolian public also has raised concerns about the ramifications of massive Chinese investment.
Publicly, Mongolian officials have claimed that they "do not choose an investor on the basis of its country, but look for the most competitive offer and one that offers the maximum benefit and profit to Mongolia. These are our criteria, nothing else. We work for our national interests and considerations like a company's base country are immaterial. Geopolitical factors do not affect our decisions."
The government of Mongolian President Tsakhia Elbegdorj, however, has implemented plans to diversify petroleum sources in the near-term while developing domestic production through new oil refineries. For example, in accordance with the Government's Action Plan for 2012-2016, construction will start on a Mongolian-Japanese joint venture "Darkhan-Petroleum" refinery with annual capacity of at least 2 million tons in Darkhan-Uul province, about 240 kilometers north of Ulaanbaatar. A feasibility study has been finished, so work will commence this year with a completion date by the end of 2015.
The Petroleum Authority of Mongolia has estimated that there are four to six billion barrels of recoverable oil in Mongolia: "Despite the scarcity of exploration data on Mongolia's petroleum potential, caused by interruption of exploration activities for the last 25 years, positive geological and geophysical data, reported oil seeps throughout the sedimentary basins and recent discoveries of oil and the geologic similarity ... of hydrocarbon basins of Mongolia to adjacent Chinese producing basins indicate the high probability to find substantial petroleum reserves in Mongolia".
There are now 30 petroleum fields, 21 of which were established through product share agreements. Of these 21, only three sites are productive, while the rest are in the exploratory stage under the direction of 14 different companies of which only four are Western. These companies include Swiss company Manas Petroleum through its subsidiary, Gobi Energy Partners LLC, in the east Gobi Basin, Australian Central Asia Petroleum LLC, Canadian Shaman LLC and Canadian Sunwing Energy.
Mongolia's only three oil producing fields are managed by Chinese majors PetroChina and Sinopec. These are Zuunbayan, Tamsag-19, and Tamsag-21, which in 2012 produced a total of 482,000 tons of crude oil (3.6 million barrels), an 11 times increase in production over the last five years.
Chairman Ulziiburen also announced that in 2013 the Mongolian government intends to increase volume from these three sites up to 660,000 tons or about 5 million barrels for export to China. Zuunbayan is in the south of the country not far from Mongolia's giant coal-uranium deposit of Tavan Tolgoi and its Rio Tinto-controlled large copper-gold deposit of Oyu Tolgoi. The other two sites are in the northeast near the Chinese Manchurian border.
Recently the Mongolian Ministry of Mineral Resources and Energy determined that the reserve at the Toson Uul deposits at Tamsag Basin amount to 119.02 million tons and estimated economically recoverable reserves will amount to 13.67 million tons.
Among the important Chinese companies now exploring in Mongolia is Mongolia Energy Corp Ltd (MEC) (menggu nengyuan youxian gongsi), a mining and energy development holding company operating in Mongolia and Xinjiang in northwestern China. MEC's exploratory concessions are in western and southern Mongolia in cooperation with CNPC Daqing Petroleum. Yet another Chinese company, Gold BC LL, has been working in Mongolia for three years.
This new agreement to exchange crude oil for processed end-products does not mean that Sino-Mongolian relations are dramatically deepening. This new purchase plan, however, does indicate that the two nations can find new ways to cooperate despite the potential for serious problems in the existing Sino-Mongolian petroleum relationship.
Mongolia has been a minor exporter of crude oil to China since the late 1990s. When PetroChina acquired received the right to conduct mining operations for the next 20 to 30 years from the SOCO sale, it claimed that 40 million of the 177 million barrels of crude oil reserves in its sites were economically recoverable reserves. PCDT projected it would excavate 93.3 million barrels of crude oil between 2010 and 2019.
The original deal included the promise by the Chinese side to build roads between the Tamsag fields and the Bichigt border crossing point by 2011, but, despite increasing exports, no road has been built. In 2012, 500 of its 521 drilled wells were operating and produced 410,000 tons of oil. This is carried in 80 to 100 trucks per day along 31 eroded dirt tracks.
PCDT - the largest of four oil exploration companies in the province - has announced that it plans to produce 650,000 tons more this year, because it will constructed new transmission pipelines. The company also is extracting oil in a neighboring province, but transports that crude via a pipeline to the Chinese cross-border refinery instead of by tanker trucks.
In a move reminiscent of Mongolian threats to use non-compliance/performance in certain clauses by Rio Tinto in its Oyu Tolgoi contract as the reason to reopen negotiations over the entire contract, this March Speaker of Parliament Enkhbold visited the oil fields of Dornod province and threatened that "if the company [Petro China] fails to build road transportation, their permit is not allowed [to continue]".
This would indicate Mongolian authorities are seeking to reopen the existing contract with PetroChina to seek more favorable terms.
Dr Alicia J Campi has a PhD in Mongolian Studies, was involved in the preliminary negotiations to establish bilateral relations in the 1980s, and served as a diplomat in Ulaanbaatar. She has a Mongolian consultancy company (US-Mongolia Advisory Group), and writes and speaks extensively on Mongolian issues.