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The Kremlin has decided to curtail its support for a new pipeline proposed for oil shipments to China after six months of appearing in public to want to accelerate the project. According to Moscow industry sources and a blitz of Japanese media leaks ahead of Prime Minister Junichiro Koizumi’s visit to Moscow last week, some officials in the Russian government are now quietly in favor of a more expensive pipeline option backed by the Japanese government. Other Russian officials warn, however, that in exchange for financing the pipeline, Japan may demand exclusive access to the oil, a condition that the Kremlin is unlikely to accept.

At present, Russian law gives the state strict control over every ton of exported crude oil and petroleum products through regulation over access to oil pipelines, tariff pricing for pipeline and rail transportation, port control, customs inspection and export taxation.

Oil industry sources in Moscow say negotiations between Yukos, Russia’s largest oil producer, and the China National Petroleum Corporation (CNPC) failed in Beijing last month because the Russian government has gone cold on the plan to build a $1.8 billion line between the Siberian town of Angarsk and the northern Chinese terminal center of Daqing. Half of the financing for the project has been pledged by the CNPC.

At about the same time, Japanese Foreign Minister Yoriko Kawaguchi wrote to Moscow proposing Japan’s counter-plan, and details were on the agenda for discussion by officials during the Jan. 10 meeting between President Vladimir Putin and Koizumi. After that, the public announcement of the intention to develop the new pipeline failed to materialize. During discussions in Khabarovsk on his way home, all Koizumi could get out of his Russian counterparts was a vague undertaking to look at all forms of energy cooperation in which Japanese investment is offered.

The change in official thinking in Moscow has been stimulated, the sources believe, by Transneft, a state-owned pipeline operator, which argues that it is unwise for the Russian government to commit new pipeline capacity to single destinations, such as China or the United States. Until now, the government has been publicly backing Yukos and the CNPC in their plan to construct the southward export line.

Industry sources in Moscow confirm that the shift in government thinking has been encouraged by a Japanese offer, rivaling the Chinese, to finance the $4 billion cost of building the new Siberian pipeline eastward through Khabarovsk to the port of Nakhodka. This route is favored by Transneft, which argues that, while more than doubling the cost of the Yukos-CNPC proposal, it would give Russian oil access to the entire Pacific and Asian market.

However, serious problems remain. Sergei Grigoryev, vice president of Transneft, told me that the Japanese interest isn’t new, and he warned that, if Tokyo insists on taking the entire 50-miliion-ton throughput of the pipeline as a precondition for financing the project, it would be unacceptable to Transneft for the same reason the China pipeline is unacceptable.

According to Grigoryev, so far Transneft hasn’t participated in any talks. “The company is proceeding with this project the same as before and considers Japanese investors to be the same as all other potential investors,” he added.

Yukos is expected to begin intense lobbying to neutralize the Transneft-Japan bid in the coming weeks. Yukos and other oil majors have already started their campaign against Transneft, complaining in a recent letter to the prime minister’s people that Transneft is responsible for a cabinet decision in December to halt oil shipments through the Latvian port of Ventspils and redirect the oil to the Transneft-controlled port of Primorsk.

Grigoryev warns that Transneft and the oil companies need each other. “The main problem remains the availability of oil for the eastern and southern pipelines,” he said. “If Yukos will not participate in the pipeline project to Nakhodka, it will be problematic to find the required 50 million tons of oil for this route, as such a volume is not available at the moment yet,” he added.
A compromise could be struck to build both pipelines, he said, “but this will require an even greater volume of oil – 70 million tons – and availability of that amount is the main problem.”

If Transneft has managed to convince the Kremlin to change its mind on its Asian oil-marketing strategy, it is also likely to put in doubt the plan of the four Russian oil majors – Yukos, LUKoil, Sibneft and Tyumen Oil Co. – that signed an agreement last month to build a new oil terminal at Murmansk, Russia’s Arctic port.

“If the oil companies have the money for the project, let them build it,” Grigoryev said regarding the Murmansk project. “However, we doubt that they will build a pipeline cheaper and better than Transneft’s.” Transneft has voiced its opposition to the Murmansk terminal plan before, arguing that Primorsk, on the Gulf of Finland, is better-positioned to supply European oil markets. Transneft is busy expanding pipeline capacity to increase Primorsk’s shipping volume by laying additional pipeline-delivery capacity to the port.

Grigoryev responded by saying he understands the desire of the oil producers to maximize their profits while export prices are high and domestic prices are low. But he insisted it was the government that decided to increase oil exports this year to Primorsk, not Transneft. At the point where the pipeline forks and crude must be routed either to Ventspils or to Primorsk, Grigoryev said, “We can only increase delivery to Ventspils at the expense of deliveries to Primorsk, and in this situation it is quite natural that Primorsk is given priority. In order to be able to deliver more oil to both ports, it is required to invest into expansion of the pipeline’s capacity.” According to a Transneft official, the current annual capacity of Primorsk, which opened a year ago, is 18 million tons, and Transneft may raise that to 30 million tons by the end of this year.

According to Grigoryev, “The proposal to build a pipeline to Murmansk doesn’t compete with the plan for expansion of Primorsk, because Primorsk is oriented towards deliveries of oil to Europe, while the Murmansk project is aimed at the United States. No tankers go from Primorsk to the United States.”

Transneft has expressed skepticism before that the combination of Yukos, LUKoil, Sibneft and Tyumen Oil Co. will be able to develop a big enough market in the United States to make Murmansk shipments economically feasible. “I’m sure that the oil companies can count their own money,” Grigoryev said. “While they are optimistic about the project now, they may later change their minds when they realize how much it will cost.”

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