China and Russia Do Business

This is interesting, and will almost certainly get more so:

China has agreed to lend Russian oil companies $25 billion in return for supplies from huge new East Siberian oilfields that will power its economy for the next two decades, a source close to the talks said today.
Russia’s state oil champion Rosneft and pipeline monopoly Transneft signed a long-delayed deal to borrow the money from China Development Bank during talks in China, the source told Reuters.

Beijing has abundant cash that Moscow needs to access in the credit crunch as its government is running major deficits and some of its companies are finding it difficult to repay loans and borrow project finance on commercial markets.

“Rosneft and Transneft can’t borrow easily, so China steps in … with a lot of funds to lend because of China’s huge wealth funds,” said Leo Drollas, deputy director and chief economist at the Centre for Global Energy Studies.

“They have trillions of dollars of reserves and they’re saying ‘we’ll lend you this amount to develop the oil fields and the pipeline infrastructure needed’ and it will be paid for by deliveries of oil,” Drollas added.

In short, China has placed $25bn worth of expectation onto the shoulders of the Russian government.  If the oil flows as promised, it will be an agreement of great benefit to both parties.  But will Russia be able to deliver?

Maybe, but it might be tricky.  For starters, what any sum of money is supposed to get you in Russia invariably ends up being not enough.  Accept a bid of $20m and you end up spending $33m.  Budget a project at $10bn and the final cost comes in at $22bn.  Everyone in Russia knows that money does not go half as far as you think it does.  So where does it go?  Mostly navigating the myriad, often contradictory, laws, regulations, approvals processes, and bureaucracy which are deep rooted throughout Russia; rules which are changed arbitrarily and often, sometimes retroactively, and to top it all off, inconsistently applied.  Obtain MChS approval for the design of a building, build it as per design, and the same authority will refuse to grant you a fire safety certificate upon construction completion because the authorising individual has a completely different interpretation of the requirements than the bloke who approved the design.  Bring in a third party, and he’ll tell you they were both wrong.  Companies either spend millions on complying with Russian regulatory requirements, or they spend millions to avoid having to.  A handful of individuals get rich, projects cost twice as much as they should, Russia is all the poorer.

Of course, there is the possibility that this being a Russian-run project of significant national importance the usual regulatory and legal requirements will be waived and the project ram-rodded through to completion regardless.  But even this is doubtful.  Consider the two posts I wrote recently on doing business in Russia, particularly the second one where I list the 54 different bureaucratic hoops you have to jump through to get a warehouse built in Moscow.  An outsider would be forgiven for thinking these vast rules and regulations all stem from a single, monolithic government body which has complete control over the entire process, but the truth is that it is far more complicated.  Various government agencies and approvals bodies operate in quasi-independence from central government, and this is especially true in the provinces far from Moscow.  Often run as personal fiefdoms the agencies build, cherish, and protect the power and authority - and hence the revenue stream – that they enjoy.  As a result, they are often unwilling or unable to implement reforms or changes dictated from Moscow, and sometimes the applicable laws in the provinces are months and even years behind what the actual law is supposed to be.  Tales abound in the expat communities of the dozens or regulatory and state bodies which businesses must deal with implementing laws which differ from those which are officially in place.  Either deliberately or through poor management and communication, Moscow has only limited control over the dozens of provincial offices whose cooperation is essential to getting a project completed.

So in practice, even on a job which is considered priority for the government, the construction company – whether Russian or foreign – is faced with enormous delays and overspends as they try to negotiate through the approvals process at every point and turn.  It is true that the government could, and almost certainly will, intervene in certain areas to speed things up (for example, it is unlikely that the environmental consultation on the new gas pipeline being built from Sakhalin to Vladivostok by Gazprom was as lengthy and detailed as that for the foreign-led projects), but they cannot do so in every instance.  And even then their intervention might not speed things up.  A building contractor on Sakhalin told me that a recent law forbids any change orders on government construction projects: if something changes which causes a price increase, the entire job – even half complete – must be rebid.  So if a construction company arrives on site and find their piling estimate was too low due the the geotechnical survey being incomplete at the time of tender, the job gets stopped as they re-tender the entire project.  No doubt this law was brought in to try to mimise corruption on government projects, but if it is applied we can expect to see either 200% contingencies in bid prices or even simple projects dragging on for decades.  The sheer complexity of the laws and bureaucracy makes executing works in Russia much harder than it should be, and it is doubtful whether this has been fully considered – assuming it even could be quantified – when calculating what the Chinese $25bn is supposed to be buying.

In any case, we won’t have to wait too long to find out:

Also planned is a spur pipeline between China and Russia, which is part of the loan-for-oil agreement under which China will provide $25 billion to Russia’s Rosneft and Transneft in exchange for 300,000 bpd of oil imports from Russia for 20 years.

Russian Prime Minister Vladimir Putin said in early April that Transneft will finish laying the 67-kilometre East Siberia-Pacific Ocean oil pipeline from Skovorodino to the Chinese border within a few weeks, with work on the line expected to be complete in 2010 in time for crude to start flowing the following year.

The pipeline was originally due for completion last year but has been delayed due to political complexities and internal housekeeping issues with Russian suppliers.

What’s that?  Political complexities and internal housekeeping issues with Russian subcontactors?  That’s the diplomatic description of what I’ve just been talking about.  The Russians might want to consider the possible consequences of oil not arriving in China when it is supposed to after taking a $25bn loan to make sure that it does.

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3 Responses to China and Russia Do Business

  1. L.S says:

    Sorry for commenting on something else Tim, but I thought you might find this Interesting. The Royal Navy is visiting St.Petersburg
    http://www.fontanka.ru/2009/06/23/096/ (news)
    Photos:
    http://www.fontanka.ru/2009/06/23/096/picture.1.html
    I saw that yesterday and it looked awesome on the Neva on a rare St.Petersburg sunny day.
    Thanks for your interesting posts, as usual.

  2. L.S says:

    I like this one
    http://www.fontanka.ru/2009/06/23/096/picture.4.html
    (You need to click on the little arrow to navigate through the pics)

  3. Pingback: White Sun of the Desert » Business as Usual in Russia’s Oil and Gas Sector

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