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    China Business
     Nov 1, 2008
China ties up Russia's crude - again
By John Helmer

MOSCOW - After years of on-off negotiations and recriminations between Beijing, Moscow and Tokyo, Russia's state pipeline company Transneft agreed this week to complete construction of a pipeline to deliver crude oil between Skovorodino, in southeastern Siberia, and Daqing, the oilfield and refinery hub in northeast Heilongjiang, in China.

The agreement, signed during Chinese Premier Wen Jiabao's visit to Moscow to meet with Prime Minister Vladimir Putin, will be sweetened by up to US$15 billion in long-term Chinese credits for Russian state oil producer Rosneft, and up to $12 billion to Transneft. In return, the Russians will commit to delivering not less than 300,000, and up to 600,000 barrels of crude oil per day

 

to Daqing, including pipeline and rail deliveries.

Just 60 kilometers separate Skovorodino from the Chinese border, but getting the Russians and Chinese to agree to pump oil over that distance and join a Chinese-built pipeline on the other side of the border has been a protracted affair lasting for more than four years. There's just one catch to the new agreement - it has been agreed more than once before.

On December 31, 2004, then Prime Minister Mikhail Fradkov signed an order that was intended to resolve a question that had been much debated for several years before: what priority Russian export of crude oil to Asia should target - to China overland, or to Japan and other Asian markets by pipeline to port, and then by tanker delivery in the Pacific. Fradkov appeared to opt for the Japan priority over the China one, but his order did not provide
clear direction to Transneft, which had been designated lead contractor for the project.

Transneft had been waging its own battle over these priorities for the preceding two years. The Siberian pipeline project was originally the brainchild of Mikhail Khodorkovsky's Yukos Oil Company. Their idea was to build a more costly pipeline over a longer distance, at Yukos expense. By paying up front, Khodorkovsky thought he would have greater freedom to deliver more oil to China than Transneft and the government were allowing him to pipe in the state-owned pipeline system to Europe. He also figured he would improve his profit margin by cutting out Transneft's fees.

Naturally, Transneft saw Khodorkovsky's scheme as a way of breaking the state monopoly over crude oil exports by pipeline, and it lobbied the government to say "yes" to the pipeline and "no: to the Yukos role. In May 2003, Transneft got what it wanted, and Yukos the consolation prize. Then prime minister Mikhail Kasyanov announced that the government was putting Transneft in charge of the pipeline, including the financing terms; Yukos would supply the oil to be pumped.

Several months later, Khodorkovsky was under arrest, and he and Yukos were indicted for a range of offences that landed him in prison, other Yukos shareholders in exile, and Yukos in bankruptcy, its assets sold to the state oil company, Rosneft.

The argument between Beijing and Tokyo over who should have first option on the Russian oil was delayed, though lobbying continued by the Japanese to turn an existing agreement with China into a dead letter.

That deal, a non-binding memorandum of understanding signed in 2002, envisaged that China would receive 700 million tonnes of Russian crude through the pipeline over 25 years at a cost of about $150 billion. That amounted to 28 million tonnes per annum, or 560,000 barrels per day. The price formula Russia and China proposed using for the oil was not disclosed because it hadn't been agreed.

The Russians understood and were sympathetic to the strategic objective for Beijing: the Chinese wanted to reduce their country's dependence on oil shipped from the Middle East, Africa and South-East Asia, and lower both oil and delivery premiums. But until Khodorkovsky was out of the way, the Russian government couldn't make up its mind what its strategic objective was in the eastward movement of oil.

The then president Putin was clear what he wanted. As he explained, even before Khodorkovsky's arrest, he would give China deliveries first priority, starting by rail delivery of the oil. In time, when proposed new oilfields in eastern Siberia came on stream, their production could be pumped over the longer distance to the coast and thence by tanker to the highest bidder. In July 2004, Putin said building the pipeline to Skovorodino should start. That would move the oil 600 kilometers further to the east of the rail junction at Zabakailsk and Manzhouli, where railcar shipments of oil crossed the border going south.

Putin said he wanted to preserve Russia's flexibility and avoid single-market oil commitments - either to repay Japanese loans for the Nakhodka pipeline or to fill volume obligations to the Chinese. If exporting Russian oil proved to be more advantageous by shipping or piping to Europe, or North America, Putin's policy was to delay the Asian plan for as long as possible.

Transneft spokesman Sergei Grigoriev told Asia Times Online in mid-2005: "We are not building a pipeline to China or Japan. We are building a pipeline on the territory of Russia. The first part of the project is to Skovorodino [terminal]. Then for the project to start operations, we will send oil from Skovorodino by railroad. It is political lobbying that will decide where it will go - to China or Japan. After that, we plan to build a pipeline from Skovorodino to Nakhodka."

Grigoriev noted that since China had been seeking 30 million tonnes of crude per year, with an additional 50 million tonnes for tanker pickup from Nakhodka, "we are building an 80 million-tonne capacity pipeline to Skovorodino, and a 50 million-tonne capacity pipeline from Skovorodino to Nakhodka."

Japan's Minister of Economy, Trade and Industry at the time, Shoichi Nakagawa, reacted angrily: "In such a situation, Japan will not provide financial cooperation." That threat played directly into Transneft's hands, as it had more than once warned the Kremlin against allowing the Nakhodka oil port plan to be held hostage by Japan's financing formula, tying construction loans for the pipeline to repayment with guaranteed volumes of oil, and favorable pricing.

This is what has turned the Skovorodino-Daqing pipeline into the longest-running soap opera in the history of oil transportation. Five years and countless episodes later, have Putin and Wen really tied the knot this time? It seems so, not least of all because the color of China's money has proved more alluring because of the urgent short-term financing problem in which both Transneft and Rosneft currently find themselves. The Chinese financing turns out to be more than double Japan's last offer.

John Helmer has been a Moscow-based correspondent since 1989, specializing in the coverage of Russian business.

(Copyright 2008 Asia Times Online (Holdings) Ltd. All rights reserved. Please contact us about sales, syndication and republishing.)


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