No. 1, 2006

Vladimir Akramovsky


The energy dialogue between Russia and China acquires a new dimension

In recent years relations between Russia and China have been developing more and more dynamically. Their trade turnover has noticeably increased, and their business and cultural relations have strengthened. But it is energy industry in particular that is becoming an important sphere of cooperation between the two countries. President Vladimir Putin's visit to the People's Republic of China, planned for March 2006, will be largely devoted to broadening bilateral relations in that sphere.

The eastern sector once more

Several promising areas of bilateral cooperation in the fuel and energy sphere have become clearly defined today: export of crude oil and petroleum products from Russia to the PRC, participation by Chinese companies in developing hydrocarbon fields in the Russian Federation, joining efforts in the construction of gas-burning and nuclear power stations, and mutual trade in ore-mining and oil-production equipment.

Russia exported crude oil and petroleum products to China as far back as the 19th century. In the 20th century, in the period between the 1960s and the late 1980s the oil trade gradually stopped because of a cooling of relations between the two countries and a sharp rise in the production of hydrocarbon raw materials in the PRC, which enabled that country to free itself from dependence on foreign imports.

However, the consumption of hydrocarbon raw materials in China was growing at such a rate that in the early 1990s the country again began importing crude oil primarily from the Middle East, the Asia-Pacific Region and Africa. Meanwhile, in the late 1990s Russia stepped up its oil production substantially and started to regain its positions on the world market of energy-producing materials. As for China, it was interested in further diversifying its imports of the valuable raw materials. The geographical proximity of the two countries and the increased oil output in Russia created favorable conditions for restoring the former ties.

The advantages of such cooperation were obvious to the Russian business circles as well. Trade in the eastern sector made it possible to lessen dependence on the oversaturated European market whose participants purchased Russian crude oil at increasingly growing discounts.

In the late 1990s the two countries signed an intergovernmental agreement under which the PRC received over 36 million barrels of Russian oil annually to a total sum of more than one billion dollars. Just as a century before, crude oil was delivered by rail.

In 2004 China's import of oil from Russia totaled seven million tons, and in 2005 ten million. In 2006, in accordance with the intergovernmental agreement, it will reach 15 million tons. Initially, the main oil suppliers were Yukos, Sibneft and Rosneft. LUKOIL joined that group later on in 2004.

In the long term, the export of Russian oil by rail will not be adequate to meet the requirements of the growing Chinese market of energy resources. Besides, transporting oil to China by rail is quite costly five to seven times more expensive than transporting it over a pipeline. Therefore, the idea of building an oil pipeline to the PRC is particularly topical today.

In accordance with the decision taken in December 2004 to build an oil pipeline from Eastern Siberia to the Pacific coast, representatives of the public joint-stock company Transneft and the Chinese national oil-and-gas corporation began discussing the economic and technical aspects of building a branch pipeline which will run from Skovorodino to Daqing and which will have a capacity of 30 million tons.

Northeast China, where Daqing is located, has a well-developed oil-refining and transport infrastructure. Concentrated in the Songhuajiang and Liaohe rivers basin is the largest group of oil fields, but oil production in the region has been diminishing. Construction of a pipeline might compensate the lack of raw materials for the domestic petrochemical industry.

At the initial stage, it is planned to fill the pipeline with West Siberian oil. On the whole, the distance from some fields of the West Siberian oil province to Peking is not much longer than the distance to some capitals in Central Europe, which will make the projected oil pipeline quite competitive. Moreover, the oil reserves prospected in Eastern Siberia are sufficient already now to bring production up to 40-45 million tons a year and fill part of the pipeline. The functioning of the pipeline will stimulate further development of the hydrocarbon fields of that region.

According to many Russian and Chinese analysts, at present considerable oil-and-gas resources have been concentrated in the hands of the state, which additionally guarantees that the construction of the strategically important pipeline and the development of Eastern Siberia will not be delayed any longer.

As for the railroad, it can be used in the long term as well to deliver Russian products of deep refining and petrochemistry to the East.

An impetus to mutually advantageous cooperation

In 2005, oil production in the PRC reached 180 million tons a gain of more than 1.5% on the previous year. In spite of that, China's import of crude oil in 2005 totaled about 130 million tons, having increased by 6%, while the import of petroleum products totaled approximately 30 million tons, registering a decrease of more than 15%.

According to the International Energy Agency (IEA), in 2006 China's requirements for oil are expected to grow by 6.5%, which practically coincides with the forecast made by the Center for the Study of Development Problems under the PRC State Council (its forecast was 6% flat). In 2010, the IEA believes, China's requirements for hydrocarbon raw materials will increase further, reaching 350 million tons of oil, of which only one-third will be met by the country's own resources.

It is quite natural that, because of China's growing demand for raw materials and the inadequacy of its own oil-and-gas resources, the Chinese companies show an interest for Russian oil; moreover, they consider taking part in developing fields located on the territory of the Russian Federation.

The first practical steps in that direction have already been taken. In July 2005 the Chinese Sinopec company signed an agreement with Rosneft on setting up a joint venture which would engage in the prospecting of the Venin block at the Sakhalin-3 field. Furthermore, Rosneft is discussing with the CNPC, another Chinese company, the possibility of conducting joint prospecting for oil and its production on the Sakhalin shelf. Taking part in exploring the Venin block field with its reserves of 114 million tons of oil and 315 billion m3 of gas are Rosneft (74.9%) and the Sakhalin Oil Company (25.1%), a state unitary enterprise which represents the interests of the administration of the region.

Traditionally, selling petroleum products is more profitable than selling crude oil, and so Chinese business keeps an eye on the projects of the Russian downstream sector. For instance, the Harbin oil company Longdu, which is not a state enterprise, intends to invest over $120 million in the construction of an oil refinery in the Urals area. Subsequently, the company plans to supply China with about two million tons of petroleum products a year.

There is a considerable potential for cooperation in the sphere of gas production. In 1996 the PRC's gas-producing capacities exceeded 20 billion m3 and continued to grow steadily. In 2005 they reached the level of 50 billion m3. According to the PRC Department of Statistics, the proportion of the country's consumption of natural gas and crude oil is 0.24:1. However, the need of the industry and the population in gas continues to grow. At present, Russian and Chinese experts are studying the alternative ways of bringing natural gas from Russia to China. This concerns the Kovytkin gas project in the first place.

This project envisages the construction of a 5,000-km export gas pipeline from the Kovytkin condensed gas field (in the Irkutsk region) to China. Currently, the reserves of the field are estimated at 2,130 billion m3. The project also envisages annual deliveries of at least 20 billion m3 of natural gas over a period of 30 years, with 10 billion m3 going to the PRC and the rest to the Republic of Korea and to Japan.

The year 2001 is justly regarded as a key point in the energy dialogue between Russia and China: it was then that Vladimir Putin, President of the Russian Federation, and Jiang Zemin, then Chairman of the People's Republic of China, signed an Agreement on good-neighborly relations, friendship and cooperation between Russia and China. The two sides successfully resolved some border problems and discussed the possibility of increasing the supplies of Russian energy-producing materials to the PRC and the issue of Russian oil prices. In the course of President Vladimir Putin's official visit to China in October 2004 all these issues were duly reaffirmed.

Over the past five years, broadening bilateral cooperation has invariably been the prevalent subject during the meetings of Russian and Chinese high level officials. No exception from this rule were the visits to China in November 2005 by the Russian Prime Minister, Mikhail Fradkov, and his first Deputy, Dmitry Medvedev.

Besides the oil-and-gas issue, the two sides discussed questions of implementing the Agreement on Cooperation in the Sphere of Electric Power. The Russian side is now considering the possibility of supplying electric power from the Far East to Northeast China. This is one of the most important and long-term cooperation projects.

There are more than 1,500 rivers in China, and the combined area of their basins exceeds 1,000 km2. The significant overfalls there create favorable conditions for the use of hydropower resources whose reserves total 680 million kilowatts and are the largest in the world. As a country which has vast experience in constructing hydropower plants, Russia could take an active part in designing such projects on the territory of the PRC. So far, however, cooperation in the oil-and-gas sphere remains a priority.

On a global scale

While the oil market stagnates in Europe and its moderate progress is observed in the United States, it is developing rapidly in the Asia-Pacific Region. In the opinion of Sergei Sanakoev, chairman of the board of the Russian-Chinese Center of Trade and Economic Cooperation, the implementation of the eastern pipeline project will make it possible to divert some of the flows from the glutted European market and ensure for Russia an independent access to the energy market in the Asia-Pacific Region and on the Atlantic coast of the United States. This will also diversify the flows in the exports of Russian oil.

Europe is buying Russian oil at a steadily growing discount. Brent crude oil is somewhat superior in quality to the Russian mix of the Urals kind which is formed in the process of different brands of oil being transported along pipelines. Nevertheless, according the Anatoly Dmitrievsky, Director of the Institute of Oil and Gas Problems, the difference in prices (about $7 in Brent's favor) is much too great. Such a discrepancy in prices will be naturally eliminated when oil is supplied to China and other countries of the Asia-Pacific Region over a pipeline. West and East Siberian oil is distinct for its high quality and is far superior to the Urals brand. The oil to be transported via the eastern pipeline will be mostly of the light and low-sulfur-content kind.

Today, China is the main customer for Russia's oil in that region. China's oil market is developing very dynamically. In the next 15-20 years the average annual increment in its oil consumption will be one of the highest in the world. Furthermore, on the Chinese market Russian oil competes successfully with Latin American and Mid-Eastern oil whose delivery to continental China is much too costly.

The argument that China's banking on an alternative fuel, such as coal for instance, may in future create difficulties for the sale of Russian oil is untenable. Though indeed coal accounts for nearly 70% of the energy consumption in China, the rapid development of the chemical industry there guarantees high demand for oil. Furthermore, according to China's predicted economic development, its GDP will be growing by an average of 9% a year. And such a considerable growth rate requires greater use of all kinds of energy resources.

In December 2005 the Russian President Vladimir Putin and Chinese Prime-Minister Wen Jiabao met within the framework of the second Russia-ASEAN summit. Both sides reaffirmed their intention to increase the deliveries of hydrocarbon resources from Russia to China and to enlarge mutual investment in the oil-and-gas industry.

Particularly important was the decision of the Russian and Chinese leaders to declare 2006 Russia's Year in China, and 2007 China's Year in Russia. This is highly symbolic in the light of the considerable progress in the Russian-Chinese relations over the past decade. The volume of trade between the two countries has grown from six billion dollars in the 1990s to 28 billion in 2005. Moreover, for the past few years the annual increment was as much as 30-35%. As stated earlier by the leaders of the two countries, by the year 2010 the trade turnover between them will reach 60-80 billion dollars.

It is expected that Vladimir Putin will visit China in the third decade of March 2006 to take part in the opening of Russia's Year in China. Undoubtedly, this visit will give a new impetus to the development of the energy dialogue between Russia and China.

Significant positive changes have taken place in the Russian-Chinese relations lately. Meanwhile, there still are ample opportunities for realizing fully the enormous potential of economic and scientific cooperation. The partnership of the neighbor countries has been developing most successfully in the sphere of energy supplies. Russia and China are convinced that it is precisely this branch of industry that will form a reliable basis for successful and mutually advantageous cooperation in the near future.

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Oil of Russia, No. 1, 2006
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