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Kremlin vows to underwrite China’s huge Yukos contract

The Business: Kremlin vows to underwrite China’s huge Yukos contract

“The state-owned gas company PertoChina struck out at Moscow in retaliation at the start of August by cancelling a $5.6bn (£3bn,€4.6bn) contract with Russia’s natural gas giant Gazprom, Shell and Exxon-Mobil to build the longest gas pipeline in the country from newly discovered gas fields in western China to Shanghai.”

5 Sept 2004

By Ben Aris

IN Moscow

RUSSIAN Prime Minister Mikhail Fradkov last week attempted to smooth over growing tensions with China by promising that the Russian government would honour oil contracts made by Yukos.

The giant oil company is facing bankruptcy at the hands of the Kremlin.

“There are no reasons for any emergency,” Fradkov said. “Oil products will keep going to China the way they have been.”

Portfolio investors may have been badly burnt by the Yukos affair, but China is facing a energy crisis if its long-term supply contracts with Yukos are not honoured.

On Thursday, Yukos said it may be forced to stop production after a Moscow court ordered the arrest of money in the accounts of its main production subsidiaries.

China produces 200m tonnes of oil a year, but domestic production started to fall this year as oil fields ran dry. Oil imports are expected to rise 40% this year to 110m tonnes and experts say China will be importing 300m tonnes of oil by 2010. Chinese consumption of energy is rising at four times the rate seen in the OECD countries on the back of red-hot economic growth. Russia is China’s obvious source of energy to fuel this growth.

Stephen O’Sullivan, co-head of research at United Financial Group, told The Business: “China and the rest of Asia are going to continue their rise as major consumers of energy. Oil and gas will be fastest growing energy sources in absolute terms and import dependence and supply security will be key issues for region.”

Russia and China have become big players on the world’s energy markets, Russia as a supplier and China as a customer. Russia’s oil output rose 11% in 2003, while Chinese consumption was up 11.5%, making it the second biggest consumer of power in the world. But geopolitics have affected what should be a natural give-and-take partnership.

Beijing was counting on the Angarsk-Daqing pipeline from Yukos’s oil fields in western Siberia to China’s energy-hungry northwest provinces to make up the difference. But the Kremlin is pushing for the longer and more expensive pipeline from Siberia to Nakhodka on Russia’s Pacific coast that will open up all of South East Asia’s markets to Russian oil, as much for strategic reasons as economic ones.

Fradkov’s statement was designed to smooth tensions between Beijing and Moscow. The arrest of Yukos’s former chief executive, Mikhail Khodorkovsky, last October effectively cancelled the Yukos-Beijing deal and killed hopes for the construction of the Angarsk-Daqing pipeline.

The state-owned gas company PertoChina struck out at Moscow in retaliation at the start of August by cancelling a $5.6bn (£3bn,€4.6bn) contract with Russia’s natural gas giant Gazprom, Shell and Exxon-Mobil to build the longest gas pipeline in the country from newly discovered gas fields in western China to Shanghai.

Badly rattled by the Yukos affair and the death of the Angarsk-Daqing pipeline project, Beijing has been sufficiently shaken to offer to guarantee Yukos’s payments to the Russian Railway Company (RZD), to ensure Russian oil deliveries to China while the wrangling continues. Japan has offered to provide the funding for the Nakhodka pipeline.

“China will pay for everything if Yukos encounters problems,” Gennady Fadeyev, RZD’s president, said at a recent board meeting. Beijing and Yukos signed a mammoth $ ISObn 25-year supply deal in May 2003 to send a total of 700m tonnes of Siberian oil into China- 20m tonnes a year between 2005 and 2010, rising to 30m tonnes after that.

The Angarsk-Daqing pipeline was a crucial to the long-term feasibility of the plan and Yukos has been shipping oil by rail in the meantime.

But the Kremlin has made it abundantly clear that Chinese participation in the Russian oil sector is not welcome. Beijing was forced to do an about face after a senior Chinese diplomat said last month that China was interested in buying Yukos’s main production subsidiary Yuganskneftegaz if it is put up for auction.

Bailiffs seized the subsidiary last month in lieu of an unpaid tax bill. It accounts for 70% of Yukos’s reserves and 60% of its production. “There is no way that the Russians will let the Chinese buy into their oil industry. They may be big trading partners, but the two are still political rivals and oil remains Russia’s number one strategic resource,” says one western diplomat.

The Chinese National Petroleum Company tried to bid in the December 2002 auction of state-owned Slavneft. Despite reportedly being willing to offer twice the starting price, the Chinese were excluded from the auction.

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