Russia steps up bid to quench China's energy thirst

By bne IntelliNews October 11, 2010

Tim Gosling in Moscow -

Russia will become China's third-largest supplier of oil from January when a new Siberian pipeline that will start to be filled in November becomes fully operational - one more concrete step in the deepening of Russia's ties with its neighbour, exemplified by Russian President Dmitry Medvedev's trip to Beijing in September to sign off on a range of deals that have been 20 years in the making.

A 3,600-kilometre border runs between the world's largest energy producer and the world's largest energy consumer, but until now Russia has sent relatively little oil and gas southwards to China, with Europe the main customer to date. This strategy has its roots in geopolitics and global economics, as much as the fact that Russia's established hydrocarbon fields and export infrastructure overwhelmingly face westwards. However, the first three of those elements have all been changing for some time, and now Russian infrastructure is also turning rapidly to the east.

Thirsty for energy and cash rich, China's magnetic pull on Moscow is growing, in yet another illustration of the shifting sands on which the global economic system stands. As Kingsmill Bond, chief strategist at investment bank Troika Dialog, puts it: "Since the crisis, the potential for trade between Russia and China has become real."

In late September, President Dmitry Medvedev made his second visit to Beijing in as many years to seal, or speed up, a number of deals, which include cooperation in coal mining, nuclear power, banking and anti-terrorism efforts.

It's clear that Russia can no longer afford to relegate China below its traditional customers to the west. Whilst China has clearly been gaining in importance for the global economy for some years, since the economic crisis wiped out growth across developed markets it now plays a pivotal role in determining global commodity markets, with the price of oil, gas and metals seesawing on the back of bullish or bearish news coming out of Beijing. It's no surprise that Prime Minister Vladimir Putin remarked in January that the new spur pipeline to Daqing in China from the Eastern Siberian Pacific Oil pipeline (Espo) "is not just a pipeline [but] a geopolitical project."

Yet despite its proximity and massive natural resources, Russia is only the fourth biggest supplier of oil to China, behind Saudi Arabia, Angola, and Iran. At the same time, the country's huge thirst for energy has seen supplies shipped across the Pacific from the likes of Brazil and Venezuela spike by as much as 160% so far this year.

The Espo spur is capable of delivering 30m tonnes of crude a year to the cluster of refineries in China's northeast, but despite the bullish statement of Rosneft CEO Eduard Khudainatov at the end of September that the Chinese "don't want 30m tonnes, they need 250m," Beijing is evidently happy to diversify energy suppliers as much as possible.

Leveraging its huge cash reserves, China has also plunged into Central Asia to build oil and gas pipelines eastwards, and Russia has fallen well behind; Gazprom currently exports no gas to China. The Central Asian producers are more than happy to fill the void, as previously they had little option but to sell their output to Russia's energy giants.

Closing the gas gap

Russia has been negotiating over gas exports to China for several years, but talks have always broken down on price. During Medvedev's visit, the two sides agreed to extend terms for gas deliveries, whilst the Russian president said that they "drew more than $60 closer to each other on the price."

Exactly what has changed to bring them towards an agreement is unclear, but it's worth noting that Gazprom is facing demands for lower prices from a European market experiencing a gas glut. That said, Lev Snykov of investment bank VTB Capital points out that China is now paying close to the oil equivalent.

Either way, to clinch its role as a major supplier to China, Moscow now needs to plug itself in via infrastructure. Just three days after Medvedev's visit, Gazprom announced that it would start construction of the Altai pipeline from Western Siberia. With Russia hoping that the Chinese will finance the route - as it did the Espo spur - it's difficult not to wonder how much leverage it will have on the final agreement over gas prices.

Indeed, infrastructure does much to lock in a supplier, but China's huge demand will also have an effect, reckons Snykov. "Suppliers - including Russia and Central Asia - will tell both Asia and Europe that they can supply all their needs, but those promises are not always reliable. Customers will look to diversify as much as possible, so Central Asian competition does not necessarily put China in the box seat in negotiations over gas prices with Russia."

At the same time, Troika's Bond points out that due to "China's geopolitical risks," it is unlikely to be comfortable with the bulk of its energy imports still arriving via sea, especially through the choked Malacca Strait. For that reason, he suggests, Russia can expect a "premium for land-based links." He also points out that China's gas consumption is likely to skyrocket as it begins to import more via pipeline, as transportation costs via other means are so much more expensive than for oil.

As Lilit Gevorgyan of HIS Global Insight points out, increased energy trade and infrastructure are "sure to shape the bilateral ties of the two countries." Medvedev also signed off on a joint venture to build an oil refinery in China on his visit, whilst automaker Gaz and aluminium giant Rusal also inked deals. The latter was also the first Russian company to complete a listing in Asia earlier in the year; by early October, oil giant Lukoil had said that it intends to list in either Hong Kong or Singapore next year.

Until the crisis, expansion of the pipeline system for delivering oil and gas to Europe had been a core strategy for Russia. Yet as Bond points out, "Russia needs cash. Until 2008, there was plenty of demand from Europe." The promotion of the Altai pipeline to be operational by 2015 puts it ahead of South Stream, which is planned to carry supplies to southern Europe.

How will Russia's turn to the east affect European energy supplies? Snykov concedes that Altai "will be taking gas from Western Siberia - which currently goes to Europe," but says it shouldn't be a major worry for Brussels, as "it's not a huge project."

Bond agrees that for the meantime there's plenty of oil and gas in Russia to keep everyone happy. "But who knows in 10 or 20 years?"

Russia steps up bid to quench China's energy thirst

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