Transneft-Rosneft Kiss and Make Up

The summer battle between two energy barons in Vladimir Putin's inner circle has been resolved.  On October 11, 2013 Rosneft chairman Igor Sechin and Transneft chairman Nikolay Tokarev reached agreement on financing the further expansion to China of the Eastern Siberia-Pacific Ocean (ESPO) oil pipeline.

The spat began in anticipation of the June 2013 signing of a contract between Rosneft and the China National Petroleum Corporation (CNPC).  That contract obliges Rosneft to deliver an additional 365 million tons of oil over the next 25 years.  This is an increase over the previous contract Rosneft signed to supply 15 million tons annually for the next 20 years.

With negotiations underway for this landmark agreement, Rosneft's Sechin began lobbying for the expansion of the ESPO pipeline spur to China.  Transneft's Tokarev would have none of it.  In a rare public display of disagreement within Putin's siloviki, the Transneft chair identified the source of the conflict:  money.  "Who will pay to expand the pipeline spur to China?" he asked in May 2013.  "Transneft isn't just a service company for Rosneft."

Despite Tokarev's objections, the contract was signed at the International Economic Forum in Saint Petersburg.  With the question of pipeline financing unresolved, Transneft upped the ante by announcing they would stop pumping Rosneft oil on July 28 because at that point Transneft would have fulfilled its previous contract with the state-owned oil company.  Sechin was unperturbed.  "We are in contact and interact with Transneft's CEO Nikolai Tokarev.  There was no conflict.  Obviously, during commercial work the companies may have different positions.  But this is not a conflict but a regular negotiations process."

Sechin's position was that Rosneft would pay an "economically justified tariff", but he did not believe he should finance the expansion of Transneft's network.  Igor Demin, spokesman for Transneft, disagreed.  He said that the pipeline project would be solely for the benefit of one oil company, Rosneft.  If Transneft had to find financing for the project, the entire Russian oil industry would have to pay for it.

The Russian government remained neutral.  Deputy Energy Minister Kirill Molodtsov basically said he didn't care who paid for the pipeline, as long as it remained profitable.  "Profitability is the top priority.  That applies both to Rosneft and Transneft.  This is what we are looking at when we consider the investment projects proposed by Transneft and Rosneft."

In August, the two oligarchs tried to use their ultimate trump card, their connections with President Putin.  Sechin began by writing an eight page letter accusing Transneft of charging too much to transport oil.  "The current system of Transneft's transport tariff system is not transparent and does not suggest reduced tariffs for oil companies, which invest in this region and supply the Far East region with oil products."  Tokarev responded with an analysis that Transneft tariff's had not contributed to a rise in gasoline prices.

Transneft then accused Rosneft of signing delivery contracts it could not fulfill.  Speaking to a ministerial meeting in September 2013, Transneft vice president Alexei Sapsai warned that Rosneft was in danger of being short at least 3.9 tons for its eastern routes.  If a planned Rosneft petrochemical complex (VNHK) comes on line, the shortage would stand at 15.9 million tons.  Transneft even decided to withdraw their role in the refinery because of the disagreement on tariffs.

Despite the fireworks, the two sides reached an agreement on October 11, 2013.  According to a statement on Rosneft's website, "Rosneft President and Chairman of the Management Board Igor Sechin and Transneft President Nikolai Tokarev have signed a number of agreements in fulfillment of the strategic plans on mutually beneficial terms and based on principles of co-financing to increase oil supplies volumes to China and to the Rosneft's Tuapse refinery in the Krasnodar region.  The package of agreements on oil supplies increase to China envisages commitments by the Parties to finance and implement the activities aimed at the capacity expansion of the Skovorodino-Mohe oil pipeline, as well as to increase respectively the volumes of crude shipment in this direction.  The pipeline capacity is expected to reach 20 million tons of crude per year beginning on 1 January 2015 and 30 million tons per year beginning 1 January 2018.  It means that 15 million tons per year will be supplied to China from 2018 to 2037 in addition to existing volumes."

According to Vedomosti, Transneft will finance the expansion of the pipeline, while Rosneft will pay back the investment through a special long-term tariff to be determined by the Federal Tariff Service.  This is a clear victory for Igor Sechin, who had made the same proposal in July.  In addition, it appears that Rosneft will only have to pay for a small portion of the ESPO expansion.  The Russian Ministry of Energy estimates that the total cost for the development of ESPO will be $1.46 billion (Transneft puts the figure around $2.29 billion), but Rosneft is only financing the Skovorodino-Mohe section, whose cost is an estimated $300 million.

The world's largest oil company has trumped Transneft, a company that is led by Putin's former KGB boss.

Putin leaves Azerbaijan With Limited Improvements

Russian President Vladimir Putin traveled to Azerbaijan in August 2013 to enhance Russian interests in the near abroad.  He was accompanied by six key ministers, including the Russian Minister of Defense, Sergei Shoigu and Minister of Foreign Affairs Sergey Lavrov.

The visit was surrounded by rumors.  Leonid Gusev, senior research fellow of the Institute of International Studies, Moscow State Institute of International Relations, focused on the inclusion of the defense minister.  "Why take Shoigu with you?  Because recently there was information that Azerbaijan and Turkey will create a unified army, and Georgia may join as well.  I think that the leadership of Russia wants to find out what it is, because you understand that Turkey is a NATO country."  Gusev's sources were remarks from Azerbaijani parliamentarian Zakhid Orudzh and Georgian Defense Minister Irakli Alasania.

Gusev's imaginings were quickly dismissed by Azerbaijani parliamentarian and political scientist Rasim Musabekov.  "There are issues in the military area that should be discussed," he said.  "It is not just military cooperation.  It is very important to consider issues that may affect Azerbaijan, such as the situation on the Caspian Sea where military activity has been gaining momentum; there is also the Iranian context, Middle East events and, most importantly, the settlement of the Nagorno-Karabakh conflict.  It is difficult to imagine the settlement of this conflict without Russia."

The Armenians also reacted negatively, convinced that the meeting would result in closer ties between Russia and Azerbaijan.  "Naturally, any bilateral relationship between our enemy and partner states cannot fail to worry us," said the chairman of the Armenian parliamentary committee on foreign relations.  "Azerbaijan is ready to exploit its relationship with any state for painting a distorted picture of its actions in the region."  Similarly, Armenian opposition leaders sounded the alarm.  Armenian National Congress spokesman Vladimir Karapetian said, "These are very worrisome developments for Armenia.  We must be prepared for further developments, especially in the Nagorno-Karabakh peace process."  Gior Manoyan of the Dashnaks criticized the Russian president, stating the visit was "not an ally's behavior."

The Armenians need not have worried.  Azerbaijani president Ilham Aliyev tried to enlist Putin's cooperation on the issue.  "Azerbaijan would like to see Russia as a referee," he said.  "The occupation of Azerbaijani land has continued for more than two decades.  What could be demolished has been demolished.  Twenty percent of our territory is occupied; the U.N. resolutions remain on paper."  In reply, Putin responded with a bland statement that any solution would have to be political.  "I want to stress that Russia is actively facilitating the search for the fastest conflict resolution, which is only attainable by peaceful means," he said.

Relations between the two countries have been strained over the past year.  Against Russia's wishes, Baku cancelled its use of the Baku-Novorossysk pipeline because it was uneconomical, and Russia cancelled its lease of the Gabala radar station rather than pay the rent Azerbaijan was demanding.  Despite these setbacks, Russian Foreign Minister Lavrov insisted the relationship had been neither affected nor deteriorated. 

Emphasizing the good relations between the two countries, President Aliyev highlighted the growing defense cooperation between them.  He said that Azerbaijan was among the top buyers of Russian arms and other military equipment, and the defense relationship was already worth $4 billion dollars.  This defense cooperation was highlighted by a visit of the Russian warship the Dagestan.

Missing from the summit’s summary were any agreements for Azerbaijan to join in Russian initiatives such as the Commonwealth of Independent States Free Trade Area (CISFTA), Eurasian Economic community (EurAsEC), or the Collective Security Treaty Organization (CSTAO-Azerbaijan allowed its membership to lapse in 1999)

The two presidents discussed the legal status of the Caspian Sea, a long-running dispute with ramifications for the underwater deposits of oil and gas there.    Putin described the discussion to reporters:  “During the talks we paid a lot of attention to the issues of the Caspian region,” reported Radio Liberty.  “There really are a very great number of unresolved problems, including security, border delimitation, preservation of biological diversity of the Caspian Sea, etc.  We have a vested interest in seeing all of these issues solved.”  In the past, Russia has used these issues to demand a veto over Azerbaijani proposals to build a Trans Caspian Pipeline.  No progress appears to have been made on these issues.

There were some positive results from the meeting.  The Russkiy Mir Foundation reported that a document on cooperation between emergency ministries was signed, as well as intergovernmental agreements on cooperation in air search and rescue, on the construction of a road bridge over the river that marks the border between the two countries, and a humanitarian cooperation program.

More importantly, Rosneft chief Igor Sechin signed an agreement with State Oil Company of the Azerbaijan Republic (SOCAR) cheif Rovnag Abdullaev.  The two CEOs pledged to cooperate on unspecified joint projects.  Sechin told reporters these would include "reciprocal deliveries, swap operations and opportunities for the use of joint infrastructure."  Rosneft subsequently released a statement that, "The companies agreed to cooperate in marketing and trading operations for hydrocarbons and petroleum products as well as jointly operate certain infrastructure facilities, such as pipelines and terminals."

In the end, both Azerbaijan and Russia emphasized the agreements that were signed, and labeled the visit a success.  On balance, however, when one balances what was achieved with the issues that were left unresolved, one can only conclude that Putin left empty-handed.  The summit meeting, Putin's first visit to Baku in seven years, was a lost opportunity.

Possible New Plans for Baku Novorossiysk Pipeline

Following Azerbaijan's cancellation of the northern flow of Azeri light because of decreasing profits, the Russian firm Rosneft is considering sending Urals crude south through the Baku-Novorossiysk pipeline.  The oil would then either be processed in Azerbaijan or be added to the Baku-Tblisi-Ceyhan (BTC) flow for onward shipment to the world market.  The BTC pipeline currently has spare capacity, as flows from Azerbaijan's offshore flows gradually decline.

Urals crude is a mix of various grades of Russian oil that trades at  approximately $4 per barrel less than Azeri light.  It was the mixing of Urals crude with Azeri light in Novorossiysk that reduced the value of the northern flow of oil, causing the cancellation of the use of the pipeline.  After Azerbaijan announced its suspension of the northern deliveries, Russian Prime Minister Dmitry Medvedev revoked the intergovernmental agreement that had authorized the northern use of Baku-Novorossiysk.

 The discussions on the possible reversal of flow in the pipeline was originally announced by the head of the State Oil Company of the Azerbaijan Republic (SOCAR) Rovnag Abdullayev.  The talks should be completed by the end of the year.  The announcement may have been premature, however:  the pipeline is controlled by the Russian pipeline company, Transneft, who had not been advised of the developments.  According to Mikhail Barkov, Vice President of Transneft, no one had coordinated anything with the company.  Barkov expressed concern that the plans might adversely affect Lukoil, which uses a portion of the pipeline to pump crude from Makhachkala to Novorossiysk.

Rosneft President Igor Sechin, possibly the most powerful oligarch in Russia today, hinted that the Abdullayev report might be correct.  Speaking to reporters, Sechin noted the pipeline was originally constructed with a southern flow in mind.  "Use of all possibilities is simply the effective work in the market," he said.

Transneft President Nilolay Tokarev noted that Rosneft has a refinery on the island of Sardinia, which would probably be the destination of the oil to be shipped from Ceyhan.  Speaking on the Russian television channel Russia 24, he pointed out that the Transneft system through Russia would cost Rosneft $45 less than use of the BTC.  (He possibly was referring to a metric ton, but it is unclear from the text).

The future of Baku-Novorossiysk thus requires two sets of negotiations:  SOCAR/Rosneft, and Rosneft/Transneft.  The latter may be adversely affected by difficulties between the two Russian companies arising from investment requirements for the expansion of the Eastern Siberia/Pacific Ocean pipeline.  Flows to the Mediterranean and flows to the Pacific have become interrelated.