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Viktor Katona

Viktor Katona

Viktor Katona is an Group Physical Trader at MOL Group and Expert at the Russian International Affairs Council, currently based in Budapest.

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Russia Reemerges As China’s Top Crude Supplier

Russia - China

Even a layman with no specific interest in international affairs could observe that the Russo-Chinese relationship has reached new heights in the last few years. Cooperation in the energy sphere is of particular importance to both regional powers – and although gas projects are still to come online by the end of this decade, trade and joint projects in oil have broken new ground. Chinese companies now have a minority stake in numerous producing upstream projects, like Verkhnechonskoye and Taas-Yuryakh, as well as in several ambitious up-and-coming endeavors, such as Yamal LNG and Sakhalin-3. Oil exports from Russia to China have experienced a seventeen-fold increase in the last 15 years and now account for almost a quarter of Russia’s exports. Yet, there is still room to expand this strategic link.

Russia is now China’s No.1 crude supplier, a status which it is very likely to retain in the following years, having demonstrated a spectacular 24 percent year-on-year increase in 2016. Almost all supply routes to China experienced growth in 2016, moreover, the ESPO pipeline and Kozmino port (exported 16.5 mtpa and 31.8 mtpa, respectively) were operating slightly above their nominal capacity (15 mtpa and 30 mtpa, respectively). Whilst major state-owned refineries are commonly bound by long-term contracts to Saudi or Angolan suppliers, independent refineries (so-called ‘teapots’) represented one of the leading forces behind this increase. Teapots did not limit themselves to ESPO or other Pacific-bound grades, they also bought Urals, as its economics proved to be more attractive than those of the Oman grade, the characteristics of which are almost identical (31° API vs 30.5° API, 1.5 percent Sulfur Content vs 1.4 percent).

The Eastern Siberia-Pacific Ocean (ESPO) pipeline will remain the main conduct of Russian oil exports to China, with its share slightly increasing from the current 42 percent of the total (22.5 mtpa). Russia’s leading oil company, Rosneft, will also take greater use of a third supply variant – pipeline transportation via the Kazakh Atasu-Alashankou. In keeping with the general spirit of the ‘strategic oil partnership’, Rosneft benefits from lower transportation costs in contrast with ESPO, whilst the Chinese guarantee pipeline-supplied crude to their only refinery in the Sichuan province, located in Pengzhou. In the previous years the Kazakhstani passage amounted to 7 mtpa, however, the two sides agreed on increasing these volumes to 10 mtpa from 2017. Oddly enough, it was not lack of demand that obstructed the ramping up of imports but the insufficiency of pipeline capacity. Related: Oil Prices Set To Rise On Back Of OPEC Deal Extension

A lack of internal interconnectors has hindered the expansion of the ESPO, as only in January 2017 did Transneft, the Russian pipeline transportation monopolist, bring onstream two important pipeline sections, Zapolyarnoye-Purpe and Kuyumba-Taishet. By October 2017, following the completion of the second Mohe-Daqing string, the ESPO pipeline is expected to increase its throughput capacity to 30 million tons per year. The throughput capacity of the other branch laid from the Skovorodino junction point, linking it to the Pacific port of Kozmino, is expected to reach 50 million tons per year by 2020 from the current 30 mtpa. These developments could not only give a fresh impetus to pipeline exports, but also foster the development of new upstream projects in Eastern Siberia that took a palpable blow from the falling oil prices and international sanctions.

Beijing enjoys multiple benefits from such a strategic energy partnership – inter alia, new supply routes have eliminated the risk of the Malacca Strait, through which most of non-Russian imports pass, being shut down in case of a sudden aggravation of matters in the South China Sea. The Russian oil and gas link is considerably safer at virtually no additional cost, moreover, subject to minimal security risk as Russia sees significant value in its partnership with Beijing and is very unlikely to take risky steps to jeopardize it (against the background of real tensions between Moscow and the West). The rapid surge of Russian imports does not counter national policy provisions, as it was the Chinese government that in 2015 lifted a ban for teapot refineries to process imported crude oil. Moreover, the construction of ESPO was greatly facilitated by loans from the Chinese Development Bank, a fully government-owned entity. Related: OPEC’s No.2 and 3 Back Deal Extension

Of course, China is not the only partner with which Russian companies collaborate, and the additional 20 million tons that the Kozmino expansion will bring to Asian markets by 2020 are to be supplied to South Korea, Japan, Malaysia and other nations, too. The competition for Asian market outlets will inevitably intensify the Saudi-Russian rivalry. After Russia unseated Riyadh as the leading oil exporter to China, it has made considerable headway in pressing Saudi oil in Southeast markets, e.g.: in Malaysia. As almost all East Asian countries have a booming automotive market, ESPO is bound to augment its positions, given its good gasoline refining characteristics. Add to this generally more favorable financing terms, a closer distance (thus, lower transportation costs), and you have all the prerequisites of a bitter market share struggle.

Russian companies are sure to try their best in consolidate their hold in new frontiers, as they are attracted by numerous “carrots” – higher premiums than in Europe, more robust demand that is expected to increase with time, as well as appreciable state backing. Rosneft alone, on the back of a 20-year contract with CNPC envisaging the supply of 300 million tons of oil, intends to increase its oil exports to China to 31 mtpa in 2017. Surgutneftegaz, the second-largest ESPO supplier, will try to stay abreast, and so will companies whose footprint so far was relatively modest compared to their capabilities (Gazpromneft, LUKOIL). China will remain the most attractive spot – as the total annual volume of supplies moves from the current 52 mtpa to the 70-80 mtpa interval, China-bound exports will be more or less commensurate with Russia’s aggregate exports from its Baltic ports. There certainly will be setbacks on the way – inter alia, the summer of 2017 is looking to be less hectic than its spring – yet the overarching trend will be really hard to stall.

By Viktor Katona for Oilprice.com

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  • petergrt on May 17 2017 said:
    Is this the same Russia that just announced with Saudis the 9-month extension of the 'production limitation'?

    The Saudis need to keep the oil price from crushing until they complete the IPO of ARAMCO, which is why they are rolling over and do nothing as they are losing gobs market share . . . . . The problem is that they will never get it back - it will be quite the show once they come to that realization . . .

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