Tuesday, July 23, 2013

Russia and China Sign Major Petroleum Deal

On 20 June 2013, Russia and China signed a deal worth $270 billion dollars.  Rosneft agreed to double its sale of petroleum to China by 300,000 bpd over the next 25 years (5 years prolongable,)  from 15 million tons to 30 million tons per year.  The agreement was signed by Rosneft chief executive Igor Sechin and China National Petroleum Corporation (CNPC) chief Zhou Jiping in the presence of Russian president Vladimir Putin.

An important part of the deal is a $60-$70 billion prepayment for the oil, alluded to by Putin at the announcement of the contract.  JP Morgan analysts said, "If confirmed, this would be a transformational event for the company's balance sheet:  Rosneft could even potentially be able to show a net cash position, though working capital would be negative.  The prepayment could minimize financing risks for the leveraged state-controlled oil company."

The increased petroleum flows began even before the contract signing.  Reuters reported on June 18 that Russia was increasing its oil supplies to China by 13 percent in July-September over the previous three month period.  With this increase, Asia as a whole was importing 17% of Russian oil exports.  According to Valery Nesterov, analyst from Sberbank CIB, "Russia has been losing its interest in Europe where oil consumption is stagnant.  It's looking increasingly to the East."

Then came the June 20 deal, in which China acquired the rights to buy from the world's largest gas station:  Russia.  According to Liao Na, Vice President of the energy consulting company, ICIS C1 Energy, the timing was right.  "The seller and the buyer both have strong willingness to reach the deal provided the price was comfortable for each of them.  It is good timing, considering current international oil prices."

It was originally announced that fuel for the deal was to come from East Siberia fields.   In the annual meeting with Rosneft shareholders, Sechin named two fields as the main source of the oil, Vankor and Verkhnechonsk, that are nearing peak output.

In fact, the oil is not coming from East Siberia, but is being diverted from fields that service the European market.  Igor Katsal, Transneft deputy vice president, told reporters, "We supplied those 800,000 mt to the west and now will redirect them to the east.  They won't be replaced in the western direction."  Transneft confirmed that at least half of the redirected crude will be produced at Samotlor in West Siberia.  Deputy Energy Minister Kirill Molodtsov confirmed Russia planned to increase oil exports from the Pacific.  "The balance between West and East will change," he told reporters.

The reason for the diversion is that Russia has promised large quantities to Asia.  In addition to the current flows of 750,000 bpd, Russia promises to send another 9.1 million mt per year to China after a CNPC-Rosneft joint refinery is completed in Tianjin.  These changes are taking place at a time that Russian domestic consumption of crude is also rising.

How the oil will be delivered physically is still undecided.  Transneft spokesman Igor Demin said that there has been no change in its contract with Rosneft.  As a result, although Transneft has adjusted its transit schedule to accommodate the larger oil flows through the East Siberia-Pacific Ocean (ESPO) pipeline, Demin said that shipments might soon be suspended because it will have fulfilled its obligations under existing contracts.

The eastern "black gold" rush is encouraging others to enter into the field.  Lukoil CEO Vagit Alekperov confirmed that they are increasing exploration in East Siberia.  Alexei Kokin, an oil and gas analyst at UralSib Financial Corporation, wrote, "Other Russian companies' experience probably convinced Lukoil that East Siberian projects can be attractive.  As a late entrant, Lukoil will be able to learn from the pioneers' mistakes and be more efficient."