Russian Oil Rivals Fighting Hard to Extract Best Deal From New Pipeline Law

Five months after the Druzhba pipeline contamination fiasco—in which chlorides-heavy petroleum from Russia was sent into the Belarusian and European pipeline networks, causing $800 million in damage (see EDM, April 26, July 23; Commentaries, May 1, June 21)—the economic fallout has pit two Russian oil giants against one another regarding long-overdue transmission-system regulations in the country. The state-owned combatants are Rosneft, one of Russia’s major producers, which sends millions of barrels of oil through the pipeline network, and the transmission monopoly, Transneft. The battle also, naturally, involves the high-profile and Kremlin-friendly heads of both enterprises—Rosneft’s Igor Sechin and Transneft’s Nikolai Tokarev. Although the Russian Ministry of Energy has the authority to decide how Russia’s pipeline system will be regulated, ultimately President Vladimir Putin will make the decision. And both Sechin and Tokarev are his protégés.

The Rosneft-Transneft feud is occurring against a backdrop of the State Duma (lower chamber of the Russian parliament), once again failing to pass a pipeline-transmission law, two decades after the first version was introduced though never adopted (TASS, August 30).

The most recent escalation of the dispute came in the form of a letter Rosneft Chairperson (and former chancellor of Germany) Gerhard Schroeder sent to Prime Minister Dimitry Medvedev in August, asking for several specific pipeline-regulation provisions (News.ru, August 27). These new rules were necessary to restore the damage that the Druzhba debacle did to Russia’s reputation as a reliable oil supplier, Schroeder said. One of the suggested provisions would be a six-fold decrease in the amount of chloride that oil in Russian pipelines could legally contain. This past spring, the oil in the Druzhba network in Belarus and Ukraine—whose systems connect with Western Europe—became so contaminated with these compounds that the pipeline had to be completely shut down and cleaned. The disruption cost Rosneft, Transneft and the Belarusian and Ukrainian pipeline systems hundred millions of dollars (see Commentaries, May 1).

Another Schroeder proposal was for Russia to establish an independent pipeline quality-control agency. In turn Transneft, concerned that its customers could be asked to pay higher transmission taxes to fund this new agency, responded by demanding that oil producers cover the regulatory body’s bills. Notably, Schroeder also asked Medvedev for more transparency and accountability at Transneft, the world’s largest oil pipeline company (News.ru, August 27). In other words, Rosneft and Transneft are each seeking to secure pipeline regulations that would be most beneficial to their own business models but with no regard for how they might affect any other industry players.

As noted above, even though Russian lawmakers introduced the country’s first pipeline-regulation bill 20 years ago, Russia ultimately never adopted a final law on the matter. At Transneft’s request, Putin became involved in 2015, asking the Ministry of Energy to update the original legislation to meet the changed energy picture. But despite Putin’s personal intervention, the law remains unpassed (RBC, December 12, 2018). The ministry was supposed to hold its latest round of hearings on the legislation in September 2019.

The pipeline-regulation law will set the conditions under which producers connect to the domestic pipeline network; moreover, it is supposed to establish a transmission fee structure. Another feature will be a pipeline infrastructure investment strategy, whose main objective is to add capacity to the network. The most recent draft of the law includes several contentious provisions. One would grant Transneft the sole authority to build or repair pipelines in Russia. This would presumably include Rosneft’s pipelines, which deliver the oil it pumps from its fields to processing terminals. Meanwhile, Rosneft wants the same tax exemption on its pipelines that Transneft already receives. At the moment, only trunk lines are exempted. Rosneft additionally wants all oil producers to have equal access to Russia’s main pipeline system. This would mean preventing Transneft from favoring some customers over others.

A key reason why Rosneft is currently energized about the transmission law is that the right regulatory formula could boost its profits at a time when the company faces stiff economic headwinds. Unlike Gazprom, Rosneft does not own a domestic pipeline system—it pays Transneft to deliver its oil. Those fees have become more burdensome as global oil prices have remained relatively low. In addition, a recent change in Russian law has shifted the energy tax burden from oil exporters like Transneft to producers like Rosneft (Petroleum Economist, July 29). Compounding this situation, Rosneft’s expenses are growing due to the fact that accessing new oil fields is costlier because fresh reserves are increasingly located in challenging locations like deep water or the Arctic.

As Schroeder’s letter suggests, Rosneft has no problem sending written policy requests to the top when it thinks it will work. A letter that Sechin, the company’s CEO, wrote President Putin in December 2018 asked that Russia back away from its policy of limiting oil production under the OPEC+ agreement, which was reached last summer with Saudi Arabia (Vzglyad, February 8). And in that same letter, Sechin asked Putin for the continuation of a tax exemption for the Priobskoe field in West Siberia—a request that was granted. Rosneft owns three-quarters of the field and Gazpromneft controls the rest.

The key takeaway from the Druzhba-precipitated Rosneft-Transneft feud is that Russian oil companies are looking at every possible way to ease the difficult financial situation they are facing. In addition to volatile oil prices, Western sanctions have hammered them. Not only are they scrambling to find financing for production projects, they are also trying to lower their taxes, including shifting the burden to others in the industry.