Since the beginning of the modern petroleum industry around 1850, oil exports from Russia and other countries in the North Caspian have flown almost exclusively one way: west. The Baku refineries in Azerbaijan were already linked to the Batumi port on the Black Sea by a kerosene-carrying pipeline in 1906. Once the oil treasures of the Volga-Ural and West Siberia basins became known and developed, more pipelines reached out to Black Sea and Baltic ports and Central Europe. Projects to develop new fields in Russia’s Arctic have invariably been accompanied by plans to move oil west, either by tanker or by pipe. The main export lines built by Azerbaijan (BTC) and Kazakhstan (CPC) point to the west.
What all this means is that up to this day almost all the oil exports originating in the former Soviet Union end up on European markets, part of the larger Atlantic Basin oil markets. Gas exports end on European markets as well and are priced to oil by using various formulas. Since the share of oil and gas in Russia’s exports exceeds 60%, this also means that Russia is dependent on the European oil and gas market for about 60% of its total export revenue and 20-25% of its GDP. Exports of hydrocarbons to Europe are of similar importance for several other countries in the North Caspian.
For a good century and half this pattern of oil and gas flows from the heart of Eurasia to markets made a lot of economic sense. To the east, until the early 90’s China was an oil exporter. Oil from Indonesia and the Middle East could easily be shipped in large tankers to Japan and Korea at a freight rate that made the construction of a pipeline from Russia’s oil fields to the Pacific economically nonviable. Domestic demand in Russia’s sparsely populated Far East was served by oil and gas produced on Sakhalin. Products were supplied by two refineries and rail shipments from Angarsk, the easternmost point on the pipeline system in Russia. Overall, Russian and North Caspian oil and gas were sold internationally where they were most in demand and brought the highest margins: on the neighboring hungry, fast growing European market.
A fundamental change in this pattern of flows may be underway. The first project in Eurasia for moving large quantities of oil eastwards by pipeline got underway in July 2006, when the link between Kazakhstan and China over the Alatau pass was commissioned. Designed to carry up to 20 million tons of crude oil per year (about 15% of China’s imports in 2005), the pipeline could not quickly reach its ultimate capacity, as inland in Kazakhstan there was no link to the main producing fields located in West Kazakhstan. To use the available capacity, transit of Russian oil was arranged via an existing line from West Siberia leading into Kazakhstan from the north and connecting to the export line. But in Kazakhstan the construction of the 761-kilometre Kumkol-Kenkiyak crude pipeline extension is slated for completion by October 2009, providing a backbone west-east connection in the country. Crude output at fields in Kazakhstan operated by CNPC, the state-owned Chinese company, was 18.62 million tons (139.3 million barrels) in 2008 and natural gas output was 4 billion cubic meters.
More is to flow to China soon: On April 21, China and Russia finalized a $10 billion loan to the Russian oil pipeline monopoly Transneft and another $15 billion loan to the state-run oil major Rosneft. The loans are in exchange for supplies of 300 million tons of Russian oil over 20 years via a pipeline between Angarsk and Skovorodino in Russia and Daqing in China. The deal will also allow Transneft to bring the capacity of the line between Angarsk and Skovorodino to 30 million tons per year and to move oil from Skovorodino to the ports on the Pacific, initially by rail. Eventually the entire pipeline between Angarsk and the Pacific will be completed, thus expanding the presence of Russia on markets in Northeast Asia.
Also in April 2009, China signed a $10 billion loan with Kazakhstan, with CNPC acquiring 50% stake in Mangistaumunaigaz for $5 billion. The remainder of the loan is to be used for the construction of the Beyneu-Shikment gas pipeline, part of a project that would allow China to import up to 40 billion cubic meters of natural gas from Central Asia, mostly from Turkmenistan. China is also talking to Gazprom about building gas pipelines from the fields in both West and East Siberia to China, and if these projects move forward, 30-40 billion cubic meters of gas could flow from Russia to the east.
The deals with Russia and Kazakhstan are seen as part of a $46 billion loans-for-oil strategy pursued recently by China in four countries around the globe. Brazil also agreed to supply 100 million barrels of crude to China in exchange for loans of up to $10 billion.
The massive infusion of Chinese investment in upstream projects and transport infrastructure across Eurasia is, of course, a major driver for reorienting oil and gas flows from the west to the east. At design capacity, the east-leading pipelines already in operation and under construction will carry 35 million tons of oil and 40 billion cubic meters of gas. Projects being negotiated could add another 20 million tons of oil and 30-40 billion cubic meters of gas flowing to eastern markets. To put the figures in perspective, one may wish to note that the total capacity of proposed new oil and gas pipelines from Russia and the North Caspian to the west is in the range of 30-40 million tons of oil (CPC expansion, Transcaspian system of pipelines and shipping, expansion of Russian pipelines to Baltic ports) and 80-90 billion cubic meters of gas (Nabucco, ITGI, Nord Stream, South Stream). Note also that some of the projects in the west are competing with each other, while none seem to be doing so in the east.
Europe will continue to be the major market for oil and gas exports from Russia and the North Caspian, but for the first time ever most of the increment of oil and gas production is likely to flow to the east. Apart from the “China factor,” other drivers tend to facilitate this outcome:
- Russia may wish to demonstrate to its counterparts in Europe that it does have options when access to markets is at stake, particularly gas markets. For years now, Russia has been trying to consolidate its control of the gas chain from the well to the retailer, acquiring exclusive rights over existing pipeline capacity in several countries, touting asset swaps, and making downstream acquisitions in Europe. These moves have often been viewed with suspicion as they may lead to vertical foreclosure on the liberalizing European markets. For Russia, the availability of alternative markets for its oil and gas means that the bargaining with the Europeans just got more fun.
- Producing countries in the Caspian region have had for decades now to rely almost exclusively on Russian infrastructure for exports. While it has been possible to transit oil across Russia, gas had to be sold at the borders to Gazprom, which then re-sold it in Europe at a huge mark-up. For producers to the east of the Caspian, the availability of alternative markets for their oil and gas means that the bargaining with Russia just got more fun.
But maybe the most striking feature of the reorientation of oil and gas flows in Eurasia is that it is from free, competitive markets, to markets controlled by government-owned entities where commerce is under long-term contracts, reminiscent of the deals between Russia (then the Soviet Union) and European customers during the 70’s and the 80’s. That used to be a stable but wasteful model of energy supply.
Most of the hydrocarbon resources of both Russia and the Caspian are natural gas, not oil, and the largest upstream and transportation projects that are being mulled are almost invariably related to natural gas: Shah Deniz II in Azerbaijan, South Yoloten and the offshore fields in Turkmenistan, Shtokman, the Yamal fields and Kovykta in Russia, and so on. Kashagan in Kazakhstan, one of the largest oil fields discovered during the last 40 years, is gas-rich and cannot be developed without factoring in infrastructure for handling the gas. So far, however, only one modest pipeline links the gas resources of the Caspian directly to competitive markets: the South Caucasus Pipeline (SCP) from Azerbaijan across Georgia to Turkey.
For the U.S., it would be reasonable to focus on solutions that provide to Caspian producers outlets to free markets, rather than lock them up in a long-term relationship with state-controlled entities. For oil, there is a history of success, for example the BTC line. For natural gas, precious little has been brought to fruition. The absence of outlets for North Caspian gas to free markets at a time when the gas sector in the littoral countries is set to grow at a fast pace from already dominant role in their economies is a chokepoint that often forces these countries into unpalatable choices and promotes instability. The U.S. and Europe should put their act together to give these countries better access to free, competitive energy markets.
Boyko Nitzov is Dinu Patriciu Fellow for Transatlantic Energy Security and Director of the Eurasia Energy Center at the Atlantic Council.