The China factor: why Russia is still betting big on oil

At a time when much of the West is planning an exit from fossil fuels, Russia is proceeding with an enormous oil project. One key reason is China, which doesn’t see a swift energy transition as a realistic path and could drive global oil demand in the medium term, South China Morning Post analysed

The pandemic has boosted the global appetite for renewables, yet Russia is focusing on its colossal Vostok Oil project, which promises to be one of the largest fossil fuel production projects in the history of the country, comparable in size with the production in West Siberia in the 1970s.

Rosneft, Russia’s biggest oil company, has started holding meetings with foreign contractors and suppliers for the project, which is valued at up to $170 billion.
The project is expected to employ hundreds of thousands of workers, create 15 industry towns and build around 800 km of new pipeline.

Given the ongoing renewable energy boom and predictions by the likes of BP that global oil demand is unlikely to recover to pre-pandemic levels, a natural question arises:

why is Rosneft implementing such an enormous project at a time when much of the West is planning an exit from fossil fuels?

There are a number of explanations, from economic factors to Rosneft’s hopes that the project could yield lower-emission oil – but one of the main variables in the success of a project like Vostok lies in Chinese economic and energy policy.

Russia has always relied on its fossil fuel resources: indeed, the wealth and economic stability of contemporary Russia is tied to its status as a petrostate.

Today, Russia is the 3^rd-largest oil producer, accounting for over 12% of global crude production.

Its economy is thus heavily reliant on oil export revenue, and Russia’s long-term prosperity as an energy superpower depends on the prolonged stability of oil prices and the global demand for Russian oil.

It’s unsurprising, then, that even as blocs like the EU outline plans for an emissions-free future, Russia believes fossil fuel demand will continue to grow in the medium term and Russian companies such as Rosneft are not winding down their production projects.

The oil giant aims to begin shipping oil from the Vostok project as soon as 2024 via the Northern Sea Route.
It is estimated that the project could produce as much as 30 million tonnes of oil in 2024, and annual production could reach 100 million tons by 2030.

Theoretically, the project could compensate for the gradual depletion of Russia’s existing oilfields in West Siberia and allow it to maintain its oil-driven income.
This would naturally require sufficient oil demand around the world, at a time when much of the West is focused on the transition to renewables.

Rosneft CEO Igor Sechin has argued that there is plenty of demand to support the project.
During a panel session at the recent St Petersburg International Economic Forum, Sechin pointed to the manner in which oil demand is bouncing back rapidly in the wake of the pandemic, arguing:

The long-term stability of oil supply is at risk due to underinvestment

He also suggested that oil from the Vostok Oil fields could be particularly attractive at a time when there is an intense focus around the world on the need to decarbonise, since oil from the project is expected to yield up to 75% lower emissions compared to other new oil projects.

Another persuasive reason Sechin offered for the project’s profitability was a reference to China’s continued need for hydrocarbons.

Indeed, Chinese economic and energy policy is one of the key reasons a project like Vostok Oil exists.

In a recent announcement that was largely overlooked by the international press but could nevertheless have huge repercussions for international energy markets, China said it would drop wind and solar subsidies.

The logic behind the decision suggests that the cost burden of the subsidies could become unsustainable for the Chinese economy.

Still, without them, renewables will find it hard to compete on price alone.

Chinese energy experts also recently drove home the message – a troubling one for the environment – that Beijing doesn’t see a swift energy transition as a realistic path.
Dismissing the IEA’s zero-emissions pathway as failing to differentiate between developed and developing countries, the experts said China would have to match energy demand growth with renewables, while relying on fossil fuels to fill the supply gap.

Beijing’s willingness to place its economic ambitions over environmental concerns is likely, therefore, to drive global oil demand in the medium term.
Even after fossil fuel demand eventually peaks in the transport sector, China’s rise as a petrochemical powerhouse and the growing demand for plastic worldwide go a long way towards explaining why projects like Vostok Oil are still of great importance.

Indeed, China’s economic policy suggests that Russia could be less susceptible to oil price shocks than previously expected in the short to medium term.
Stable oil demand and investments in the new project could also allow Russian companies some time to fill the vacuum being left by other oil giants, such as Shell, which are shifting away from fossil fuels.

A more complicated question is how long China’s economic growth can support parallel growth in oil demand as many countries accelerate their long-term transitions to green energy sources.
Vostok may be a sound investment, but could it be the last of its kind?

Author: Dmitriy Frolovskiy