Publication: Eurasia Daily Monitor Volume: 3 Issue: 106

Moscow and Beijing have long hailed regional cooperation as an important element of bilateral ties. While meeting Volgograd Governor Nikolai Maksyuta on May 27, Wu Bangguo, chairman of the Standing Committee of China’s National People’s Congress (NPC), noted that the Volgograd region has enjoyed successful cooperation with China’s Jilin province (RIA-Novosti, Xinhua, May 27).

Meanwhile, Beijing appears to emphasize cooperation with Russia’s energy-rich regions. Notably, China’s State Bank for Development (CSBD) has begun to finance Chinese-owned companies in Sakhalin. According to bank vice-president Wang Yi, Sinopec Oil, as well as the Xinzhou and Chinese Engineering construction firms, have received loans from CSBD. On May 19, Chinese bankers met the first deputy governor of Sakhalin, Sergei Sheredkin, to discuss investment cooperation among the CSBD, Russia’s state-run Vneshekonombank, and the Sakhalin region.

Later this year, Sinopec is due to take part in exploratory drilling at one of the offshore oil fields on the Sakhalin shelf. Chinese firms are also building a Chinese trade center, hotel, and office complex in Yuzhno-Sakhalinsk. Both sides also discussed Chinese investments in the construction, oil, fishing, and forestry in the region. Preliminary negotiations on these projects reportedly started when Sakhalin governor Ivan Malakhov visited China as part of an official delegation led by President Vladimir Putin in March 2006 (Itar-Tass, RIA-Novosti, May 19).

A CSBD delegation spent nearly three weeks in Sakhalin, beginning in late April. At a meeting on April 26, deputy Sakhalin governor Vladislav Nikitin told them: “We will no longer just sell you raw materials, you should realize that we are interested in developing the processing industries.” However, Nikitin also said that local authorities are amenable to both Chinese direct investments and loans to Chinese companies in Sakhalin because the latter firms are registered in Russia and pay local taxes (PrimaMedia, April 26).

Russia has long indicated that China’s leading petroleum companies would be welcome in Sakhalin. Last summer, Russia’s state-owned oil company Rosneft and Sinopec, a subsidiary of the China National Petroleum Corporation, clinched a deal to launch a joint company for geological exploration of the Veninsky deposit, part of the Sakhalin-3 project (RIA-Novosti, July 1, 2005).

Now Rosneft is also considering export-oriented projects, including construction of a petrochemical complex at the Komsomolsky oil refinery in Russia’s Far East. According to Rosneft vice-president Stepan Zemlyuk, “This is an ideal variant for making products in good demand overseas” (RIA-Novosti, May 12). In the meantime, the Sakhalin-1 partners are also considering natural gas supplies to China.

Sakhalin-1 has estimated reserves of 2.3 billion barrels (307 million tons) of oil and 485 billion cubic meters of natural gas. Sakhalin-1 began oil production in 2005 and expects to begin large-scale oil shipments by the end of the year. However, commercial production in the Sakhalin-1 project has trailed that of another major Russian off-shore project, Sakhalin-2, which has reserves of some 150 million tons of oil and 500 billion cubic meters of gas. Oil production at Sakhalin-2 started in 1999. The second stage includes gas production and liquefaction at a new liquefied natural gas (LNG) plant on Sakhalin with projected annual capacity of 9.6 million tons.

In July 2005, Royal Dutch/Shell nearly doubled cost estimates for Sakhalin-2 — up to $20 billion — and postponed the first LNG shipment from the end of 2007 to summer 2008, citing technical complications. The Russian Industry and Energy Ministry postponed approval of the new budget to study the reasons for the higher costs. Expert analysis of the rising costs at Sakhalin-2 should be completed over the summer, according to Russian Energy Minister Viktor Khristenko (RIA-Novosti, May 18).

Meanwhile, in an ominous sign for Western investors in Sakhalin, the Russian Academy of Natural Sciences submitted a report to the Natural Resources Ministry claiming that delays and inefficiency by foreign companies had cost Russia over $10 billion. The academy called for production-sharing agreements (PSAs) to be revised to give Russian companies a 51% stake. Although the Russian Academy of Natural Sciences is separate from its better-known counterpart, the Russian Academy of Sciences, the government took notice of its advice.

The Russian Natural Resources Ministry is considering a recommendation to slash foreign oil majors’ stakes in the Sakhalin-1 and Sakhalin-2 energy consortiums and give Russian companies majority control. Ministry spokesman Rinat Gitazulin said that he agreed with the academy’s evaluation of foreign companies’ inefficiency. “We believe that [Russia] is losing money” (Moscow Times, May 26).

Furthermore, the Kremlin now seems to be trying to regain control over strategic energy resources. The Natural Resources Ministry was also reported to be mulling restrictions on foreign investment in subsoil resources. It reportedly has drafted a bill that would limit foreign investment to 50% in the development of hydrocarbon fields with more than 50 million to 100 million tons of oil or 500 billion cubic meters of gas. The proposed lower limits had previously been 150 million tons for oil fields and one trillion cubic meters for gas fields (Vedomosti, May 25).

State-owned Rosneft has a 12% stake in Sakhalin-1, while Russia’s gas monopoly Gazprom has been in negotiations to acquire a 25% stake in Sakhalin-2 in an asset swap with Shell. Gazprom planned to buy all gas from Sakhalin-1 for re-export to China and Korea. The report said Gazprom wanted ExxonMobil to sell all of its gas, so that Gazprom could re-export the gas to China and Korea, thereby making sure it remains the sole Russian gas exporter (Vedomosti, April 25). Gazprom refrained from commenting on the report.

It remains to be seen whether the Kremlin’s drive to regain control over Sakhalin energy resources could entail revision of the PSAs there. However, stronger government controls would mean a friendlier business climate for current and future Chinese investors there.