China Gets Ready For More Russian Oil

An analysis by Michael Lelyveld
2017-07-10
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A workman hangs a traditional Chinese lantern from the entrance of the headquarters building of China National Petroleum Corp. in Beijing, Sept. 27, 2014.
A workman hangs a traditional Chinese lantern from the entrance of the headquarters building of China National Petroleum Corp. in Beijing, Sept. 27, 2014.
ImagineChina

Russia is planning to nearly double its oil exports to China through its only direct pipeline next year as it competes with Saudi Arabia to be the country's leading supplier.

On June 20, a spokesman for Russia's pipeline monopoly Transneft said China had given its "preliminary" agreement to receive expanded deliveries through the 924-kilometer (574-mile) line from Skovorodino to Mohe on the route to China's oil center at Daqing starting in 2018, Interfax reported.

The cross-border connection has been operating as a branch of Russia's 4,188-kilometer (2,602-mile) East Siberia-Pacific Ocean (ESPO) pipeline to Kozmino Bay port near Vladivostok since 2011 with a capacity of 15 million metric tons per year (300,000 barrels per day).

In 2013, the two countries reached an agreement allowing an increase to 30 million tons per year with a second branch line after state-owned Rosneft signed a contract to supply China National Petroleum Corp. (CNPC) with an additional 360 million tons of crude over 25 years.

In 2015, a vice president of CNPC PetroChina confirmed that the company would double its imports from Skovorodino as soon as October 2017 after a second branch was built, Platts energy news reported at the time.

The Transneft statement indicated that the increase is going ahead with some adjustment.

"From 2018, we were supposed to begin pumping 30 million tons of oil (per year) along that branch, said Transneft presidential adviser and press secretary Igor Demin, according to Russian news agency Interfax.

“According to preliminary agreements with the Chinese side, in 2018 there will be 28.5 million tons of oil pumped to China along that branch, and a further 1.5 million tons through the port of Kozmino," he said.

"The Chinese partners are saying that their infrastructure is ready to receive this amount of oil," Demin said, although there have been no additional confirming statements from the Chinese side.

Russia and China are said to be working separately on the pipeline project on their respective territories, but the implied uncertainty is notable for an increase that is projected to start in the next several months.

"I would say that 'readiness to receive' is not the same as 'readiness to buy,' and of course, Transneft can only speak to the first and not the second," said Edward Chow, senior fellow for energy and national security at the Center for Strategic and International Studies in Washington.

"I expect tough negotiations regarding crude pricing," Chow said.

Top agenda item

The prospect of closer energy links between the two countries was a top agenda item during state visit of President Xi Jinping to Moscow last week.

Despite a history of caution and mistrust, Xi said that bilateral relations are now at their "best time in history," the official Xinhua news agency reported.

But in a sign of uncertainty for the Russian plan, it was not included in the list of reported agreements reached during Xi's visit or in statements released by the Kremlin after meetings with President Vladimir Putin.

A Reuters report in May quoted a regional official of northeast Heilongjiang province as saying that pipelines for both expanded oil and the first natural gas imports from Russia would not be operational on the Chinese side until the end of 2018.

Russian oil reaches China by several routes, including by pipeline through Kazakhstan. Last year, China bought 70 percent of the ESPO oil shipped through Kozmino Bay, Platts reported.

The push to supply the world's biggest importer with more oil comes as prices continue to sag despite cutbacks by the Organization of Petroleum Exporting Countries (OPEC) and cooperating non-OPEC producers, including Russia, under an agreement known as OPEC-Plus.

While China's oil demand growth has been relatively weak, Russia has surged to the top of its list of suppliers.

May marked the third month in a row with Russia in the lead as its deliveries to China averaged 1.35 million barrels per day (bdp), rising 9.4 percent from a year earlier.

Russia is also the country's largest oil supplier so far this year, Reuters reported.

Saudi Arabia slipped to third place behind Angola in May with deliveries to China averaging 1.04 million bpd, according to customs data.

As a result of low prices and high production costs, China's oil output for the month dropped to the lowest level since National Bureau of Statistics (NBS) reporting began in2011 with an average of 3.83 million bpd.

China's imports rose 15.4 percent from a year earlier to a near-record 8.8 million bpd.

The figures suggest that the planned increase from the Skovorodino line may offset falling output at China's ageing Daqing oilfield rather than reduce imports from elsewhere.

china-oil-derrick-daqing-heilongjiang-may2-2016-400.jpg
Chinese locals walk beside oil pumps in Daqing, northeastern China's Heilongjiang province, May 2, 2016. Credit: AFP
Independent refiners

China's reliance on foreign oil has grown steadily since last year with import dependence now routinely nearing 70 percent.

While China's imports from Russia may rise further, its real need for more oil is hard to assess.

China's buying has increased in part because the government has allowed independent refiners, known as teapots, to bring crude into the country under a quota system since last year.

Last month, the Ministry of Commerce approved a second batch of quotas that will allow refiners to import an average of 1.83 million bpd this year, Reuters said. The increased refining activity may account for a portion of China's demand growth.

But how much is uncertain, since the increase has already pushed the domestic market for refined products into oversupply.

'In early June, China's state-owned oil giants were forced to lower their retail fuel prices in competition with the independents, "effectively launching a price war with teapots," International Oil Daily reported.

The unusual market reaction was remarkable, since the government still manages retail price changes with a formula that takes international crude costs into account.

The oversupply problem threatened to spill over into the international market in June.

"China will have to export product... onto Asian markets, which given demand conditions regionally does not appear particularly constructive," said Harry Tchilinguirian, head of commodity markets strategy at France's BNP Paribas, as quoted by Reuters.

The result is likely to be more downward pressure on prices and China's domestic production. Russia's planned increase in supplies may only add to the glut.

International oil markets are frequently swayed by relatively slight changes in U.S. production or inventory data, but less attention is paid to the larger uncertainties of China's demand.

Despite years of complaints about its lack of transparency, China does not provide regular reports on its inventories or other vital data, such as filling of its strategic petroleum reserve.

Analysts are left to estimate China's apparent or implied oil demand, leaving gaps of uncertainty that may dwarf other price factors, a problem that has only grown with its rise in imports.

Edward Chow said the uncertainties created by the lack of transparency have become a problem for China itself as it tries to assess the effects of major changes like the doubling of Russian imports on the Daqing route.

"In recent years, they have been surprised repeatedly by the volatility of oil markets, ignoring sometimes even market reactions to their own actions," said Chow.

"As soon as they think the price has stabilized, it heads up or down abruptly, as it is doing now," he said.

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