CHINA/RUSSIA: OIL-FOR-LOANS DEAL STILL IN THE

C O N F I D E N T I A L SECTION 01 OF 04 BEIJING 000625 SENSITIVE SIPDIS STATE PASS USTR FOR STRATFORD E.O. 12958: DECL: 03/10/2019 TAGS: ECON ENRG EPET EFIN CH RS SUBJECT: CHINA/RUSSIA: OIL-FOR-LOANS DEAL STILL IN THE PIPELINE REF: A. MOSCOW 528 ¶B. BEIJING 592 Classified By: Economic Minister Counselor Robert S. Luke for Reasons 1 .4 (b/d) SUMMARY -------------- ¶1. (C) After months of negotiations, China and Russia appear closer to reaching an agreement on the expansion of the East Siberia-Pacific Ocean (ESPO) Pipeline to northeast China. A USD 25 billion oil-for-loans agreement announced in mid-February will, if finalized, provide much-needed liquidity to debt-ridden Russian pipeline and oil companies, while also reducing China's reliance on imports from the Middle East and further extending China's energy security at a time when domestic oil supplies are nearing maximum production. Embassy contacts report that the deal is commercially-driven and that terms of the agreement will be market-based, but key details about the deal are elusive. Issues that have reportedly plagued previous attempts to reach an agreement - including oil pricing mechanisms, loan interest rates, and repayment arrangements - remain under negotiation, and embassy contacts, including one member of the Chinese negotiating team, predict that the final approval process could be slow. END SUMMARY China, Russia announce USD 25 billion oil-for-loans agreement -------------- -------------- ¶2. (C) After months of negotiations, China and Russia appear closer to reaching a detailed agreement on the expansion of the East Siberia-Pacific Ocean (ESPO) Pipeline to northeast China (Ref A). Chinese Vice-Premier Wang Qishan and Russian Deputy Prime Minister Igor Sechin reached a preliminary intergovernmental USD 25 billion "oil-for-loans" agreement in Beijing on February 17. China National Energy Administration Department of Oil and Natural Gas Director Dr. Yang Lei confirmed that commercial agreements have also been signed by the parties involved, but added that the terms of agreement remain either confidential or still under negotiation. ¶3. (SBU) According to media reporting, Russian state-owned oil company Rosneft and oil transport company Transneft have each signed long-term agreements with China National Petroleum Corporation (CNPC) and China Development Bank (CDB),a Chinese policy bank in the process of becoming a commercial financial institution. The Export-Import Bank of China (Exim Bank) will reportedly also contribute to the loan package. Under the agreements, CDB will loan USD 10 billion to Transneft and USD 15 billion to Rosneft, collateralized by an agreement to supply approximately 15 million metric tons of crude per year over twenty years (the equivalent of 300,000 barrels/day) to CNPC via pipeline. Transneft will construct a 67 km pipeline spur linking the East Siberia-Pacific Ocean (ESPO) Pipeline from Skovorodino to Mohe terminal in China's northern Heilongjiang Province, while CNPC will construct a 960 km pipeline to transport the oil from Mohe to Daqing, China's largest oil field, where it will connect with the broader Chinese pipeline system. "Go Out" policy bolstered by economic crisis -------------- ¶4. (C) The oil-for-loans agreement reached with Russia is one of several recent high profile international energy and minerals deals financed by CDB in support of China's "Go Out" (zouchuqu) policy, which encourages capable firms to invest abroad to promote China's economic development. Initial formulations of the policy focused on investment overseas to secure brands, distribution channels, management expertise, and technology. The latest wave of Chinese outbound investment is overwhelmingly focused on the natural resources sector, although the local Chinese press has been full of commentary, some contradictory, by various government and private sector officials about the sectors in which China should encourage overseas investment. ¶5. (SBU) Beijing-based economist Arthur Kroeber concluded in a recent report that Beijing seems to have decided that the BEIJING 00000625 002 OF 004 "time is ripe to move aggressively to lock in resource assets. Loans collateralized by guaranteed oil deliveries appear to be China's new tactic of choice," the report stated. According to Caijing Magazine, a well-regarded Chinese economic journal, CDB is now working as the primary lender for some USD 60 billion in credit packages. Two other major deals in progress involving CDB and Chinese state-owned oil companies include a USD 10 billion loan to Brazil's Petrobras for a guarantee of 100-160,000 barrels/day, and a USD 4 billion loan to Venezuela's PDVSA in exchange for a supply of 80,000-200,000 barrels/day. CDB is also reportedly involved in financing the state-owned Aluminum Corporation of China's (Chinalco) controversial bid for a stake in Anglo-Australian mining giant Rio Tinto (Ref B). ¶6. (C) Zhang Guobao, Head of China's National Energy Administration (NEA) and Vice-Chairman of the National Development and Reform Commission (NDRC) announced in February that "the (economic) slowdown has reduced the price of international energy resources and assets, and favors our search for overseas resources." Although the broader Chinese economy has been hard hit by the crisis, China's major state-owned commercial and policy banks have had less exposure to global financial markets and remain well-positioned to finance China's leading state-owned enterprises' (SOEs) overseas projects and investments. Arthur Yan, of Cambridge Energy Research Associates' (CERA) Beijing office told Econoff that most of the recently announced deals would not be possible without Chinese policy banks and high-level support from the Chinese government, including the State Council and the NDRC. "Deal benefits China, Russia; boosts global energy security" -------------- ¶7. (C) CNPC International Department Director-General Zhang Xin called the deal a "win-win" agreement, noting that it would serve both countries' economic interests, including by supporting Russia's market diversification goals, and added that it would also enhance global energy security by bringing more oil to the market. CERA's Yan and Dr. Zhao Hongtu, Research Professor at the Institute of World Economic Studies at the China Institutes of Contemporary International Relations (CICIR),told Econoff in separate meetings that the deal would also strengthen China's energy security by reducing its reliance on oil imported by tanker through the Strait of Malacca from the Middle East. (Comment: Imports satisfy about 50 percent of China's oil consumption, a figure that is expected to rise as domestic fields reach peak production. Beijing believes tanker shipments could be threatened in the event of a crisis in the Taiwan Strait or the Middle East, and oil channeled by pipeline from Russia could therefore play an important energy security role. End Comment.) ¶8. (C) Zhao also noted that recent long-term oil supply deals will also reassure Chinese energy planners concerned about the impact of market volatility on oil supplies. "Chinese energy policy makers don't trust the market. They hold a lot of conspiracy theories," he explained. (Comment: A long-term supply contract does not necessarily constitute a supply guarantee and it appears that the current deal is simply an agreement to make oil available to sell to CNPC. That said, given the alternative of shipping oil at a high cost from the Russian Far East to other markets, Russia would have a significant incentive to increase oil exports to China once production is at full capacity and the pipeline is fully operational. End Comment.) Chinese approval "shouldn't be a problem," but Russia may "need more time" -------------- -------------- ¶9. (C) CNPC DG Zhang and Russian Embassy Economic Counselor Sergey Yakimets informed Econoff separately that commercial details would be worked out in the coming month and that the agreements should be concluded by the end of March. Other Embassy contacts, however, predicted that more time would be needed. NEA's Yang told econoff that although an agreement had been signed between Wang and Sechin, it was not finalized BEIJING 00000625 003 OF 004 and would still require formal approval by both governments. Yang predicted that "China's approval would not be a problem but that Russia would likely need more time to officially approve the deal," suggesting that Russian negotiators may not yet be satisfied with China's proposed terms and that further negotiations could be protracted. CERA's Yan, an advisor to CNPC and other Chinese state-owned oil companies, also predicted that deal negotiations would be unlikely to move forward quickly. China not dependent on Russian oil -------------- ¶10. (C) CICIR's Zhao underscored that China by no means views itself as dependent on Russia for oil. "International oil markets are better integrated than in the past, so China can source its oil from anywhere in the world. China would not agree to a deal with Russia unless there were clear benefits," he stated. NEA's Yang, who participated in the deal negotiations, also stressed that China does not need to acquire Russian oil in the near-term since oil is available in other markets. Yang observed that during the latest round of negotiations, the Russian delegation "portrayed themselves as doing China a favor by supplying it with oil." From China's perspective, "Russia is not doing anyone a favor...It's a commercial deal and China will pay the Russian companies a fair price," Yang asserted. Commercial Details remain elusive -------------- ¶11. (C) CNPC and NEA contacts report that details involving oil pricing, loan disbursement, and loan interest rates are either confidential or remain under negotiation. Dr. Zha Daojiong, Director of People's University's Center for International Energy Security and an advisor to the Chinese Government on energy security issues, told Econoff that, given all of the "unknowns" at this point, it is still too early to tell whom the deal would benefit in the long and short-term or whether the deal will ultimately move forward at all. Zha noted that there have been many cases in which energy supply deals with Russia have been hindered due to the inability to reach agreement on details such as pricing. "I hope the Chinese government has thought this through very carefully," he said. Russian Embassy economic counselor Sergey Yakimets also acknowledged that disagreements on pricing and interest rates had hindered previous deals and noted that ongoing commercial negotiations would have to carefully address such issues. Interest rate, loan disbursement mechanism, and repayment details still murky -------------- -------------- ¶12. (C) Caijing Magazine reported March 9 that the two sides had agreed to adopt a partially floating interest rate pegged to the Libor rate using a special pricing mechanism to hedge against extreme fluctuations. According to Caijing's sources, the rate is expected to float between 6 and 7 percent. NEA's Yang declined to confirm interest rate estimates published in the media and was also unable to comment on loan disbursement plans. Yang told Econoff that CDB considers this a commercial loan and therefore, the interest rate would "follow international market rates." Depending on how the loan is structured, CDB should be able to profit from the loan, but many questions remain unanswered. CICIR's Zhao pointed out, for example, that it is unclear how the loan will be handled if either Russian party fails to hold up its end of the agreement. The deepening economic crisis could reduce the Russian companies' ability to complete the oilfield and pipeline infrastructure needed to bring the oil online in an agreed upon time frame, he explained. No clarity on pricing details -------------- ¶13. (C) NEA's Yang told Econoff the oil price "would not be fixed," and that it would be "based on international prices," but he was unable to elaborate further. As noted in reftel A, media reporting suggests that loan repayments will be linked to oil supply contracts, yet the exact mechanisms BEIJING 00000625 004 OF 004 linking oil and loan repayment remain unknown, with the key variable being the price of the oil. China-based energy analyst Ahmad Abdallah stated in a recent research note that it is almost certain that the widely-quoted figures of USD 20 and USD 73 a barrel are wrong. Abdallah calculated that the lower figure incorrectly assumes that the loan value is the oil purchase price; the higher figure is implausible because it is the highest price on the current forward curve, and fails to take account of the value of the loan and interest payments that should be netted out. Comment: This could take awhile -------------- ¶14. (C) Comment: China-Russia energy deals have been hindered in the past by diverging views on pricing and interest rates. Despite optimism last October that an agreement on the pipeline deal would be finalized by the end of 2008, talks were suspended in November reportedly due to a failure to reach agreement on loan terms and a pricing mechanism. In the latest round of negotiations, Russia was under far more duress to borrow than China was to lend. This is not a new story. The last time that Rosneft borrowed under duress from China in 2005, both parties found themselves back at the negotiating table just a couple of years later due to changing market conditions. In light of this history, there are clear incentives for both sides to structure a deal this time around to account for a range of eventualities, including major oil price swings. Negotiating the final crucial details on such a complex deal could take several months. End Comment. PICCUTA