Alexei Nikolsky/Pool Photo/AP
Saudi King Salman bin Abdulaziz Al Saud visited Moscow last Wednesday, the first such visit by a Saudi monarch since the Soviet Union collapsed. Two topics dominated the agenda: Syria and oil. Saudi Arabia has likely found itself in the uncomfortable position of accepting Assad’s grip on power into the future in hopes of drawing Russia further away from Tehran in trying to resolve the Syrian Civil War.
To that end, Saudi Arabia is reportedly buying Russia’s S-400 missile system and signed a Memorandum of Understanding (MoU) on industrial cooperation in the defense sector. Saudi Arabia is trying to use its leverage – financial resources – to influence Russia on other priority areas, namely Iran. As expected, energy played a big role during the visit and deals associated with it.
Reports say that $ 3 billion in projects have been agreed to between the two countries, including a $ 1.1 billion petrochemical plant to be constructed in Saudi Arabia by Russia’s Sibur and an agreement between Saudi Aramco and Gazprom Neft on drilling technology. A $ 1 billion investment fund for energy and technology was also announced. Russia and Saudi Arabia have worked together to try and raise crude prices by lowering production 1.8 million bpd with other producers. But these cuts have disproportionately affected Saudi Arabia’s standing on Asian markets and Russia’s state oil major Rosneft has jumped at the chance to grab market share and assets in Asia. As is so often the case, today’s solutions laid the seeds of tomorrow’s conflict. Saudi Aramco and Rosneft are positioning for a post-cut market, and Saudi Arabia may be offering cooperation to spite Qatar as well as temper the risks of its increasingly active foreign policy and proxy wars with Iran.
China has understandably played the leading role in Russia’s attempts to broaden its role as an energy supplier in Asia. Rosneft recently sold 14.16 percent of its shares to CEFC China Energy for about $ 9 billion by way of the Qatar Investment Authority and Glencore. The move reflected the challenges financial sanctions have created for the firm as well as China’s growing clout as an importer. Chinese demand hit 11.67 million barrels per day (bpd) and had risen 6 percent year-on-year in July. Rosneft was smart to finalize supply agreements with PetroChina set to boost its daily exports to China from 400,000 bpd to 600,000 bpd next year. Rosneft also signed an agreement with CEFC to jointly explore for Eastern Siberian reserves and increase direct deliveries to China.
These deals play into Russian-Saudi competition for the Chinese market. China’s oil imports are up 12.3 percent year-on-year, but cuts haven’t hit Russian exports. Saudi oil exports to China hovered at 1.03 million bpd so far this year, a 1.7 percent drop. Russia’s stood at 1.16 million bpd, a 13.2 percent increase. After closing the CEFC deal, Rosneft announced it expected to deliver 40 million tons of oil to China by year’s end, a 9 million ton increase on their expected deliveries. That would average out to around 800,000 bpd from Rosneft alone, assuring Rosneft’s dominant control over Russian supplies to the Chinese market. The increase in supplies has paralleled a long-standing project to develop a refinery in Tianjin. But the project, first announced in 2009, has no clear end date despite a press release concerning its implementation with CNPC in January.
Saudi Arabia has disproportionately lost share in China for several reasons. For one, it bears the burden of cut compliance. Angola overtook it because of China’s dominant position there and didn’t feel the need to comply. For another, Russian firms have built up new assets and export capacity in Eastern Siberia and the Far East. Russian blends have more physical access to Asia-Pacific markets, making them more competitive than they’ve historically been. Finally, spreads on the market between light and heavy crude have narrowed, making Russia’s lighter crudes more competitive against Saudi heavy crudes. But Saudi Arabia is not without a means of responding.
Saudi Aramco reached a refinery deal with state-owned China North Industries Group Corp. in May around the Belt and Road summit. Though the refinery is smaller than that proposed in Tianjin, Saudi Aramco has one considerable advantage over Rosneft: it lacks the same messy history Rosneft has with China’s state firms and it’s not sanctioned. CEFC was a logical partner for Rosneft in China because, unlike CNPC and state-owned players, it could more easily afford to take the sanctions risk. It can also dangle shares to China. Further, the refinery deal signals a willingness to work with China’s independent refiners. These so-called “teapot” refineries have driven demand growth and provide Aramco greater diversity in business opportunities longer-term than Rosneft’s relationships with CNPC and CEFC afford it.
Ever since the company started talking about an IPO of 5 percent of its shares, China has been a logical partner. A sale to Chinese firms in exchange for investments into China’s downstream would be huge win. The Kingdom also signed a similar agreement for an investment platform with China worth $ 20 billion in late August, just as it became clear CEFC would acquire stakes in Rosneft. That throws a fair bit of shade on Russia’s $ 1 billion fund agreed to this last visit. Topping it all off, King Salman and Aramco also signed deals reportedly worth $ 65 billion with China in March.
Judging Saudi Arabia’s position against Russia’s on daily barrel counts alone is misleading. But Rosneft has signaled intentions to buy some Sinopec assets in Argentina, a move presaging greater interest in China’s petrochemical market. To access that market, it will need Sinopec in particular, a state firm, to ignore sanctions risks. If Aramco can beef up its relationships with private firms and independent refiners, it can limit Rosneft’s room to develop synergies between upstream and downstream operations on the Chinese market.
The Kingdom and India
Rosneft made a major splash by acquiring 98.6 percent of India’s Essar Oil with partners Trafigura and United Capital Partners, gaining the company’s refinery in Vadinar, a port, and 3,500 filling stations. The Vadinar refinery has a daily capacity of 400,000 bpd and assures Rosneft access to India’s growing oil market. However, the sale was meant to deleverage 60 percent of the Essar Group’s debt. There remains the perception that Indian firms lost out on the country’s growing downstream sector. India’s Intelligence Bureau and Home Ministry also red-flagged the deal on security grounds, citing the port’s proximity to the border with Pakistan and nearby military installations. Whatever the reason, there’s clearly significant concerns in India about the sale.
Saudi Aramco was bidding for the Vadinar refinery but didn’t match Rosneft’s willingness to pay off billions in Essar’s debt. As King Salman was in Moscow on Wednesday, Aramco issued statements that it plans to open an Indian subsidiary in the coming weeks. Back in June, the company showed its interest in exclusive talks with Indian counterparts like Indian Oil Corp., Hindustan Petroleum Corp., and Bharat Petroleum Corp. for a stake of a proposed 1.2 million bpd refinery on India’s west coast. Prime Minister Modi is likely facing pressure from two directions on the country’s energy security needs: China has thrown considerable financial resources at Saudi Arabia and now owns shares of Rosneft and India’s firms would be better positioned on Asia-Pacific oil markets with a more diverse array of international partners.
Saudi Arabia’s exports to India dropped 8.4 percent in the first half of 2017 as Russia has begun exporting more. Rosneft already owns an asset, though the US Treasury Department did throw up roadblocks last year. That places it firmly ahead on India’s market. But Saudi Aramco is most likely taking a hit now in the name of driving up prices for its public listing, which will provide a cash infusion exponentially larger than that gained from Rosneft’s privatization of shares last December considering estimates for Aramco’s market valuation. India is also signing more supply deals for exports from the US. Aramco has much better relationships on the U.S. market, particularly evidenced by its complete ownership of the Port Arthur refinery and its 600,000 bpd capacity. The U.S. Senate is looking to scrutinize any potential Rosneft acquisition of Citgo by way of Venezuela. Needless to say that Rosneft has few friends in the United States these days.
The ASEAN+ way forward
Aramco has moved to secure its position in Southeast Asia ahead of its IPO even though production cuts have led it to cut Southeast Asian exports to protect market share on larger markets like Taiwan, South Korea, and Japan. Despite lower exports, Saudi Aramco bought a 50 percent stake of the PRPC Polymers project from Petronas Chemicals Group Berhad (PCG), signing a strategic partnership agreement. Aramco is investing $ 7 billion into the project, slated for completion in 2019, and will provide up to 70 percent of the petrochemical plant’s crude oil needs.
Last December, Aramco reached an agreement with Indonesia’s Pertamina for a $ 5 billion expansion and 45 percent stake of a refinery. The expansion, slated for completion in 2021, will put the refinery’s capacity at 400,000 bpd. Aramco sources most of the refinery’s crude supplies. Pertamina and Rosneft are reportedly expected to finalize a refinery deal at the end of this year for a new refinery at the same ownership split, but Pertamina is unlikely to get access to Russian upstream projects.
Russian crude blends have been more attractive to refiners in Northeast Asia but Saudi Arabia has defended its turf. Aramco held on to 40 percent of Japan’s imports in the first half of 2017 without any sustained gains for Russian crudes and agreed to add 1.9 million barrels of crude oil storage on Okinawa. The storage site on Okinawa is also used to deliver crude oil cargoes to South Korea and China. Rosneft has no such relationships, reportedly dangling shares before last year’s privatization in exchange for developing joint projects and creating joint ventures at different stages of production and marketing. But Japanese firms linked political concessions regarding the Northern Territories to any deal, a nonstarter.
Saudi Arabia is mulling the construction of 17.6 gigawatts worth of nuclear power plants by 2032 with the help of firms from China, South Korea, and France. South Korea is set to hold a ministerial visit on October 26 to discuss cooperation in several sectors, including nuclear power. As Saudi Arabia works out the tenders for nuclear projects, it has an opportunity to cement its energy security relationship with South Korea. Nuclear power will free up oil used for domestic power generation, possibly putting downward pressure on prices in Asia-Pacific markets as demand growth slows in the medium-term. Russia’s Rosatom has not gotten any attention for Saudi contracts.
The best laid plans of oil giants
Cooperation is set to deepen between the two countries’ energy sectors, but Rosneft and Aramco have different strategic outlooks that suggest that many of these moves are tactical on Saudi Arabia’s part and opportunistic on Russia’s part. Most of the deals signed were MoUs, important symbols but relatively insubstantial commitments from either party unless more specifics emerge. Deals focused on Eurasia Drilling Co. and Novatek’s Arctic LNG 2. MoUs touched on Sibur, Gazprom, Gazprom Neft, and Lukoil’s trading arm Litasco. There was talk of cooperation between Rosneft and Aramco on crude oil trades, but there is a fundamental mismatch between the two countries’ intentions: Russia wants investment without political strings attached and Saudi Arabia wants Russia to back off of Iran.
Aramco targeted Rosneft’s competitors for memoranda and deals that would lead to projects for several reasons. Were Gazprom to gain access to Saudi fields or allow Aramco into Russia, it would gain considerable clout as a negotiator and lobby for policy pertaining to Saudi Arabia. Sibur is owned by Gennady Timchenko, a close friend of Putin’s who was named chair of the Russia-China Business Council. China has shown policy success by investing into projects owned by those close to Putin while balancing against drawing too much sanctions scrutiny. In short, Aramco wants to give other players in Russian policy circles a boost against their primary Russian competitor.
The U.S. Treasury Department revised its sanctions prohibitions on new debt on September 29, tightening the limits on Rosneft’s ability to finance major deals with U.S. partners. EU sanctions continue to target state oil firms like Rosneft rather than gas and remain an impediment. Rosneft’s debt to capital ratio has improved in the last year, a good sign for its fiscal health but not necessarily enough to avoid the byzantine dealing it went through for the privatization of shares last December. For its part, Aramco is set to benefit from up to $ 120 billion in debt Saudi Arabia is aiming to issue by 2020 as the country looks to increase its investments into renewables like solar. That debt alongside the IPO is likely to happen sometime late next year or early 2019 and will provide a dramatic infusion to state coffers to finance reform projects aimed at reducing Saudi Arabia’s oil dependency.
Aramco is set to take its trading operations further afield to begin trading non-Saudi crude oil with an eye towards feeding its growing range of refinery and petrochemical assets. The company is retreating to advance by targeting competitive moves into downstream projects and trading to minimize the effects of losses in market share. The issue remains that higher oil prices are needed for the IPO to maximize the money raised to finance projects like a $ 50 billion renewable energy initiative that would increase the amount of oil available for export.
Rosneft would also like higher prices, but has already sold all the shares it can while remaining a state-owned firm. CEO Igor Sechin is also fighting to undermine any institutional or informal constraints on his power in the country. Gazprom’s piped gas export monopoly, for example, is in his crosshairs. As a result, Rosneft has no time to waste. It’s going full bore, trying to acquire assets abroad to break out of the financial limitations of sanctions and grow and larger portfolio, expanding Russia’s foreign influence. There’s a reason the company has maneuvered in Venezuela, Kurdistan, and Libya in the last year.
Rather than count barrels, it would be best to consider how the two firms’ interests differ. Rosneft is feeding large amounts of military spending in Russia and is angling for greater power domestically. To a much greater extent, Aramco is the state in Saudi Arabia. It can afford a more measured approach given it always has the nuclear option: a radical break with production cuts and massive increase in production. As such, Aramco is preparing for an Asia-Pacific market where diversifying petrochemical assets will outweigh crude oil market share for profits. Rosneft is moving in the same direction, but may find that sanctions and domestic rivalry will hinder its attempts. Sechin has been on a winning streak for some time, but the elections may change things up. Aramco doesn’t have that problem looming on the horizon.