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Transneft’s luxury pipe is turning VSTO into a “black hole”

27 Apr '09
Oleg Kouzbit, Online News Managing Editor

In February Marchmont reported on cost overruns plaguing Transneft’s East Siberia – Pacific (VSTO) oil pipeline project. In late April Transneft claimed it needed yet another 9%. As the company races to complete its December deadline for commissioning the pipeline, it may be forced to pump even more money. A likely source could be its portion of China’s expected $25bn money-for-oil loan.

Cost overruns of more than 60%

On February 26, 2009 Marchmont reported that VSTO management’s investment estimates for the first project stage—just the pipe alone—had mushroomed from $8.9bn to $10.8bn (click here, February 26, 2009).

Just two months later word came that Transneft needed another 9%. This will bring the estimated construction cost of the first VSTO stage to $14.4bn (including both the pipe and construction of an oil-loading terminal in Kozmino Harbor on the Pacific coast, Transneft said).

The background

The VSTO pipeline project is being built to deliver Russian oil to the promising Asian-Pacific market. The first state of the project, to be completed by December 25, 2009, calls for the laying of a pipeline section from Irkutsk Region’s Taishet to Amur Region’s Skovorodino with a throughput capacity of 30 million tons of crude a year, and construction of the Kozmino terminal.

The project has a long history. It was conceived in 2003 when two pipeline project ideas for Russia’s Far East were merged into one. It took until 2004 for the government to approve the deal, but then concern from environmentalists about possible damage to the Lake Baikal area forced Transneft to add 500-km to the project. With this hurdle completed, construction began in earnest.

The art of milking

According to Russian newspaper Vedomosti, in Q2 2004 when the first tentative financial forecasts for VSTO came out, overall project expenses were estimated at approximately $5.5bn.

At the beginning of 2009 the first stage project budget was set at $13.2bn, including $10.8bn for the pipe and the rest for the oil-loading terminal.

It was not the first or only time project costs far outstripped estimates.

The extra cost of re-routing the pipeline around the fragile Lake Baikal ecosystem, Vedomosti reports, had the cost of VSTO’s first stage skyrocket from its original $5.5bn to $11.7bn in Q2 2006 (at the then rate of 26 rubles per dollar).

Between July 2006 and December 2008 budget estimates were growing almost in sync with Russia’s unrestrained 30.7% inflation.

Transneft has adamantly claimed that the cost can’t be lower than $11.8bn even using current dollar rates, and insists it will need more.

The RF Audit Chamber has audited Transneft books and despite its ever-increasing budget requests found no misappropriations or embezzlement committed, according to Vedomosti, except a few “petty crimes” like running the project for one month without approved investment or paying out to minor subcontractors an unregistered $170k over several years.

Having passed its government audit, Transneft is counting on the Kremlin to keep the cash flowing to meet its December deadline. The big question: how important is it to the RF government that the deadline be met? If the project can be slowed down, the cash burn will be reduced as well as efficiency.

Borrowing from Peter to pay Paul?

There’s one more factor to consider. In mid-February 2009 a bilateral governmental agreement was inked stipulating construction of a VSTO branch to China.

Under this deal the Chinese party is expected to loan Russia’s Rosneft (the chief oil provider) and Transneft (the VSTO builder) $25bn in exchange for 15 million tons of oil a year for 20 years (click here, February 20, 2009).

Rosneft reportedly signed a delivery contract with Transneft earlier this month to make sure the latter completes its $10bn portion of the work under the $25bn commitment.

The cost of the Chinese branch of the pipe has been set at $280m. Transneft hasn’t revealed if it plans to use any of its Chinese loan to pay for part of its cost overruns. But if the Kremlin turns it down, it’s a new well they could tap.
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