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.

Possible Reopening of the Baku-Novorosiysk Pipeline

Following a visit by Vladimir Putin to Baku and the signing of an energy cooperation agreement between Rosneft and SOCAR (State Oil Company of the Azerbaijan Republic),  the two oil companies have begun discussions on possible joint projects.

Rovnag Abdullayev, head of SOCAR, told reporters that he is in discussion with Rosneft to reverse the flow of the Baku-Novorossiysk pipeline.  This pipeline was recently closed when Russia refused to keep it running below capacity, and Azerbaijan refused to increase the flow because SOCAR lost money on the product.  (Russia mixed Azeri light with Urals crude, decreasing the value of the Azeri light).

Abdullayev said the two sides would hold talks through the remainder of 2013, and it was possible that Urals crude could begin traveling south in 2014.  Once the oil reaches Baku, it could either be put into the underutilized Baku-Tiblisi-Ceyhan pipeline for onward shipment to Europe; or, it could be used as feedstock for new Azerbaijani refineries scheduled to be completed by 2018.  Abdullayev said that the use of the pipeline would be negotiated directly by Rosneft with the Russian pipeline company, Transneft.

The two sides are discussing shipping 5 million tons annually (100,000 barrels per day) through the pipeline.  If the entire amount were shipped onward to Europe, the BTC would still have capacity.  Originally built to carry 1.2 million barrels per day, it is currently shipping approximately 750,000 barrels per day as Azerbaijani oil production begins to dwindle.

Baku-Moscow Growing Closer on Energy

While the Baku-Novorossiysk pipeline remains out of commission, talks have resumed between Baku and Moscow on the future of the pipeline.  Russia claims the line is underutilized and therefore unprofitable; Azerbaijan claims they lose money when Russia mixes Azeri crude with the heavier, Ural blend.

On 8 July 2013, however, Transneft spokesman Igor Demin said commercial negotiations with the State Oil Company of Azerbaijan (SOCAR) had resumed.  In making the announcement, he underscored the issues dividing the two sides: "The issue of the quality of transit oil has not been rasied in negotiations yet, but discussion of the matter of Azeri light oil quality is hardly possible because of the small volume of transportation.  At that, oil can be carried by shipments to maintain the quality, but it will greatly increase the cost of its transportation."

Despite the controversy, talks on other forms of energy cooperation are progressing.  SOCAR President Rovnag Abdullayev and Rosneft President Igor Sechin met in June 2013 in Moscow and July in Baku to discuss long-term projects.  SOCAR issued a press release stating, "The presentation opened the possibility of expanding cooperation between the two companies in Azerbaijan and Russia and in third countries.  In particular, possibilities exist on ongoing and pending projects by the two companies."

One area of cooperation is the Absheron off-shore gas field, jointly owned (40% each) by SOCAR and the French company TOTAL.  Sechin has held recent talks with both parties about obtaining a stake in the project.

The new-found cooperation in energy reflects improving ties in other fields, as well.  In 2012, Azerbaijan ordered a billion dollars worth of weaponry from Russia, including 100 T-90C tanks, and truck-mounted multiple rocket launchers.  Previously, Azerbaijan purchased a $2 billion air defense system from Russia.

South Stream Moving Toward 2015 Completion

While the Western news outlets have been full of information on the Shah Deniz 2 consortium choosing the Trans Anatolian Pipeline (TAP) to deliver Caspian gas to southern Europe, Russia has quietly continued work on the rival South Stream pipeline.  The pipeline, which will cross the Turkish economic zone in the Black Sea, is scheduled to make landfall in Varna, Bulgaria.  After that, plans call for the line to split.  One spur will provide product to Russia's traditional client states in Central Europe; the other will challenge TAP by transiting Greece and ending in Italy.  Italy's biggest energy company, Eni SpA stated it expects to receive the first gas from South Stream by the end of 2015.

The key to the project is Bulgaria:  both the pipeline's landfall and the location of the split.  Bulgaria's Minister of Transport, Daniel Papazov, confirmed the project was a top priority of the government, and that everything was ready to begin construction.  "This project will be implemented very soon," he said.  According to a Gazprom spokesman, the company is ready to begin construction in Bulgaria by the end of 2013, with the first phase completed by 2015. Such planning is ambitious, as the project is already behind schedule.  Gazprom CEO Miller said, "The project has been implemented with certain delays from schedule...We are however certain that the deadlines for the start of construction will be met."  Bulgarian Minister of Economy and Energy confirmed Miller's statement:  "We will speed up work on South Stream as it is important to diversity our natural gas delivery routes and have direct deliveries from Russia without passing via third countries.  We need to have final detailed site development plan, environmental impact assessment and front end engineering design by the end of this year and apply for construction permit."

According to  Deputy Head of Project Management Alexander Syromyatin, the need for South Stream continues.  "South Stream is an answer to the increased demand in natural gas and will enable diversification of the Russian gas supply routes to the EU, decrease transit risks, guarantee stable gas supplies to Central and southern Europe and help improve the environment," he said.

The project has the support of the overwhelming majority of Bulgarians.  According to a survey conducted by World Thinks, 68% of Bulgarians support the project.  "Very few feel opposed or strongly opposed," said company director Ben Shimshon.  "Only 5% felt negative about it and the remainder were either unsure or undecided on how they feel."  Shimshon said the public supported the project primarily for the jobs it would create, with good gas prices in second place.  "The public are much more clear," he said, "that there will be economic benefits:  61%  of people agree that Bulgaria will benefit economically from the pipeline."

One reason support may be so high is that the project will not cost the Bulgarian taxpayer any money.  Gazprom CEO Miller confirmed that Russia was prepared to fully finance the construction of the Bulgarian section.  Russia would lend Bulgaria 3.1 billion euros (approximately 5 billion dollars) to be repaid with transit and gas transportation fees.  Bulgarian Economics Minister Dragomir Stoynev confirmed "The South Stream will be financed on a project principle--there will be no money of the Bulgarian taxpayers to be spent."

Not everyone agrees that the pipeline should go through Bulgaria, however.  Julian Lee, a senior energy analyst at the Center for Global Energy Studies in London, claims that Bulgaria does not need South Stream.  "Bulgaria will still have access to gas from Azerbaijan via TAP and the Interconnector Greece-Bulgaria," he said.  Lee is joined by the citizens of Varna, the city where the pipeline will land.  The townspeople are concerned about noise and air pollution from both the construction and the operation of the pipeline and compressor station, to be built less than one mile from the city's southern suburbs.  The entry point is supposed to be the Pasha Dere Beach, which is a protected area under the EU's Natura 2000 program.  However, the project's environmental impact statement lists a number of advantages for Varna, including 2500 new jobs, profits of 30 million euros for the port, and a local business boom with profits for all.(The job creation figure is suspect, since South Stream Bulgaria's CEO Georgi Gegov claims the construction phase will create 2500 jobs in the entire country, not just in Varna.  Once it is built, South Stream Bulgaria will need an addition 3500 jobs to service and supply the pipeline.

Russia also plans a branch of the pipeline to go to Macedonia.  Russian Prime Minister Dmitry Medvedev ordered the Russian energy and foreign affairs ministries to begin discussions with Macedonia for a feasibility study.  Assuming this study shows the viability of the spur, the two countries would establish a 50/50 joint venture to complete the project, although Russia would retain the right to use the pipeline's full capacity, according to a Russian draft agreement that was signed by both countries on July 23.

Serbia is also excited (73% public approval rating) about the pipeline.  Serbian Prime Minister Ivica Dacic said, "South Stream is the most important international project that Serbia is currently involved in and will be key to the country's economic development, ensuring job creation, and energy security for the region...Our objective is to ensure energy sector supply and develop our partnership with Russia."  The Serbian Minister of Energy predicted the pipeline would create at least 1,000 new jobs.

What is clear is that, with Central Europe mired in a recession, the lure of jobs is stronger than the fear of dependence on a Russian monopoly for energy supplies.

No Russian Gas for China Yet

In March 2013, Gazprom CEOAlexei Miller stated that an agreement with China on the pipeline gas deal that they have been negotiating since 2004 would be signed by June 2013.  "The parties plan to sign legally binding principal terms and conditions of the contract in June this year and sign the long-term contract by the end of the year," he said.  With that deadline now on the ash heap of history, Miller is now hopeful for a September contract.  "I think it can be said in September we could achieve the signing of the basic terms of the contract."

Gazprom's Export CEO Alexander Medvedev was not as optimistic.  He said Miller's statement was a hope, not a reality.  He said that Miller was engaged in wishful thinking, and that thinking made it so.  The issue has not changed over the decade:  Gazprom wants to charge China using a price linked to the European market; China has never accepted this, arguing they are a developing country that cannot afford such prices. China has also claimed that the transit distance between Russian fields and China is less than between the wells and Europe; accordingly, prices should be less.

Despite these issues, Russian President Vladimir Putin remains optimistic about the Asian market.  "We  are thinking about entering the promising market in the Asia-Pacific region.  We should find our niche here; we have every chance of doing that," he said.  "The Asia-Pacific region is developing rapidly.  Its consumption is growing rapidly, and Russia can play a prominent role."  Putin's remarks may be fulfilled with the newly signed Rosneft contract to deliver petroleum to China, but Gazprom's $68 billion pipeline project remains mired in the inability of the negotiators to move toward an accommodation.