An agreement was announced late last month between Russia and China for China energy FDI to construct a pipeline branch to China from the East Siberia-Pacific Ocean (ESPO) oil pipeline. This is only one aspect of a relatively new strategic policy direction from Beijing to acquire foreign assets during the ongoing global economic downturn.

The pace of current China energy FDI

Caijing Magazine, using information compiled from Dealogic, reports that Chinese companies initiated 22 overseas acquisitions in January and February. These had a total value of US$16.3 billion, with the pace accelerating. Almost all acquisitions concerned natural resources. Nine-tenths of the total investment was directed to Australia. This is a marked switch from 2008, when less than two-thirds of investment was in the natural resource sector, and one-third of that went to British companies.

In the oil sector, China has signed or extended agreements with companies from Saudi Arabia and Brazil in addition to Russia. In the case of Brazil, as in Russia, the Chinese Development Bank (CDB) has offered loans to national oil companies caught in a credit crunch. Ten billion dollars are earmarked for Brazil’s Petrobras on the understanding that current oil and chemical sales to Chinese para-statal trusts will increase.

Analytical opinion is divided over whether it has been a good strategy for China to purchase equity stakes in companies in such countries as Ecuador, Yemen, Sudan, and over a dozen others in the past decade. Dangers include political risk and the absence of transparency. Moreover, only in Kazakhstan and Sudan have Chinese moves increased their companies’ reserves.

Nevertheless, cash-rich China has a clear advantage over Western countries in the current worldwide downturn. It will be able to continue making acquisitions and deals at good prices while Europe and North America are in the throes of the global financial crisis. These deals will be not only in the energy sector. For example, aluminum giant Chinalco, also financed by the CDB, has agreed to lend iron ore producer Rio Tinto $20 billion to help it pay off its debts falling due this year and next.

Chinalco, which is seeking to diversify its interests, wants to double its stake in Rio Tinto from 9 per cent to 18 per cent over time. It plans to invest over $12 billion in the company’s copper aluminum and iron ore operations. The planned vehicle is the purchase of convertible bonds. However, the Australian government may block the move legislatively by changing the treatment of debt as equivalent to equity.

Recent China energy FDI in Russia

As for the recent Siberian deal between Russia and China, UOBKayHian calculates that the agreement’s implied oil price is $22 per barrel. This makes it very advantageous to China, and with an embedded interest rate of 6 per cent, also very advantageous to Russia. In return for a $15 billion loan to Rosneft and $10 billion to Transneft, Russia will supply a minimum of 300,000 barrels per day (bpd) to China. This is equivalent to about 8 per cent of China’s oil imports in 2008 and 4 per cent of total consumption.

The agreement foresees construction of a short spur of the Eastern Siberia Pacific Oil (ESPO) pipeline from Skovorodino to the Chinese border. Beyond that, China has elaborated its own project to construct a near 1,000 kilometer pipeline to Daqing, long a center of Chinese petrochemical production.

According to a Transneft spokesman, Russia intends to build a 1.6 million barrel per day (bpd) pipeline to Skovorodino. It would also build a 1 million bpd pipeline from there to Nakhodka so as to accommodate expressed Chinese demand. The respective roles of PetroChina and Sinopec in the deal remain unclear. The latter may receive more of the imported oil than the former simply because its refining capacity is 40 per cent greater.

Also this month, Russia inaugurated its first liquefied natural gas (LNG) plant for East Asia in Sakhalin. This plant would supply about one-twentieth of the global LNG when it reaches full capacity. That is about three times the initial capacity now foreseen. The launch of the plant, over a year later than originally planned, is Russia’s first foray into the world market for LNG.

According to Global Insight, about two-thirds of exports in the beginning will go to Japan with the rest divided between South Korea and North America.

The Russia-China agreement for the ESPO spur and its knock-on deals appear to be part and parcel of an attempt by the Kremlin to orient its energy exports away from Europe towards Asia. This strategic move by Russia corresponds with the International Energy Agency’s estimate that annual demand for gas in Asia will increase at a 3 per cent rate for the next two decades. That is one-and-a-half times faster than the average global demand increase. China and India together would possibly represent one-third of total Asian demand.

Prospect for further China energy FDI

The Russia-China deal indelibly confirms the trend of bilateral energy cooperation between the countries in Central Eurasia, and also including third countries, that I first identified when it was merely incipient over five years ago.

[First published in Asia Times Online, 5 March 2009.]

Also published on Medium.