Middle East Economic Survey
VOL. XLVII
No 29
Kazakhstan, China Revive Pipeline Deal
By Michael Lelyveld
The following is adapted from a PFC Energy presentation on the Kazakhstan-China oil pipeline given by Michael Lelyveld on 3 June 2004. Mr Lelyveld is a senior advisor to PFC Energy’s Caspian Service.
On 17 May 2004 in Beijing, China and Kazakhstan agreed again to build an oil pipeline between the two countries, nearly seven years after China National Petroleum Corporation (CNPC) shocked the industry and the region with its pledge to invest $9.5bn in Kazakhstan.
Many of CNPC’s previous promises of projects never came to pass, including development of Kazakhstan’s Uzen oilfield and a crude pipeline to Iran. CNPC was willing to bid far more than western competitors thought some of these projects were worth, and on the whole, the investments did not pan out. CNPC did develop the Kenkiyak and Zhanazhol oilfields in western Kazakhstan, but work came in fits and starts, in part because the 1998 Asian currency crisis caused China to pull in its horns. China’s joint venture CNPC-Aktobemunaigaz then pursued marginal or unprofitable operations for several years in shipping oil across the border to the Russian refinery at Orsk for local use.
Although Kazakhstan’s relations with China are among the least transparent in the region, industry sources
say that Kazakhstan’s leaders essentially became stuck in a standoff with CNPC over what they felt was a broken promise to develop the trans-Kazakhstan oil pipeline project. CNPC said it needed to merge volumes from its other fields with those from the Uzen field, while Kazakh officials would not give them permission to develop Uzen until they made good on the pipeline project. Since then, one side has wanted the pipeline when the other did not, and practical considerations of volumes and the 3,000km distance have produced little more than talk.
So, what is different this time?
Rising China Demand
For one thing, demand. China’s crude imports last year rose 31% to 91mn tons, or 1.83mn b/d, after a similar increase the year before. Its production is flat at about 3.4mn b/d. Output declined last year by 3.5% at China’s flagship Daqing oilfield, some say to dangerously low levels. GDP grew 9.1% last year, peaking at 9.7% in both the fourth quarter of 2003 and the first quarter of this year, according to the latest official reports (earlier reports put fourth quarter growth at 9.9%).
In the first four months of this year, crude imports have risen again by over 33% to 40mn tons or over 2.3mn b/d. All the arguments about reliance on the Middle East have started to hit home, and China has started to make some progress on diversifying supply. But the Middle East, including Sudan, still accounts for 50% of China’s oil imports.
Kazakhstan has been contributing very little in terms of the share of China’s imports and has actually dropped this year, mostly due to railcar and logistics problems. Last year, China imported an average of 24,000 b/d from Kazakhstan, or 1.3% of its imports, but the volume was a record. So far this year, imports of Kazakh crude are down to 21,000 b/d, or less than 1% of China’s total.
Imports from Russia are rising, mostly due to the stepped up rail service for Yukos oil. Russian deliveries averaged 105,000 b/d last year or 5.8% of China’s imports. This year, Russian exports rose to 173,000 b/d or 7% of China’s imports. April’s exports of Russian oil to China jumped to 264,000 b/d, making Russia the third biggest import source for the month behind Oman and Angola. But, that said, China is enormously disappointed, distrustful and resentful over Russia’s failure to build the Angarsk-Daqing pipeline from Eastern Siberia, which was originally scheduled to open next year and would have served China’s market in a time of need.
Pipeline Solutions
These conditions set the stage for the resurrection of the trans-Kazakhstan oil pipeline project, which still by most measures seems to fall below western standards of commercial viability. But it is safe to say, after the experience with the West-East gas pipeline project in China, that the Chinese authorities may not give full weight to what western investors may think is commercially viable when it comes to pursuing what they think the country’s strategic interests will be.
From Kazakhstan’s perspective, the authorities have tried to deal with questions about the viability of the initially conceived 3,000km project by breaking it into pieces. The current 1,240km project, known as the second stage, would run from Atasu in Kazakhstan’s central Karaganda region through the Alashankou rail crossing with China’s western province of Xinjiang. The project, undertaken jointly by KazMunaiGaz and CNPC, includes 988km within Kazakhstan, while the remaining length would reach Xinjiang’s refinery and petrochemical complex at Dushanzi. Other refineries in the province to be served include those at Karamay and the capital Urumqi.
The Atasu-Alashankou pipeline would initially carry 10mn tons/year (200,000 b/d) of Kazakh Kumkol crude annually and cost an estimated $700mn to $850mn, making it seem relatively modest. Officials expect construction to start perhaps as soon as August and to be completed by the end of next year. An additional 10mn tons of capacity would be added by 2011. However, reports in the Chinese official press in recent days indicate that the project may be far larger on the Chinese side.
Despite some suggestions, there is virtually no market for imported oil in Xinjiang, which is an oil exporting region with a population of only about 19mn. China’s major consuming markets are all far to the east. China expects to invest $1.2bn in two pipelines running east, with construction set to start simultaneously with the Kazakh project. The first line for crude would stretch some 1,500km from Shanshan in Xinjiang to a refining center in Lanzhou, in north central Gansu province. A second 1,800km line would run from Urumqi to Lanzhou, carrying what officials are calling "finished oil." Each line could handle 10mn tons annually, suggesting that they could be used for later volume increases from Kazakhstan or for Xinjiang’s own product shipments. Plans call for linking the lines to petrochemical complexes in eastern and southwestern China, although no timeframe has been given.
Some Chinese official press reports now speak of a 10,000km oil pipeline extending across the Asian Silk Road route in two years. Clearly, these need to be taken with a grain of salt. But a marked change seems to have taken place in Chinese reports since an apparent coolness when agreements were signed with President Nursultan Nazarbayev in Beijing on 17 May.
China’s increased enthusiasm may be due to resolution of financing details, which seemed uncertain or contradictory at the time of the announcement. Or, the initial coolness may have been due to an embarrassing environmental decision last month on an apparently unauthorized section of pipeline built by CNPC in western Kazakhstan. In any case, China now seems to be pushing just as hard for the Atasu-Alashankou project as Kazakhstan, which may be the most important factor in whether it will actually be built.
Several notes of caution should be sounded, however.
Although China’s demand and energy security needs may overcome some commercial disadvantages, the pipelines are still likely to be economy-driven. China is in the middle of delicate maneuvers aimed at bringing its economy in for a soft landing. Power shortages have hit nearly every province in the country. Infrastructure constraints may impose their own unmanaged limits on growth. Bank lending has been officially barred to some overheated industrial sectors, but such directives seem to be routinely ignored.
The outcome may have effects not only on China’s economy but also on demand growth, and to some extent, world prices. The variables may well play into pipeline economics if swings in the numbers are substantial. Clearly, the projects seem more certain with $40/B-oil, 30% import increases and 9% GDP growth than with indicators at half those rates. On the whole, the likelihood of the projects may diminish with time if construction does not get underway this year and economic conditions start to slip, repeating the no-action experience of 1998.
Kazakhstan will reportedly rely heavily on Kumkol oil produced by PetroKazakhstan for the Atasu-Alashankou pipeline. The Canadian-registered company expects to produce 160,000 b/d to 165,000 b/d this year. But portions of the total are devoted to other destinations and interested parties, including a PetroKazakhstan joint venture with German interests. The ability to redirect the oil to China remains unknown. While PetroKazakhstan has met a series of challenges in the country, its ability to serve as a linchpin for the China pipeline is uncertain. The participation of Russia has also yet to be clarified.
Mixed Russian Reaction
Kazakh officials initially sounded out Russia on its interest in the pipeline for transit. The responses from Moscow have been mixed. Last month, two days after Transneft Vice President Sergei Grigoryev was quoted by Kommersant as saying that the company had no interest in the project, Transneft CEO Semyon Vainshtok suddenly voiced interest in shipping 10-12mn tons of Russian crude annually through the pipeline.
Vainshtok’s offer may have appeared a bit strange after his opposition to Russia’s Angarsk-Daqing pipeline, but one possible explanation is that Russia needs the export capacity and sees a Kazakh pipeline to China about to be built anyway. Some analysts doubt that Russia would want to transit its own oil through another country. On the other hand, it seems to have decided that it will not give China a direct link for political reasons.
From Kazakhstan’s side, Russian oil could help solve a nagging problem. As originally conceived, a China line would need 1mn b/d to be economic, but that volume is too large for Kazakhstan to risk committing to a single customer. A contribution of Russian oil reduces the risk. Even so, a three-sided deal is certain to be far more complex.
Kazakhstan’s plans to complete the system have yet to be fully fleshed out. The 448km Kenkiyak-Atyrau pipeline in the west, which opened last year, has now been labeled as the first stage of the China line, although it currently runs west and not east toward China. The full system assumes Caspian supplies to China, but such long-distance economics have yet to be proved. Officials say the third stage would include rebuilding and expansion on the route from Kenkiyak to Atasu, but no firm estimates and timeframes have been given. Final capacity of the entire system has been variously reported as 50mn t/y, 70mn t/y and even 100mn t/y.
In the grand scheme of things, the parties see China as increasing its role in Kazakhstan with rail projects, a gas pipeline and investment in the Caspian shelf. But the past suggests that we should probably be wary about the outlook for grand plans and be careful not to ignore the obvious. In this case, the obvious is still that, although China and Kazakhstan are neighbors, Kazakhstan’s biggest resources are in the extreme west of the country while China’s biggest consuming markets are in the extreme east at opposite ends of a continent. When and if China becomes heavily invested in the Caspian offshore, it may still be tempted by the economics of shipping oil west rather than piping it east, all the way across Kazakhstan to its territory.
An alternate view is that a steady but smaller flow of Kazakh oil could eventually be seen as a logical source for China’s planned strategic petroleum reserve, which may be built up slowly over the coming years, rather than Kazakh oil being used as a quicker and costlier fix for demand growth.
Russia/China Distrust
Finally, the mutual distrust between Russia and China remains an unquantifiable factor. In many ways, the countries have become complementary opposites, in terms of population, natural resource needs and industrial growth. Analysts have been tempted to see Russia’s exportable surplus of oil as a perfect fit with China’s soaring demand. Yet, it is difficult to explain Russia’s repeated rebuffs to China’s investment and import interests.
The answer may well lie in President Vladimir Putin’s campaign to promote Russia’s "processing industries," which would provide more value-added to the economy than simply relying on exports of gas and crude oil. Russia looks across the border and sees a powerful, populous nation where processing industries have grown at astonishing rates. Moscow may also see that by selling China large amounts of crude oil, it gets very little value-added for itself. It only increases China’s value-added instead.
If this is, in fact, the mindset behind Russia’s barriers to more energy deals with China, the way may be open for Kazakhstan’s oil to reach China, even at a high cost.
Kazak Crude Transport System
