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The oil industry in Russia has developed so quickly that current pipelines cannot handle the outflow. Now, it is up to the government and oil industry officials, both in-and outside of Russia, to decide the next step.

A decision signaled by the Kremlin last month, to authorize the construction of a new oil pipeline to China, is a clever piece of policymaking that appears to give Russian oil producers, especially Mikhail Khodorkovsky, CEO of Yukos, exactly what they have been demanding.

However, the small print of the deal reveals that Yukos has been pushed aside in the financing of the project, the terms of which take a leaf straight out of the oligarchs’ book – that is to say, raising and risking other people’s money, or money that does not exist at all.

The new pipeline move puts a stop to speculation in Moscow that the Kremlin is unwilling to proceed with the China pipeline because it does not want to allow a single consumer, the China National Petroleum Corp. (CNPC), to monopolize the offtake. This reassurance also rescues the “strategic” relationship with China, which was embarrassingly close to oblivion, at least in the oil sector.

In fact, the real reason the Kremlin forced negotiators to suspend talks on the pipeline in Beijing last December was that Russian officials were unwilling to allow commercial interests, led by Yukos, to plan and execute the project on the Russian side. While Khodorkovsky has been pouring personal resources into cultivation of the Republican leadership in Washington, he has been stymied at home.

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. Most of Russia’s pipeline capacity is also owned by the state and managed by Transneft, a state company.

Oil company sources have been lobbying hard to have the government allow them to build and finance new oil pipelines, because their production is rising faster than the country’s export capacity. Planning to double the amount of oil exported from 3.5 million barrels per day (bpd) to 7 million bpd by 2012, Russia must double its pipeline and other export capacity.

The Kremlin wants to retain its control over exports in order to preserve ultimate control over the oil companies themselves. “Russia’s pipeline system should remain under state control,” Prime Minister Mikhail Kasyanov said at a meeting last month at the Energy Ministry in Moscow. “But the state should work out an automatic system for oil companies to access the pipes.” That the ever-obliging Kasyanov was obliged to say this much was no victory for the oligarchs.

Khodorkovsky and other Russian oil-company leaders have demanded that, if the government and its pipeline monopoly, Transneft, cannot afford the multi-billion-dollar cost of new pipelines, the government should relax its grip and allow commercially owned pipelines instead. Not that the Russian oil companies intended to put any of their money at risk on such ventures: As the Kremlin realized, the oligarchs were planning to capture a resource using borrowed foreign funds secured by repayment in oil.

The government has rejected this. But it has agreed to authorize an increase in shipments of oil to China. The compromise formula that officials now propose will see Transneft take over the pipeline between Angarsk, in southeastern Siberia, and Daqing, in northern China. It will be responsible for financing the Russian share of the $1.8 billion construction cost. Yukos, which had intended to raise the money for the project, instead will supply the oil to be pumped through to China, but nothing more.

The new Kremlin idea is also to get China to finance both halves of the project – both the pipeline segment from the frontier to Daqing and the Angarsk section. However, it will be China’s pre-existing debt to Russia that will be applied to the Russian sector of the pipeline, thus making the Russian state the financier, without having to put up any cash.

The Energy Ministry is also recommending that the Kremlin approve a second and much longer and costlier pipeline to ship oil to Asian markets through Nakhodka, on the Sea of Japan. However, the projected cost of this is at least three times that of the China pipeline. Also, it is certain that, until the underdeveloped eastern Siberian oilfields begin to produce much more than they do now, there will not be enough oil to pump through both pipelines at once. As a result, the Kremlin is proposing to delay the Nakhodka route until development of new Siberian oilfields starts to generate more oil for piping.

Sergei Grigoriev, vice president of Transneft, has noted that the Japanese interest is not new. He says that the high level of talks on the pipeline project does encourage hope in its future implementation, but he warned that, if Tokyo insists on taking all of the annual 50-million-ton (970,000 bpd) throughput of the pipeline as a precondition for financing the project, that would be unacceptable to Transneft. According to Grigoriev, “So far, Transneft hasn’t participated in any talks. Transneft is proceeding with this project the same as before and considers Japanese investors to be the same as all other potential investors.”

Grigoriev also confirms that “the main problem remains the availability of oil for the eastern and southern pipelines. If Yukos will not participate in the project of the pipeline 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.”

A compromise could be struck, he added, to build both pipelines, “but this will require an even greater volume of oil – 70 million tons – and availability of that amount is the main problem.” Oil-industry experts believe that most of Russia’s increased oil output over the next five years -that is also most of the new wealth to be earned by the oligarchs – will come from central, northwestern and southwestern Russia. Recoverable reserves in eastern Siberia are estimated by Yukos to total 2.3 billion tons (16.6 billion barrels), but to develop the oilfields to lift this oil will take many years, and, if the Kremlin has its say, Yukos will be just one of many producers bidding for access.

All of this should have been clear when the government planned to announce its decision at a meeting on March 13. In postponing the meeting until May 1, the public reason offered by the Energy Ministry is that more time is needed to calculate eastern Siberian oil reserves. The real reason is that the oil producers realize they have been beaten to the punch. So they have called a timeout to see if, in six weeks’ time, they can change the government’s mind.

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