by Nicholas Trickett
Russia and China have appeared to edge closer together of late, yet Kremlin-backed deals from Rosneft are countering China. This trend will accelerate as Trump comes into office and the OPEC deal takes effect.
A very busy year
The last year was kind to Rosneft. Even with continuous low oil prices and the Western sanctions, the Russian state-owned oil giant signed a landmark refinery and supply deal with Essar Oil in India. In addition, Rosneft began offshore operations in Vietnam, signed a refinery deal with Indonesia’s Pertamina, began offshore operations with Statoil in the Sea of Okhotsk, reportedly got Japanese firms to agree to joint exploration of the Sea of Japan, bought a 30% stake in an Egyptian gas field from Italian firm Eni, and closed a deal for the privatization for 19.5% of its state-owned shares with Glencore and the Qatar Investment Authority. Domestic developments have gone well with the acquisition of Bashneft and the arrest of Russian Economy Minister Aleksandr Ulyukaev who supported more aggressive privatization. Igor Sechin, Rosneft’s CEO, has been busy.
Most observers point to increased cooperation between Russian and Chinese leaders on the world stage, yet underplay the extent to which it was Rosneft that took the lead in Russia’s Pivot to Asia back in 2013 through a $270 billion mega-deal with China National Petroleum Company (CNPC). Despite broader and deeper engagement with CNPC, Sinopec, and Chinese banks, Rosneft has pointedly avoided selling shares of upstream assets to Chinese firms. Mistrust is mutual. Chinese firms don’t trust Rosneft because it took a $60 billion prepayment for the 2013 deal to pay off dOPECebts when it acquired TNK-BP for its oilfields in the Russian East without offering Chinese stakes in those fields.
China’s inability to buy into Russia’s upstream has been vexing, but China remains Russia’s principal partner for energy financing with the sanctions regime, keeping numerous projects, such as Yamal LNG, alive without fully committing the resources that Russian firms need in order to respect China’s largest trading partners: the European Union (EU) and United States (US). Rosneft’s moves underscore a coherent Russian strategy to undermine China’s leverage and go after Chinese interests abroad.
Drivers of expansion into 2017
The OPEC deal to cut production coincides with a planned 7.2% increase in Russia’s Federal Mineral Extraction Tax (MET) per barrel of oil from 857 rubles (RUB) to 919. Transportation costs inched up 2.9% this summer, production and operating costs increased 7.3%, and export customs duties increased 29.6% to prop up the Russian budget. In short, Rosneft is being pressed by taxation to cut production at its more expensive, remote fields to support the OPEC deal and help the Federal budget. The recent rally in oil prices will improve profitability—profits from sales of crude oil dropped 8.8% over the summer—but it remains to be seen if India and international demand growth will sustain higher prices. Transit tariffs for pipelines also declined by 22% in the third quarter this year, pushing Rosneft towards pipeline exports, which are less flexible and dependent on China for Rosneft’s Asia portfolio.
Cash is also tight. At the end of September, Rosneft had about $14 billion on hand at today’s exchange rate against around $21.5 billion in loans and accrued liabilities. After buying Bashneft for $5.3 billion in October and spending several billion on recent deals, privatization of shares brought in $11.1 billion. Rosneft’s liabilities still outstrip its cash reserves. State support has and will continue to fund most of these deals, particularly as increased taxation is a hindrance for Russian energy firms’ domestic production.
It remains to be seen if the strengthening dollar is sustainable, but it would impact both profitability for oil firms and the cost of imports. Though OPEC’s deal only lasts through May, it may be enough to speed up the rebalancing of supply and demand dynamics, at which point China’s advantage with the oil glut would be lost.
Rosneft’s deals and China’s interests
Rosneft has strategically targeted projects in the past that would compete with Chinese interests. Rosneft’s acquisition of TNK-BP also brought with it Venezuelan assets. Now deceased president Hugo Chavez’s goal of making China Venezuela’s key energy partner was frustrated by Rosneft’s tenacity despite other firms’ decision to leave, overtaking Chinese upstream production in Venezuela in 2015—an estimated 209,000 barrels per day (bpd) for Rosneft against Chinese firms’ 171,000 bpd.
Rosneft’s deal with Eni for a 30% stake in the Zohr natural gas field in Egypt granted Rosneft access to natural gas reserves in the Mediterranean. Less obvious, it’s a means of influencing a politically volatile regime pivotal to China’s OBOR initiative. Given Russia’s expanding supporting of Libyan strongman Khalifa Haftar—happy news to Egyptian president Al-Sissi—and attempts to use Al-Sissi as a go-between for a role in discussing Israeli-Palestinian peace, the deal finally secures Rosneft an integral point of contact for the Egyptian regime’s rent collection while advancing its aims to be a significant player in the international natural gas trade.
The Essar refinery deal is a means of cementing a Russian-Indian relationship strained by Russia’s recent overtures towards Pakistan, driven in part by the developing China-Pakistan Economic Corridor (CPEC) that includes a future energy hub in Gwadar and oil pipeline to Xinjiang. Rosneft announced it would use Venezuelan oil from its TNK-BP acquisitions there to supply the refinery. Rosneft also sold off stakes of strategically significant fields to Indian firms in a snub to CNPC and signal that India’s oil market—a move against China-dependent National Iranian Oil Company—is of greater value.
Receiving less scrutiny, Rosneft began drilling for oil, natural gas, and gas condensate off of Vietnam’s coast in March. Using the offshore project to develop corporate expertise with equipment that is only sanctioned for domestic use in Russia, Rosneft could also give life to Vietnam’s maritime claims over time if its projects successfully expand. Though it’s only preliminary, Rosneft reached an agreement at the Abe-Putin summit to jointly explore the Sea of Japan with a Japanese consortium, including the state-owned Japan Oil, Gas, and Metals National Corporation (JOGMEC). The findings will not touch on Sino-Japanese competition over potential resources in the East China Sea but would mark a significant cooperative project if the reserves end up being exploited as tensions rise between China and Japan.
What’s in store for 2017?
For next year, the biggest new developments have been Donald Trump’s electoral victory and his choice of former ExxonMobil CEO Rex Tillerson for Secretary of State. Igor Sechin has a relationship with Tillerson and the Trump transition team has signaled willingness to reach a détente of sorts with Russia while aggressively countering China. Whereas the Obama administration attempted to use the Treasury Department to freeze Rosneft’s Essar deal, Trump would more likely not intervene. Tillerson may even tacitly encourage such deals if they fit within an emerging anti-China strategy under Trump.
Brazil will be a hotspot for further projects in the near-term. Rosneft has a subsidiary—Rosneft Brasil E&P Ltda—exploring the Solimoes basin. At the same time, Chinese firms have been working with Petrobras for several years and have covered most of the Brazilian firm’s debt this year. The Kremlin may seek to deepen ties as best it can with its relatively meager financial resources.
Statoil has recently made new finds in Norway, encouraging for Rosneft as Norway is seeking to normalize economic ties with Russia again at the same time talks with China over a free trade agreement are back in motion. Rosneft needs Statoil to improve its offshore capabilities.
Unlike China, Russia has considerable untapped reserves that interest international oil majors. Financing will likely become more available after the successful conclusion of the privatization deal with Glencore and Qatar. Rising oil prices will help. No matter if the OPEC deal holds steady, the Kremlin has aggressively used Rosneft this year to alleviate Russia’s dependence on China and weaken the sanctions regime. Both trends are only set to accelerate as the structure of Chinese trade limits the value of Sino-Russian cooperation.
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