TCS Daily


Pipe Dreams

By Dominic Basulto - June 6, 2003 12:00 AM

Russia, the world's second largest oil exporter trailing only Saudi Arabia, has been itching for years to expand its global reach and oil export capacity. In just the past nine months, Russian oil tycoons have floated a number of proposals to leaders from Japan, China, Western Europe and even the United States about the construction of new pipelines that would allow these nations to reduce their dependence on Middle East oil exports. In late May, Russia finally signed an historic, 25-year, $150 billion energy pact with China. The deal will commit Russian oil major Yukos to deliver 600,000 barrels of crude oil daily via a soon-to-be-built new $2.5 billion, 2,400-kilometer pipeline stretching from Angarsk in eastern Siberia to Daqing in northeast China. So is Russian oil finally ready to play in the big leagues, or are these just pipe dreams?

While the Russian-Chinese pipeline is certainly a landmark deal, there have been other clear signals that the Russian oil industry is ready to compete head-to-head with the world's oil leaders. In February 2003, BP sank $6.75 billion into TyumenNefteGaz (TNK) for a 50% equity stake - a move that the New York Times recently characterized as "Russia's oil deal of the decade." Privately, BP officials noted that TNK could be able to start shipping oil and gas to China. Then, in April 2003, there was the blockbuster $15 billion merger of Yukos and Sibneft that created the sixth largest publicly traded oil & gas producer in the world, trailing only Exxon Mobil, BP, Royal Dutch/Shell, ChevronTexaco and TotalFinaElf.

As if these steps were not enough, along comes fusty Warren Buffett, the "Sage of Omaha" who recently paid close to $400 million for 2.4 billion shares in Chinese oil company PetroChina, which is a 88.7%-owned subsidiary of Chinese state oil giant CNPC (China National Petroleum Corporation). Since only 11.3% of PetroChina's total shares are exchange-traded, Buffett owns approximately 13.4% of all listed shares and 1.3% of the total share capital. At the most recent Berkshire Hathaway shareholder conference in May, pundits quizzed Buffett about his stake in the Chinese oil industry. At the time, it was a curious move. After all, Buffett is known more for his well-timed bets on companies like Coca-Cola and Gillette, not for exotic oil plays. Even hedge fund managers based in Hong Kong appeared puzzled by Buffett's investment.

Now it is all clear. CNPC - along with Russian state-owned pipeline monopoly Transneft - will have exclusive rights to develop the new $2.5 billion Trans-Siberian oil pipeline connecting Russia and China. In other words, Buffett's gambit was not a Chinese oil play - it was a Russian oil play. The new pipeline will route over 600,000 barrels of crude oil per day to China. The economics of the arrangement are staggering - crude oil goes for $5/barrel in Russia and $30/barrel on the world energy markets. Even if CNPC pays a significant premium for Siberian crude, it stands to make billions of dollars selling oil to the energy-starved Chinese economy. With a parent like CNPC, PetroChina looks like a sure bet on the future economic development of China.

And there are more deals on the way, if the chatter from the Russian oil industry is any indication. While all eyes have been turned to Iraq and its rich oil fields, the world's oil majors have been lining up deals in the Far East. After all, guess who owns 20% of the publicly traded shares of PetroChina? That's right - BP Amoco, the same company that recently paid close to $7 billion for a 50% stake in Russian oil giant TNK. There are even plans on tap to extend the Trans-Siberian pipeline to Japan (which relies on the Middle East for 88% of its oil supply) and, if all goes well, the construction of a natural gas pipeline connecting Russia, China and Korea. Warren Buffett may be eating beluga caviar and drinking Cristall vodka for a very long time if his (indirect) investment in Russian oil pays off.
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