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Analysis & Opinion
17.06.11 ESPO Pipe Dreams
By Martyn Larys

Russia’s pro-east oil pipeline strategy may be facing a setback, with many experts expressing concerns that the country is betting on the wrong horse. While diversifying the markets for Russian oil is important to the country’s energy security, questions remain about the viability of the specifically Chinese oriented pipelines, and whether it is profitable for Russia to build it energy cooperation with China under the current economic realities.

The cornerstone in Russia’s eastward thrust is the Chinese-bankrolled Eastern Siberia Pacific Ocean pipeline (ESPO), which runs from Eastern Siberia to China. With China showing dynamic growth and Russia holding vast natural resources, the two seem to be a match made in heaven for energy cooperation. Yet with China occupying an increasingly strong bargaining position, doubts on the profitability of the ESPO pipeline point to the possibility that Russia may be getting the short end of the stick.

Doubts on Profitability

The price of Russian oil sold to China is estimated at about $60 per barrel, less than half the current global price. The ESPO has the ambitious goal of supplying 80 million tons of oil to China before 2030, but many experts say that this goal is unrealistic. “The oil pipeline will be profitable only if it transports more than 50 million tons of oil. If not, then transport by rail is a more profitable option,” said Maria Belova, the head of the energy department at the Institute for Energy and Finance. There is a Russian lobby for using rail as an alternative to the pipeline, spearheaded by Vladimir Yakunin, the director of Russian Railways.

The main risk of the Chinese oil pipeline branch from Skovorodino to Daqing is its reliance on a single consumer, which gives the Chinese a very strong negotiating position. This was confirmed by recent Chinese efforts to revise the transit tariffs, which were considered unprofitable by Beijing.

The majority of experts believe that the current transport of oil to China is unprofitable for Russia, and in particular for the Russian state gas giant Transneft. Current transit tariffs on Russian oil to China are fixed at close to $57 per ton, but real costs for that transit are almost $140 for the same amount. From an economic point of view, the oil’s transit is subsidized by the Russian state because Transneft has to transport oil across almost all of Siberia, from its Vancor oil field in the Krasnoyarsk Region to the ESPO. Transneft loses about one billion dollars annually on its oil deliveries through the ESPO.

Belova, however, noted that the ESPO does provide some economic benefits to society. “The project is clearly running at a loss for Transneft, but it can be profitable for the whole Russian economy because of the new energy infrastructure, for example, the port in Kozmino, the only Russian port accessible for the heaviest oil tankers. Kozmino offers an opportunity to transport Russian oil anywhere in the world in relatively large amounts.”

There are also concerns about the extraction profitability of smaller oil fields in Eastern Siberia. Wojciech Konończuk from the Polish Center for Eastern Studies said that “extraction will be profitable if prices reach at least $80 to $90 per barrel.”

Overall the ESPO is now unprofitable and costs the state budget a huge amount of money. At this stage, the political aspects of diversification from European markets and geopolitics should be weighed more heavily, especially when the oil transport and extraction are unprofitable. On the other hand, Moscow’s oil diversification strategy may turn a profit in the future, if oil prices remain high and energy infrastructure in the whole region is further developed. Currently, however, many of the oil fields are still undeveloped, and are not expecting oil extraction earlier than in 2016.

Enough Oil for China?

Many experts are worried that there is not enough oil in Eastern Siberia to fill the ESPO. Konstantin Simonov, the director of the National Energy Security Fund, is concerned that “if there is a decline in exploration of traditional oil fields and a new market is opened, it means nothing less than abandoning the old markets and their replacement by the new ones, which are less profitable. We should, of course, export oil to China, but under other, more advantageous conditions.” Exploitation of the Eastern Siberian oil fields is now in its first stage, and last year only yielded several million tons, far too little to fill the ESPO. Nonetheless, there is a high potential for natural resources in Eastern Siberia, as they are almost untouched because of their remoteness and the harsh climate. Weak infrastructure also complicates the transport of both the necessary equipment and production export to the region.

Optimistic reports show that Eastern Siberian oil fields can produce approximately 45 million tons of oil until 2020, but new taxation on these oil fields may reduce incentives to exploit them. The current taxation system makes these oil fields unprofitable, said Belova. In an analytical report titled “The Eastern and Western Vectors of Russia’s Oil And Gas Complex Development” published in April of 2010, the National Energy Security Fund stated that “The Russian eastern energy strategy concentrates on the doubtful presumption of steady oil exploration growth, which should secure preservation of European markets and ‘conquest’ of the new eastern ones. Exploration in Eastern Siberia is proceeding very slowly, and therefore the whole system of eastern energy policy focuses on transferring oil from Western Siberia (Vancor oil field) to China. The economic sense in these steps is not very clear.”
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