beyondbrics

The prospect of European Union sanctions against Iran is driving up oil prices and sending buyers looking for cover. But Europe should not assume that Russia, the world’s biggest oil producer, will replace the missing Iranian crude when the embargo kicks in on July 1.

After years of delays and billions of dollars of investment Russia is beginning to redirect its oil trade away from the west towards premium energy markets in China and east Asia.

Some 600,000 barrels a day of Russian crude, or 11 per cent of the country’s total oil exports, are already being transported through the East Siberia Pacific Ocean (Espo) route. By late 2012 when Espo is completed the volume will rise and could eventually exceed 1m barrels a day.

“Russia will have more options by the end of this year about where it exports its oil,” says Julia Nanay, senior director at PFC Energy, the Washington-based oil consultancy.

Traditionally, Russian oil exports flow in a westerly direction in pipelines to Europe or ports on the Black Sea and the Baltic. Although capacity in these routes is sufficient to handle all Russian oil exports, the Kremlin has pushed ahead with the $20bn Espo project to diversify the country’s oil trade and reduce dependence on sluggish European markets.

The first phase of Espo was commissioned in early 2010, and involved construction of a 2,694km pipeline from Taishet in east Siberia to Skovorodino near Russia’s border with China. From Skovorodino up to 300,000 bpd of oil is transferred to rail wagons for transport to a new terminal at Kozmino on the Pacific Ocean. Cumbersome rail transfers will be phased out after the second, 2,064km phase of the Espo pipeline is completed late this year allowing for the uninterrupted delivery of oil to the Pacific. Deliveries through the system are then expected to double.

In addition, Espo is being used to pump 300,000 bpd of oil into a 63km spur line from Skovorodino to northwest China that was built in 2009 at China National Petroleum Corporation’s expense.

Of course, oil is a fungible commodity so the completion of the Espo pipeline will not necessarily lead to a shortage of oil in European markets. However, buyers may have to scrabble for supplies and pay higher margins to satisfy their requirements. Russia officially opposes sanctions against Iran, but stands to benefit economically if the EU oil embargo pushes up prices for its main export commodity.

However, the EU cannot expect Russia to come to the rescue as Iranian oil supplies dwindle. In the first place, Russian oil production, although flowing at a post-Soviet record, is rising by less than 2 per cent annually, leaving exporters with little slack. Secondly, the Kremlin is encouraging producers to modernise their refineries and process more of their oil in Russia into value added products for local consumption. Customs duties on heavy fuel oil that is usually traded in Europe have increased to discourage export of the product.

Meanwhile, Espo crude is seen as the big new thing in Asian oil markets. Better quality than most Middle East oil traded in the region, the Russian crude has customers clamoring for supplies from Japan to Korea, the Philippines and Thailand. China, having settled a dispute this month with Russia over the price of oil delivered through the Espo spur, has asked for an increase in deliveries to help meet its insatiable demand for energy.

For Russia, Espo is a prestige project bolstering the country’s role as a global energy power. The Kremlin has set a goal for Espo to become a benchmark crude in east Asia off which other oil blends are priced in the market. If that is to happen, deliveries of Espo will need to be maintained at a consistently high level. Europe should think about that.

Related reading:
Crude defies supply and demand forecasts, FT
Russia: Rising taxes cast shadow over eastern expansion, FT
Russia: China pipeline is good politics but not necessarily good business, beyondbrics
Pilot flame flickers on gas pipeline project, FT