Strat Risks – Saudi GazetteRUSSIA, the world’s largest crude producer, is shying away from Europe – as far as crude supplies are concerned – ramping up instead supplies to China. And as the process gains pace, new alliances are springing up on the global energy chessboard while the old ones are being discarded. The small, yet, strategic shift in target markets is providing Moscow not only with an opportunity to end its reliance on weak, saturated and somewhat fragmented European markets, but is also a major source of instant, handy cash at a time of great need. And the swap ensures Beijing long-term supply security.
A win-win situation on more than one count!
Russian state-controlled oil company Rosneft will supply China with 365 million tons of oil over 25 years under a $270 billion deal, Igor Sechin, its chief executive said on Friday. A day earlier, Russian President Vladimir Putin said Rosneft planned to sign a deal to provide China with oil worth $60 billion. Russian business daily Vedomosti later said Putin was referring to an advance payment that Rosneft would receive.
Under the deal, deliveries could start as early as this year. As per Vedomosti, the deal was a contract between Rosneft and Chinese state energy firm CNPC. The oil supplies in the multi-billion deal will be delivered to China from the existing Eastern Siberia-Pacific Ocean (ESPO) oil pipeline. ESPO was also built with a $25 billion loan from China to the Russian oil pipeline company Tansneft in 2009, as upfront payment for oil to be sold.
Moscow already supplies Beijing with 15 million tons (300,000 barrels per day) of oil annually via the pipeline. Russia now has plans to increase oil supplies to China by 13 percent in July to September from the previous three months, a shipping schedule obtained by Reuters showed. Rosneft agreed in March to triple supplies to China. It did not specify over what period, but it planned to increase deliveries by 800,000 tons this year on top of the 15 million tons (300,000 barrels per day) it already supplies annually.
Traders expect the volumes of Russian crude to China to rise to 17 million tons in 2014 and by 2015 they could amount to as much as 20 million tons, on par with Germany, the top individual consumer of Russian oil to date.
The new agreement between China and Rosneft was timed to tie in with the launch of new streams of East Siberian crude to avoid big redirection of existing flows and allow time to expand export infrastructure.
Igor Sechin also underlined that the 25-year deal between Russia and China would be one of the biggest (oil) supply deals in the history of the country.
Mr. Putin, in meeting with China’s vice premier, Zhang Gaoli, last week also expressed the hope that two Russian gas companies, Gazprom and Novatek, will similarly strike deals to export energy to China. Energy analysts said Rosneft has also been negotiating with Chinese companies to form joint ventures to drill in the Russian sector of the Arctic Ocean above eastern Siberia, after granting similar deals to Exxon Mobil, Eni of Italy and the Norwegian oil company Statoil to drill in the Kara Sea, an inlet on the western side of the long coastline.
While the overall volume of Russia’s oil output has remained level, sales to Europe has been down the slope. “Russia has been losing its interest in Europe where oil consumption is stagnant. It’s looking increasingly to the East,” Valery Nesterov, analyst from Sberbank CIB, has been quoted as saying.
Even a modest shift could have a significant effect on Europe, raising prices across the region. European consumers, who had been used for decades to buying Russia’s, export blend Urals, at a steep discount to benchmark Brent prices, now, have to live with a gradual strengthening of prices for the blend. Consequently over the past few years, Urals has repeatedly traded at a premium to Brent.
And to some extent, this growing camaraderie between Moscow and Beijing makes pure economic sense. Things are changing in Moscow too. The great gush of oil and gas wealth that has fueled Mr. Putin’s power and popularity is leveling off. Foreign investors are hanging back, depriving the economy of essential capital. And more than a decade of efforts to diversify the economy has largely failed.
Consequent to all this Russia’s economy, is slowing down to a near standstill in the first months of this year, and the Kremlin is now preparing to dip into its $171 billion rainy day fund in a bid to spur growth. With flattening revenues, the government badly needs to attract foreign capital.
Energy prices, while still relatively high, are expected to flatten or decline in the years ahead – courtesy the global shale revolution. Gazprom has already been cutting prices and renegotiating contracts, under pressure from cash-poor clients in Europe and rising competition globally. Discounts to customers cost Gazprom $4.2 billion, or about 7 percent of pretax earnings, according to Renaissance Capital, an investment bank. Oil revenues are also projected to decline long-term as production grows more costly and new technology curbs demand.
And it is here that Beijing, flush with dollars, comes handy. Kremlin oil majors have raised tens of billions of dollars from Beijing by pre-selling its oil under long-term deals – to finance growth and its acquisition drive. The $25 billion cash advance for ESPO in 2009 was not something out of blue. Rosneft first took a loan of $6 billion from Chinese state banks as prepayment for oil exports in 2005. The company, in turn, used the money to finance its takeover of the largest production unit of Yukos Oil Company, after the imprisonment of the founder, Mikhail B. Khodorkovsky.
Under the terms of the deal, Chinese banks that lent the loan were to be with 2.5 billion barrels of oil exported to China over 20 years from 2010 until 2030.
Interestingly, Rosneft’s debt burden has spiked again this year after it acquired Anglo-Russian producer TNK-BP in a $55 billion cash-and-stock deal. Industry sources have told Reuters that Rosneft may secure up to $30 billion in prepayment from China as part of the new deal. That could even double, business daily Vedomosti said on Friday. Analysts say the possible upfront payment from China would be a big positive for indebted Rosneft.
Both sides have benefited from this barter. It helps Russia weather its current economic slump and permits Beijing not to lose sleep over energy security.
However, the global energy markets continue to remain one. Dwindling Russian supplies to Europe has to be a gain for someone. Who that could be? Does one need to point that out?