Russia’s oil and gas export stategies

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Russia has begun to diversify its oil transport routes to avoid dependence on certain transit countries, writes Stratfor. 

Stratfor is a global intelligence company providing geopolitical analysis based in Austin, Texas. 

"In the mid-2000s, Russia was entangled in disputes with many European states over energy, which led to oil and natural gas cutoffs on several occasions. One notable instance was the natural gas cutoff to Ukraine, which led in turn to a cutoff of most of Central Europe's supplies from Russia. In 2006, a break in the Druzhba pipeline to Lithuania occurred after a refinery dispute, and Russia has refused to repair the damaged pipeline. In 2010, Russia also cut oil supplies to Belarus over a pricing dispute, and Moscow had to make up supplies to Europe via shipments by sea.

Russia then created a strategy to begin diversifying its oil transit routes to its biggest customers in Europe without relying so much on the transit states. First, Russia increased oil transit to the port of Primorsk via the Baltic Pipeline System. Then Russia began building a large second line of the Baltic Pipeline System to the Baltic port of Ust-Luga. Baltic Pipeline System-2 was completed in November 2011 and is expected to become operational in late March. Its capacity will be 1.1 million barrels per day (bpd), though only 850,000 bpd are planned for export via the newly expanded port at Ust-Luga. The rest of the oil will go to the Kirishi refinery and will be exported via tanker.

This export expansion will enable Moscow to strike direct deals with customers such as Poland and Germany and ship oil directly to them without having to rely on troublesome transit states. Russia is currently in a protracted dispute with Ukraine over natural gas prices and energy infrastructure ownership. Moscow can increase its leverage over Kiev now by diverting oil that would be transited by Ukraine to the new oil pipeline, depriving Ukraine of oil transit revenue and some of its importance as a transit state.

There are two problems with the Baltic Pipeline System-2, however: the aforementioned freezing of the Baltic ports for two months a year and the price difference of shipping compared to piping the oil. It costs approximately $3 per barrel to ship the oil out of the Baltic compared to piping it overland via Druzhba, meaning the 850,000 bpd to be exported via the Baltic line and then shipped in tankers from Ust-Luga port will add millions to the cost of export. Overall, though, Russia sees these as minor problems compared to what they gain by using the expanded Baltic Pipeline System.

Russia's second diversification strategy is to expand its customer base so as not to rely so much on Europe. In 2009, Moscow and Beijing commissioned the Eastern Siberia-Pacific Ocean oil pipeline (ESPO), which runs more than 4,800 kilometers from Russia's central Siberian oil fields to China and the Pacific coast. The first leg of the line has a capacity of 600,000 bpd, with 300,000 spurred off to China at Daqing and the other 300,000 sent to the Russian port of Kozmino, where it is bought on the open market. In 2011, customers who bought oil from Kozmino included the United States, China, Japan, South Korea and the Philippines.

The second stage of ESPO is due to be launched in December, two years ahead of schedule. The expansion will add another 400,000 bpd of capacity to the line. The oil ultimately will be sent to a massive new refinery at Nakhodka, near Kozmino, but a refinery that large will take years to build and ground was just broken on the project this month. Meanwhile, Russia will sell the oil from Kozmino.

In deals to construct the first and second parts of ESPO, China agreed to loan $25 billion to Russian oil companies Rosneft and Transneft on the condition that oil supplies are sent to China with a price break. Though the first line has been built and the second is under construction, the expansion of the line is being disputed as Russia and China disagree over pricing. China wanted to lock in its oil supplies from ESPO in a multi-decade contract with the price per barrel $3 to $13 less than prices at Kozmino. But Russia wanted to add an extra transit cost for the oil already being piped via the ESPO spur line to Daqing. On 28 February, the countries struck a deal under which China will receive a discount of $1.50 per barrel from the price at Kozmino for 20 years.

Russia is diversifying its customer base so that if demand in Europe declines – or if Russia and its European customers find themselves in a politically untenable situation – Russia will still have a large market to its east. In the past decade, Russia has increased its oil exports to Asia from 3% to 15% of total exports, with more increases expected. When ESPO is expanded, Russia theoretically could supply one-fifth of China's imports, or one-third of Japan's imports. However, Russia is not singling out one customer in East Asia yet; it is supplying many customers. Conversely, no East Asian country wants to become too reliant on Russia after seeing Moscow cut off supplies to its customers in the West.

Russia has a goal to double production in Central and Eastern Siberia to supply East Asia by 2015. However, the fields in Eastern Siberia reportedly are a year behind in development. The Kremlin is trying to spur the projects along by giving the projects and their developing companies tax breaks and cutting export duties.

Thus far, exporting oil to Asia has not led Russia to divert any oil supplies from Europe, since the infrastructure is separate. It does, however, give Russia the security of having multiple markets and more flexibility should problems arise in one area or the other. This gives Russia knowledge that its oil revenues are a little more secure in spite of the market's inherent instability."

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