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Home / Issue Archive / 2011 / February #2 / Cooperation Between Russia and China in the Energy Sector Interests, Problems and Prospects

№ 2 (February 2011)

Cooperation Between Russia and China in the Energy Sector Interests, Problems and Prospects

   Unlike the U.S.-China axis, where the two sides compete for global energy resources, on the industrial and food markets, and in the future may become rivals on the financial services market, links between the Russian and the Chinese economies structurally complement each other; besides this, huge deposits of Russia’s primary resources are geographically close to the Chinese border.

By Andrei Korzhubaev

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Options for Cooperation

   China uses its significant investment reserves to acquire primary resources globally, wherever possible. This strategy targets several issues: access to real assets that will grow in price, unlike the financial assets; ensuring energy security of the own economy; and creating an opportunity to establish a foothold in the host country for studying the political and economic environment.
Russia has several options of using its natural resources, which constitute a significant part of the global reserve:
supply of raw materials for sale at the point of manufacture (the African scenario);
sale of raw materials at the border (the Central Asian scenario);
sale of raw materials using “delivery to the customer” option (the Middle Eastern scenario);
processing raw materials domestically or joining refining and sales in the buyer country (the Canadian-Australian scenario).

   Today’s Russian oil and gas business encompasses all four options presented. Which of these will dominate in the development of large-scale energy cooperation with China will depend on the state’s industrial and regional strategy and governmental and business position on the issues of international trade and foreign investment.

Russia’s Interests

   Russia ranks first in the world in oil and gas production. The bulk of its volume is delivered to international markets. In 2010, oil and gas production reached almost 1.1 billion TOE (in terms of oil by energy value), including 505 million tons of oil and 650 billion cubic meters of gas; oil and oil products export topped 370 million tons, gas export – 185 billion cubic meters (Fig. 1-2).

   West Siberia is currently the key hydrocarbons (HC) production area, producing some 70 percent of Russian oil and over 90 percent of the country’s gas. In the future, East Siberia and the Far East will become new major centers for oil and gas industry.

   Russia’s interests, based on its ongoing geopolitical and economic goals, regional developments in the global economy, trends in the international energy supply system, include:
diversifying exports by switching oil export flows from the “overheated”, basically stagnant European market to receptive, dynamic Asia-Pacific Rim markets (primarily China and Korea);
providing direct access to the traditional and new markets for crude oil, oil products and gas (bypassing transit countries);
securing long-term guarantees on purchases of crude oil, oil products and gas;
participation in management (joint operation), of transit, transportation and distribution infrastructure for crude oil, oil products and gas on the territory of the destination countries;
 participation in profits from the sale of crude oil, oil products and gas on the territory of the destination countries.

China’s Energy Supply

   The Chinese economy is the world’s second largest (after the U.S.) in terms of aggregate GDP and is one of the fastest-growing major economies in the world. China is also the second largest global consumer of energy resources (in 2010 – over 2.3 billion TOE pa). Continued rapid economic advance, growing population, improved living standards, modernization of industry, agriculture and transport require further growth of energy consumption levels. Over the past ten years, oil consumption growth in mainland China is comparable with the growth elsewhere, but the country’s oil consumption continued to grow rapidly even in 2008–2010, against the backdrop of a global recession and then stagnation.

   Development of the China’s economy copies industrial model of Europe and North America with a lag of 25-35 years (depending on the segment). The country continues large-scale introduction of existing industrial, energy, transport technologies with service life of at least 20-30 years. High persistence of technological systems means that in the coming decades China will further boost its energy consumption levels.

   In order to continue economic growth, China is forced to use all opportunities of energy supply: the country is implementing the nuclear power plants program, developing wind, solar and bioenergy segments. Still, in modern economic and technological conditions, only the traditional sources – oil, gas and coal – have the actual capacity to meet the growing energy needs of the country.

   In 2009, China produced some 3.1 billion tons of coal, with forecasted short-term growth rise to over 3.5 billion tons – which is the ceiling for this energy carrier, both resource- and technology-wise (current proven reserves will last for just over 40 years, compared to global average of about 150  years). Also, China is facing increasingly serious constraints on its growing anthropogenic pressures on the environment, which is largely linked to the expansion of coal production and use. Over 80 percent of all freight traffic in China is coal. This forces the leadership of China to encourage the development of oil and gas industry, organizing supply routes from various regions of the world.

   Changes in the energy supply technologies, further motorization of economy and population, transformation of energy balance structure would propel the demand for oil and gas skywards.

   In 2020 China would consume 560-600 million tons of oil, importing 380-420 million tons. In these conditions, oil exports from Russia, particularly pipeline export to the western and northeastern China will face no serious competition from other suppliers.

   In 2020 gas demand in China will reach 300-350 billion cubic meters. Burma deliveries will not exceed 10 billion cubic meters per year, shipments from Central Asia – 30-35 billion cubic meters per year. Considering the possibility of boosting domestic gas production to 115 billion cubic meters per year and the plans for developing LNG infrastructure to 80 billion cubic meters; starting 2020, the Chinese market will be able to accommodate 60 billion cubic meters per year of Russian gas, with a tendency to a further rapid increase. Starting 2018, the largest APR gas supplier – Indonesia and after 2025 – Malaysia will leave the market, becoming net importers of gas; this will open new opportunities for Russia on the China’s market.

Options for Russia’s Oil and Gas Exports to China

   In recent years, Russia has been exporting to China just over 20 million tons of oil and oil products, mainly by railway through Manchuria, as well as via Kazakhstan and own Far Eastern ports. Oil flow via the new Skovorodino – Daqing pipeline started in December 2010.

   Implementation of intergovernmental agreement (signed in April 2009) will allow Russia to boost its share in oil export to China in 2011 to 15-16 percent (35-40 million tons). Further consolidation of Russian presence on the Chinese market requires boosting Skovorodino-Daqing pipeline capacity to 30 million tons per year, expanding shipments from the Khabarovsk, Primorye and Sakhalin seaports, increasing transit flow through Kazakhstan to Xinjiang using Omsk – Atasu – Alashankou pipeline. Total export of Russia’s oil and oil products to China may reach 70-80 million tons by 2020.

   In the gas segment, Russia would be advised to set up shipments of standard gas and LNG, as well as gas supplies with the participation of Russian companies (primarily Gazprom) from other regions of the world. Being a global energy company, Gazprom has an opportunity to enter the swap projects on LNG supply to China (now being organized by international and multinational companies from various regions of the globe), exchanging such entry for access to production projects in Western and Eastern Siberia. Creating gas and LNG transportation infrastructure will allow Russia to dominate the Chinese gas market supplying 80-100 billion cubic meters per year starting 2020–2025.

Altai Gas Pipeline

   The Altai gas pipeline is the nearest workable option for organizing large-scale gas exports from Russia to China. This trunk gas pipeline route was initially proposed in 1998 by Alexei Kontorovich, member of the Academy of Sciences, in a RAS study commissioned by Gazprom, as an alternative to the difficult northern route offered by the company’s top management at the time (SRTO – Podkamennaya Tunguska – Far East – China).

   The construction of another trunk gas pipeline within the transport corridor Yamal-Nenets Autonomy (PS Purpeyskaya) – Surgut – Kuzbass – Altai – China is also in the cards. To implement shipments from West Siberia, Russia is planning a new pipeline system in the existing transport corridor, with a subsequent extension to China via the Canas mountain crossing and the Ukok plateau which will link to the existing trans-China pipelines West – East, West – East-2 and West – South.

   Pipeline gas shipments to the Xinjiang-Uygur Autonomous District could begin as early as 2015–2016. The length of the pipeline to China’s border is about 2,670 km, and the pipeline has a diameter of 1,420 millimeters. The projected annual export is at least 30 billion cubic meters of natural gas.

   Gazprom and CNPC are already closing in on a mutually acceptable price for gas shipments. Currently state-regulated prices for natural gas in the Shanghai area are close to $230 per 1,000 cubic meters, which is higher than the price paid for Russian gas by some CIS countries. Yet growing competition from LNG, including on the traditional markets, is putting extra pressure on Gazprom. The growing flexibility of the Chinese is due to the steady rise in domestic prices (in contrast to the global trend), on the background of high economic growth, yuan revaluation and exacerbation of environmental and energy problems.

   CNPC participation in financing the Altai pipeline project on Russian territory is also  reccommended. This might be followed by the establishment of a joint venture for geological and geophysical work and gas production in the Yamal-Nenets Autonomous District. Both solutions will provide acceptable for Gazprom and CNPC price formula, also attracting Chinese investment in long-term capital-intensive projects and opening a huge new terrain for Russian gas exports.
Importantly, in developing cooperation with CNPC, Gazprom must have the opportunity to participate in projects on transportation, storage and distribution to end-users in China. Gazprom also should participate in mainland and offshore upstream projects in China as this would ensure inside control of the market via its own oil and gas production projects in the Middle Kingdom.

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