The energy relationship between China and Russia is increasingly becoming a “spectator sport” in the sense that spectators gain more interest from the relationship than the parties themselves. Despite more than ten years of rhetoric from both sides about the need and desirability for collaboration in the field of energy, the story of this relationship resembles trench warfare rather than concerted engagement – long periods of idleness are interrupted by short bursts of intense activity. The respective governments have just entered one of these periods of intense activity. Why?

The reason is clear. The Russian oil companies, Rosneft and Transneft, are short of cash and need to borrow a large amount of money, very soon, in order to sustain their investment programmes. The Chinese oil company, CNPC, and the Chinese government are keen to secure long-term imports of oil from Russia and are cash-rich. The urgency of the need for oil imports arises from the imminent expiry of an import deal signed between China and Russia in 2005, and this deal itself involved a multi-billion dollar loan from CNPC to Rosneft.

Russia provides about 8% of China’s annual imports of crude oil. Deliveries of oil from Russia to China rose dramatically from 3 million tonnes per year in 2002 to 16 million tonnes in 2006, and have stabilized at 13 million tonnes per year. These deliveries follow five different routes:

• On the East Siberian railway via the frontier post at Zabajkalsk;
• On the Far East railway via the frontier post at Gridekovo;
• Via the Atasu-Alashankou pipeline through Kazakhstan;
• By marine tanker from Sakhalin;
• By pipeline and then tanker from Iran.

The largest share of oil exports comes from Western Siberia via the East-Siberian railway. At 9 million tonnes per year, this comprises more than 60 % of all deliveries of Russian oil to China. Since 2005, after the nationalisation of Yukos, these deliveries have been managed by Rosneft and rose from 4 million tonnes in 2004 to a peak of 10 million tonnes in 2006. This increase can be directly linked to a loan granted by CNPC to Rosneft in 2005.

After the bankruptcy of Yukos, its assets were sold by auction. In 2005, Rosneft succeeded in acquiring for US $ 9.3 billion Yukos’s most valuable subsidiary, Yuganskneftegaz, through a company called Baikalfinansgroop. As Rosneft was unable to raise this amount of cash from domestic sources, CNPC agreed to lend Rosneft US $ 6 billion as an advance payment for the future deliveries of 48.4 million tonnes oil between 2005 and 2010. CNPC passed the US $ 6 billion credit through China’s Eximbank to the Russian Vneshtorgbank, which in turn gave the credit to Rosneft. This is clearly a wonderful example of a re-nationalisation of an energy company using foreign funding.

Since that time, all subsequent deliveries of oil to China made by Rosneft have been carried out under the terms of this arrangement. If the level of oil exports by rail in 2009 remains at the same level as 2008, then Rosneft will have satisfied the requirement to supply 48.2 million tonnes to China.

In the meantime, the progress of construction of the Eastern Siberia –Pacific Pipeline and of the branch line to north-east China continues to face delays. China has been pressing Russia to build this oil export pipeline for ten years, initially in partnership with Yukos. In 1999, Yukos acquired the company Tomskneft and thus gained the rights to exploit one of the largest oil deposits in Eastern Siberia, the Yurubcheno-Tohomsky field. At the same time, Yukos began to carry out trial deliveries of oil from Western Siberia through Eastern Siberia and then on to China by rail.

In September 2001, Russia and China signed a general agreement to carry out the engineering design for an oil pipeline. It was planned that the total annual throughput would be 30 million tonnes and that Yukos would provide not less than 50 percent of this supply. The oil would be delivered from Angarsk to Daqing in the northeast of China and the pipeline would be commissioned in 2005.

The dismantling of Yukos undermined this plan, and Russia’s government then evaluated a range of export options. In 2006, President Putin made the decision to construct an oil pipeline which would pass at least 200 km to the north of Lake Baikal, thus avoiding some environmentally sensitive areas and allowing the pipeline to link in with other oil fields. The following year, all the preliminary studies were completed for the construction of an 80 million tonnes per year pipeline from Taishet in Eastern Siberia to Nakhodka on the Pacific coast. The first stage involved a branch to Daqing in China with a capacity of 30 million tonnes

The original deadline for the construction of the first stage of the project, to China, was the end of 2008, but this has now been postponed for at least one year. The main causes of this delay have been the failure by contractors to honour their contractual obligations and difficulties in constructing the pipeline across the major rivers of Eastern Siberia and in the Far East. In other locations, progress has been delayed by unforeseen complexities of geology and landscape.

The construction of a pipeline to Russian ports on Pacific Ocean was intended to form the second stage of the project. However, in the summer 2008 the president of Rosneft proposed that the first stage of the project should take the pipeline to the coast and only then should the branch line be laid to China. This potential change of plan was linked to the failure to agree a price for the oil to be delivered to China.

In October 2008, CNPC signed a Memorandum of Understanding in which it agreed to provide Rosneft with an additional loan of US $ 15 billion and Transneft with US $ 10 billion, in return for a guarantee that the branch line to China would be completed and that shipments would reach 15 million tonnes per year by 2011. Negotiations to finalise the deal quickly stalled over the high level of interest payable for the loan proposed by the Chinese. As of the middle of February 2009, no final agreement appears to have been reached and the Memorandum of Understanding expires at the end of March. Meanwhile the President of Transneft has been reported as saying that construction of the branch line to China might not even start until 2010. The stated reason for the further postponement? Delays in arranging financing.

Given the Russian companies’ need for cash, I would expect a deal to be signed relatively soon. Cash will flow one way, and oil the other. But delays in the construction of the pipeline are likely to persist, and the oil will probably continue to flow by rail for some time yet. Looking further afield, expect China’s oil companies to be on the look out for cheap, attractive assets, and expect them to be offering loans to national oil companies which lack the cash to develop the fields they have. Petrobras may be the next candidate.

Philip Andrews-Speed is Director of the Centre for Energy, Petroleum and Mineral Law and Policy at the University of Dundee, UK