ebb and flow ... Fishing for higher prices has a catch
  from: Offshore Engineer
  by: Michael J Economides
  Friday, September 05, 2008

At $130 oil and in today’s highly complicated and interconnected energy ties, Russia and China are still caught at an impasse over oil and gas prices, and over building the East Siberia-Pacific Ocean (EPOC) oil pipeline and two new natural gas pipelines that are supposed to pump eastern and western Siberian natural gas to China.

Based on the original plan, Rosneft should have completed the eastbound EPOC stretching from Taishet in East Siberia to Skovorodino before the end of this year, but the latest news is that the company is likely to delay the project by at least one year, in part because of prolonged crude price talks.

Rosneft believes that it would incur about $40 of loss for one metric ton of crude sold to China based on the original price formula agreed in 2006 and is urging the Russian government to resume crude price negotiations.

As currently the Chinese government still controls oil product prices in order to head off inflation, it is impossible for CNPC, Rosneft’s Chinese counterpart, to accept a sharp price rise.

For gas exports to China, Gazprom prefers to use the same price formula as for its European customers, which CNPC would not accept.

The two sides are quite apart in their pricing methodology, with Rosneft and Gazprom strictly following market prices while CNPC insists that price for gas to China will have to factor in Chinese purchase ability. CNPC insisted that gas imports from Russia should be priced in line with the price index of coal in northeastern China, which is not acceptable to the Russians.

Price is not the only issue for natural gas. Supply uncertainties are far more serious for the viability of the pipeline project.

Russia’s natural gas resources would be insufficient to supply both Europe and China since Siberia natural gas is not even enough to feed European customers by as early as 2011.

Though the Sakhalin I project has 485 billion cubic meters (17tcf) of proven natural gas reserves, not much of that gas will go to China, because Japan has a lion’s share in the project.

Political statements have been far more expansive. Vladimir Putin, former Russian president and now prime minister, said in 2006 that Russia will increase oil exports to Asia from the current 3% to 30% over the next 10-15 years, which had given impetus to the EPOC plan.

The same year, Russia mulled building a 4700km crude pipeline from Taishet to Nakhodka port via Skovorodino with annual designed transmission capacity of 584 million barrels. The first phase – from Taishet to Skovorodino – will be able to carry 219 million barrels, with 146 million barrels to supply China through the spur line.

In 2006, Gazprom announced plans to export gas from Siberia to China, including plans to construct two highly challenging pipelines and offering 68 billion cubic meters of gas per year.

Russia’s ambitious plan has aroused suspicion as to the country’s true motivation behind the project: does Russia want to urge Europe to import Siberian gas before it is ‘snatched by China’ or is Russia hoping to monopolize China’s gas import? Russia is likely to justify these plans by its intention to induce insecurity in European countries so as to create competition for Siberian gas. At any rate, it is a rather clumsy threat that Russia is posing to Europe.

From the geopolitical point of view, China is unlikely to import 68bcm of gas per year from a single country, especially from Russia, with which it has an intricate political relationship burdened by history, as it is more concerned with national energy security than ever. Before Russian gas pipelines get off the ground, China has already jumped the gun by building a gas pipeline to import gas from Turkmenistan.

China has warned Russia to make a quick decision on the gas pipeline construction or it may miss the opportunity to lock in Chinese customers before LNG hits the market early next decade. CNPC is planning to build two LNG terminals in northeastern China, which may dampen the demand for Russian gas in the region.

It is even tougher for Chinese companies to share Russia’s upstream pie. Chinese companies are successful in many overseas upstream deals, but no big deal so far with Russians.

One such problem is the legal hurdle. In 2006, Russia passed a law which will oblige foreign companies interested in seeking upstream access to prove that they are owned by Russians. According to the law, companies wishing to participate in auctions for oil and gas deposits would have to show that Russian citizens are the beneficiaries of at least 50% of their outstanding shares, giving local players a major role. This of course is also likely to breed corruption at unprecedented scale.

The new regulations are also meant to give the Russian government a more active role to play in the oil and gas sector.

Russians are very sensitive to the buying interest of the Chinese companies in part due to the government ownership of these entities.

Russia and China are connected at the energy hip but the symbiosis will be uneasy and likely to prove one of the biggest geopolitical dramas in coming years. OE

Michael J Economides is a professor at the Cullen College of Engineering, University of Houston, and editor-in-chief of the Energy Tribune. The views expressed in this column do not necessarily reflect OE’s position.

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