October 01, 2011

Asia: in the pipeline



Russia has huge oil and gas reserves, from the Urals to Siberia. The dynamic economies of Asia want those energy supplies, preferably delivered as directly as possible by pipeline. The scramble to invest and construct new pipelines and rehabilitate old transit routes is now intense.

by Rafael Kandiyoti

RUSSIA’S economy relies on crude oil and natural gas exports. The formidable dynamism of the east Asian industrial giants promises an excellent market for Russia’s oil and gas export potential. But the contrast of this dynamism with the vast untouched emptiness of east-central Siberia makes the region seem vulnerable. Adjacent China has the men and now it has the means. The Russians are in a position of both strength and weakness. How will they move in north-east Asia?

During the past decade China has joined Japan and South Korea as a major importer of crude oil. Almost 50% of China’s oil comes from the Middle East; for Japan and South Korea, it is 80%-85%. Much of the oil is shipped through the straits of Hormuz and Malacca, widely considered as potential choke points for oil transit. The vital importance of these oil supplies sits awkwardly with the increasing geopolitical difficulties of the Middle East and the potential vulnerability of shipping near the strait of Malacca. China, already the world’s second largest oil consumer, Japan and South Korea are all in need of alternative crude oil sources and supply routes.

The natural gas situation is more complex. Asia’s great cities need to reduce air pollution by switching to natural gas. Already the liquefied natural gas (LNG) imports of Japan, South Korea and China (Taiwan) account for nearly 80% of all traded LNG; much of it comes from south Asia and Australia. For mainland China, the cost of LNG has been a constraint, and it has been looking for more cost-effective ways of increasing its access to natural gas. Nearby east-central Siberia and Sakhalin Island have large hydrocarbon reserves.

The Irkutsk basin in the east-central Siberian plateau has large oil and gas reserves, but they have not been fully explored. Future exploration is expected to greatly increase proven reserves, but at present even the refinery near the regional capital, Angarsk, imports its crude oil from western Siberia.

Hopes are high for the hydrocarbon reserves of the Yakutsk basin in the north-east, where exploration is far from complete. Extraction and transmission of oil and gas would mean crossing permafrost, which is technically feasible, but expensive. The 1,300km trans-Alaskan oil pipeline crossing similar terrain cost $8bn in 1975. Together with the estimated reserves of the Krasnoyarsk basin, the resources of east-central Siberia are potentially enormous. But the time and investment needed to explore and develop reserves is as yet unknown.

Progress on Sakhalin Island (1) is far more advanced. Most onshore hydrocarbon reserves have already been depleted; several oil and gas projects are in progress offshore, primarily on the north-eastern shelf of the island. Of these, the Sakhalin-I project developers intend to construct pipelines across the island to the De Kastri export terminal on the Siberian mainland (2). The oil can be sold anywhere. Some of the gas utilisation options discussed for Sakhalin-I have involved pipeline transmission to both North and South Korea, as well as to Japan, the last probably as LNG. But with North Korea’s political isolation, pipeline options involving both parts of the Korean peninsula must be well in the future.

The Sakhalin-II project is run by a multinational consortium led by Shell (55%) and Japanese companies. The first oil was produced in 1999; current production averages more than 70,000 bbl/day, raising more than $1bn in annual revenue. The next phase is under way, involving an investment of some $10bn, the largest foreign direct investment project in progress in the Russian Federation. The gas will be piped to the southern tip of Sakhalin Island, where oil and LNG terminals are being built at Prigorodnoye.

When a pipeline alternative is available, truck and rail transport are rarely used: over a 4,000 km journey, rail transport can add $1.50-$2 (1993 dollars) to the price of a barrel of crude (3). In the absence of pipelines Russia has recently confirmed its commitment to increasing western Siberian oil exports to China by rail, the volume rising to 15m tonnes in 2006. This seems an expensive way to buy oil. In 2003 energy-hungry China also imported about 1m tonnes of crude from Kazakhstan, again by rail. Besides capacity limitations, rail transport incurs a cost penalty, inevitably reflected in energy and chemicals production. Western analysts could be forgiven for thinking that Russia is unwilling to sell cheap energy to China. The two giants may have recently resolved their border disputes, but China is fast emerging as a rival on the world political stage, as well as an industrial and economic competitor.

The Chinese, sensitive to the cost of oil, signed an agreement with Yukos to construct a 2,400km oil pipeline from Angarsk to Daqing; the oil was to be pumped from western Siberian fields. But in 2004, before the project began, the Russian government moved on Yukos, to eliminate a centre of alternative political power and reclaim control of a former state asset “privatised” during the colossal plunder of the Yeltsin years. The move was in line with President Vladimir Putin’s aim to realign the objectives of Russia’s large private corporations more closely with those of the state.

Another major factor has upstaged the Angarsk-Daqing project: the Japanese have pressed for a larger, more expensive line, pumping 1.6m barrels a day through a longer (3,800km) line, circumventing Chinese territory and ending at Nakhodka, near Vladivostok. They have also offered untied loans more than $5bn (the line was estimated to cost $8-$10bn). The Nakhodka outlet would allow tankers from any nation to bid for Siberian oil. In the past oil auctions have proved lucrative in times of tight supplies.

Originally, Lukoil had proposed to construct and operate the Nakhodka line. But the Russian government reaffirmed its determination to maintain its pipeline monopoly through the state-owned pipeline giant Transneft, and nearly doubled its estimate for the line to Nakhodka, from about $8-$10bn to $16bn.

Russia depends on the European market to buy 80% of its oil exports. The limitations of the western energy export corridor through Belarus and Ukraine, and the expansion of Nato eastward have been major concerns for Russian planners. They would like to diversify, and have had their eyes on plans linking western Siberian fields with ports on the Barents Sea, first mooted in 2000-01 by a private consortium led by the now jailed Mikhail Khodorkovsky of Yukos. This northern route is shorter than either vast Siberian pipeline alternative. Also, the distance from Murmansk to oil terminals near Houston is nearly half the equivalent distance from the Persian Gulf. The project would fit in with the Russia-US energy dialogue and perhaps help mitigate tensions over the tugs of war in Georgia and Ukraine.

In December 2004, reticent to tie the line to a single customer, Russia announced its long-delayed decision in principle in favour of constructing a line along the Taishet-Skovorodino-Perevoznaya axis to the Pacific. The choice of this virgin bay over the deep-water port of Nakhodka-Vostochny has attracted opposition from environmentalists. But the Japanese have not yet congratulated themselves on a diplomatic victory over China: Russo-Japanese negotiations have progressed slowly over the capacity of the line, the amounts to be borrowed and conditions tied to these loans. In the face of Chinese disappointment Moscow has been leaking news about the possibility of constructing a spur from the main line to supply Daqing. Skovorodino is only 50km from the Chinese border, a usefully short distance for keeping Japanese negotiators on their toes.

Where will the crude oil come from? While the potential productive capacity of east-central Siberia may be huge, the supplies to fill the Nakhodka line as well as the Daqing spur do not seem to be immediately available. To fill the Taishet-Nakhodka line would mean pumping 30m tonnes of western Siberian oil annually, presumably diverted eastwards from European markets. But the Russians admit that to fill the line to the Pacific at 80m tonnes, they would need to develop reserves in east-central Siberia. Still more oil is needed to fill the spur to Daqing (4). Until new production comes on stream, that would mean an annual gap of about 20m-50m tonnes in Russian crude oil production, promised to Japan and China. Much would depend on the sequencing of oilfield development and the (usually shorter) time required for pipeline construction.

Arguments in favour of the Perevoznaya (or Nakhodka) line are complicated by the absence of a peace treaty between Russia and Japan. The Russians have retained the four southernmost Kuril Islands, seized by the Soviets in the last days of the second world war. Japan continues to view the Soviet assault in the north as a violation of the Soviet-Japanese neutrality pact of 1941 and as a betrayal by the Soviets. The Japanese have since shown some flexibility in their negotiations, but always with an eye to the northern territories issue (5). The purchase of Sakhalin gas by the city of Tokyo may be seen within the framework of this flexibility.

The Russians may have different ideas. Planning permission has been issued to Transneft to start construction of a 50m-tonne oil pipeline between western Siberia and the Barents Sea coast. Two-thirds of this oil is to be provided by western Siberia (6), suggesting that the western Siberian network may have no more than 30m tonnes (a year) to spare for any route, unless production is expanded more rapidly than expected. Although reports since the new year suggest the Nakhodka outlet will be given priority, the news raises still another question for Japanese negotiators.

As a proportion of total energy requirements, north-east Asia consumes less natural gas than North America or Europe, mainly due to supply problems. Japan’s main island of Honshu does not have a systematic gas pipeline network due to stringent safety standards and high real estate prices: the cost of the right of way would have made a new line prohibitively expensive. Japan’s LNG import-based gas economy is primarily aimed at supplying power generators. In May 2003 the city of Tokyo signed an LNG purchasing agreement with Sakhalin-II for about 1.1m tonnes per year. Several other Japanese and US-based concerns have followed in signing contracts for the LNG output of Sakhalin-II (7).

South Korea has a well-developed gas pipeline grid aimed at domestic use, and less geopolitical reticence. It would be technically feasible to transmit Sakhalin-I gas landed at De Kastri down the coast and through North Korea to the South. In practice, the current difficulties with North Korea constrain South Korea to pipeline options involving underwater transmission from China. They still estimate that pipeline-supplied natural gas through China would cost about 25% less than their present LNG imports.

All major cities in China urgently require natural gas, to reduce air pollution. Like India, China would favour importing natural gas, provided it could be delivered at reasonable cost. Like India, China has so far not invested in expensive LNG reception facilities. However, several large multinational groups in India have now undertaken the construction of regasification plants near the existing Hazira-Bijapur-Jagadishpur pipeline, which eventually runs into Delhi. They aim to recoup their investment through the sale of gas.

Price permitting, both the Shanghai area and the Tianjin-Beijing complex would have been natural candidates for the reception of LNG. But the Chinese government has proved sensitive to the long-term consequences of purchasing expensive energy. One problem it has is that of weaning a customer base with low purchasing power away from cheap coal. China recently announced a relatively low natural gas purchasing price from the internal west-east line, for Shanghai. The move appears to have persuaded several multinational companies to withdraw from investment in regional pipelines, putting on hold LNG regasification projects in nearby Zhejiang province.

China is also actively considering a natural gas pipeline, to carry 30bn cubic meters annually from the Kovykta (Irkutskaya Oblast) gas fields into north-east China. An alternative route, 1500km shorter, would run through Mongolia. This line is technically feasible and significantly cheaper to construct. But negotiations in 1998 involving Russia, Mongolia, China, South Korea and Japan have failed: the Russians had proposed selling the capital, some of the gas to Mongolia, which is desperate to reduce air pollution in the capital, Ulan Bator. China expressed concerns over the political risks and possible transit fees.

Russian collaboration with Mongolia was always likely to attract Chinese suspicions: Ulan Bator (the Red Hero) was the messenger sent to ask help from the Bolsheviks against the depredations of the homicidal white general, Baron Ungern-Sternberg, who plundered the Mongolian capital and massacred much of its population. But, the Soviets also assisted “Outer” Mongolia in its bid for independence from China. Ultimately, the Chinese seem not to want to benefit a country that they still tend to view as their lost northernmost province.

Peace and trade have their own attractions. The potential economic benefits of an Iran-Pakistan-India gas pipeline have forced the old enemies on the subcontinent to think seriously about peace. The intricate network of pipelines and countless cross-border projects within the European Union could not have been imagined 60 years ago. There are new methods for ensuring the commercial success of cross-border infrastructure projects that carry some political risk, including participation by export credit agencies and the use of international bank guarantees.

Putin’s visit to China in October 2004 brought no agreement over pipeline issues. Subsequent negotiations between China and Kazakhstan have focused on Chinese crude oil and gas purchases. Although incomplete, the oil pipeline arrangements are at a more advanced stage, with the Atyrau-Kenkiyak stretch already functioning. The Kenkiyak-Atasu segment, in the centre, is at the planning stage while an agreement has been signed for constructing the 1240km segment from Atasu to Alashankou in Xinjiang, at a cost of $700m. From Alashankou, it is planned to carry the oil by rail to three nearby refineries. The line will carry 10m tonnes of crude oil annually and eventually double in capacity. These imports are viewed as politically sensitive for the development of China’s westernmost, potentially rebellious, Xinjiang province.

China and Kazakhstan are also reviewing the possibility of building a natural gas pipeline from western Kazakhstan into Xinjiang. The undertaking is expensive and the project is considered a strategic reserve for the longer-term.

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