China taps into Russia’s ESPO oil pipeline

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ESPO pipeline

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An agreement has been reached this week between Russia and China regarding oil from the East Siberia-Pacific Ocean (ESPO) pipeline that Russia began building in the Spring of 2006.  “This is a unique agreement of a long-term nature, which is accompanied by financial agreement; and to implement it we have already begun building a branch from the main pipeline toward China,” Russian Deputy Prime Minister Igor Sechin said.  Vice Premier Wang Qishan said that the deal brings “a packet of agreements and contracts on building the pipeline, buying and selling crude, and a provision of credit between the companies of our two countries, which represents a significant breakthrough in bilateral energy relations,”.  In the deal, China agrees to loan Russia $25 billion in exchange for roughly 300,000 bbl of oil guaranteed for the next 20 years; the money will be used by Russia’s state controlled oil company Transneft to finish building the pipeline to the Pacific Ocean where the oil can be released onto the Asian markets more freely.

Russian Prime Minister Vladimir Putin is confident that the new arrangement with China will allow for the pipeline to be completed and ultimately open up new markets for Russian oil. “In a few weeks, the phase of the pipeline, which will reach the Chinese border will be completed and then we will advance to the Pacific Ocean,” he said.

Russia has 6-10% of the known oil reserves; it pumps about 9.4 million bbl per day and exports nearly 7 million of those.  Russia is second only to Saudi Arabia in total oil exports, but by less than only 400,000 bbl per day.  There is no doubt that the run-up on oil last year provided Russia with the opportunity to advance its agenda on the world stage, but the collapse of the energy markets has taken that away and instead given Russia an economic crisis that seemingly is worse than other regions of the world.  The ESPO pipeline seeks to raise Russia’s exports in the future in oil thirsty Asian markets.

The first stage of the pipeline (1700 miles) to the town of Skovorodino is scheduled to be completed in 3Q 2009; it is from an export terminal at this station that oil will cross over the border into China.  The remaining 1300 mile section from Skovorodino to the Pacific Ocean is not scheduled to be completed for several years. (see map)  It is Russia’s hope to be able to supply countries like China, Japan, S. Korea, even the U.S. from its eastern shores, but the reality on the ground in Russia may prevent the project from proving to be economically profitable when all is said and done.  “The venture today appears to be a giant boondoggle-in-the-making: built in the wrong place, carrying a huge price tag, plagued by slow construction as well as environmental and legal concerns, and in the end, likely to make the oil almost too expensive to be profitable,”  says the American Enterprise Institute.

The state-owned Transneft controls roughly 29,000 miles of pipelines in Russia.  About 4 million bbl of the 7 million that are exported from Russia travel through Transneft’s pipelines; the remaining 3 million bbl are shipped via rail.  If Russia hopes to increase its export capacity in the future, as well as bring down its overall costs, it will have to not only build new pipelines, but also modernize its aging pipeline infrastructure.

Yet, the ESPO pipeline is symptomatic of a larger pattern of development in Russia.  Earlier on, in 2002-03, a plan was devised to build a private pipeline to one of Russia’s northern ports, Murmansk.  In the end, although Transneft was offered the position of sole manager of the pipeline, the Russian government denied the private funding. “The decision, among the first signs of changing economic policy, amounted to an effective veto of private construction of pipelines in Russia and the affirmation of the Transneft monopoly”; but even with a monopoly, Transneft is having trouble paying for pipeline extensions and retrofits.

A branch in the pipeline to China was not originally planned in the ESPO design, but was implemented due to the need for funding and Russia’s use of the pipeline as a political bargaining tool.  China has been looking to diversify its geographical supply of oil, which is currently concentrated in the Middle East.  

The pipeline has already raised serious environmental concerns regarding the proposed route, particularly in the Lake Baikal (world’s largest freshwater lake) region.  

The pipeline is expected to pump 1.6 million bbl per day into the Asia-Pacific region when it is completed.

Is there enough oil in Siberia to justify building such a massive pipeline?  What happens to Russian oil exports if domestic petroleum use increases in the coming years?  Will the project be able to overcome the remaining environmental and legal challenges it faces on its march to the sea?  Russia is taking a gamble by investing so heavily in eastern Siberian oil; by the looks of it, China just doubled down on Russia's bet.

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