Archive for December, 2012

Russia’s ‘China Card’

Friday, December 7th, 2012

Sino-Russian energy relations play an critical role in Russia’s push towards East Asian oil and gas markets. China is, after all, the largest consumer of energy in the world and shares a 4,195km (2,607 miles) long border with Russia – one of the largest global producers of oil and gas. There is tremendous potential for a strategic energy partnership to materialize between the two countries, but current relations are plagued by price disputes and political calculations.

“Energy is the one area where Russia is a significant economic partner for China,” Dmitri Trenin wrote in a February 2012 report for Carnegie in Moscow. “[Russia] sells oil at far cheaper prices than Middle Eastern countries, and it holds the potential to become a large exporter of natural gas to China, too,” Trenin continues. Yet, energy trade between the two countries lags far behind its potential, especially when it comes to natural gas.

Yesterday in Moscow, a high level delegation from the Chinese National Petroleum Corporation (CNPC) and energy ministry held talks with Russian Energy Minister Alexander Novak and Gazprom’s Alexey Miller. At the annual “Russia-China Dialogue” (link in Russian), a government-to-government initiative started in 2003, Novak said that China is a “key strategic partner” of Russia in the energy sphere. Outside of signing a vague bilateral “Memorandum on cooperation in evaluating energy market conditions,” however, only two public mentions of specific projects were made the whole day: one agreement on increasing Russian electricity supply to China from 2.6 billion kWh in 2012 to 4.5 billion kWh in 2014; and a short reference to a minor gas pipeline project to China, made at the meeting between Miller and CNPC chief Tsao Tsipin.

While Gazprom’s press release of the event states that both parties emphasized “issues surrounding the set-up of Russian gas supplies to China,” only the minor Altai Pipeline project to supply gas to China’s western Xinjiang Uygur province was mentioned. The Altai pipeline would cross 6 Russian regions from Khanty-Mansiysk to the Russo-Chinese border, but “construction will start only after a gas purchase and sale agreement is inked with the Chinese side,” the press release states. No estimate of the projected cost of the pipeline was given.

Gazprom's Altai Pipeline Project
Gazprom’s Altai Pipeline Project

Russian President Vladimir Putin originally proposed the Altai project in Beijing in March 2006. The 3,000-kilometer pipeline was envisaged as a 30-40bcm per year trunkline that would anchor Siberia’s oil and gas infrastructure development to long-term gas supply contracts with western Chinese customers. Here’s the potential problem for Russia, though: China already has enormous local reserves of underdeveloped natural gas in its western border region with Russia.

According to the U.S. Energy Information Administration (EIA), Xinjiang Province is one of the leading gas-producing regions of China already, with an annual output of 827 billion cubic feet (23 billion cubic meters) as of 2011. The region is believed to hold a further 15 trillion cubic feet (425 bcm) of gas reserves in two underdeveloped gas fields and projects are underway to develop these reserves for China’s industrialized and energy-hungry Guangdong Province in the east.

Chinese Provinces Map
Map of China’s Provinces

“PetroChina’s two cross-country West-East Gas Pipelines, connecting Xinjiang Uygur Autonomous Region to Shanghai, Beijing and Guangdong, have greatly expanded the upstream potential of the Tarim Basin [in western China] to supply markets in eastern China,” the EIA reports. Beijing announced in October that it is building a third West-East pipeline that is expected to carry an additional 30 bcm of gas at a cost of $20 billion. If China is expanding local natural gas production in its western border region with Russia and already receiving 25 bcm of gas each year from Central Asia on top of that, does it really need additional gas imports from western Siberia?

PetroChina's Pipelines
PetroChina’s Pipelines (Source: EIA)

The answer is unclear. China has a high potential to see sustained gas demand growth over the long-term. But with the direction of gas demand hinging on global economic recovery, among other factors, it is difficult to predict actual demand growth trends over the long-term. Returning to the Altai pipeline, however, history points to another major factor in Sino-Russian energy relations: political motives.

According to a 2010 report by Shoichi Itoh for the Russian Analytical Digest, when Putin introduced the Altai project in 2006, “Moscow had neither calculated an estimated cost of the project, nor reached an agreement on gas prices with Beijing.” Instead, Itoh explains, Moscow just wanted to “brandish the ‘China card’ in order to influence its negotiations with the EU.” At the time, the EU’s long-term gas demand prospects were almost guaranteed, but questions were being raised about comparative advantages of oil indexation and hub-based pricing regimes. “Gazprom’s chosen strategy has been to keep its share of the very profitable European market, while using its contacts with the Chinese as a tool to pressure the Europeans,” Dmitri Trenin stated in his February 2012 report. “The Kremlin has backed Gazprom’s power politics vis-à-vis its EU customers as a source of leverage in its broader political arguments with European governments.”

It is striking that very similar conditions seem to hold true today. Gazprom has neither announced a pricing estimate on the Altai pipeline project, nor come to an agreement with China on gas supply prices. Yet this was the only concrete project mentioned publicly by Gazprom officials during talks with CNPC.

According to Trenin, all gas pipeline projects to China have been stalled since 2006 because Beijing continues to insist on a lower purchasing price than Gazprom is willing to pay. Itoh reports in 2010 that Gazprom ultimately shelved the original plans for Altai already in 2009 because of the project’s “economic non-viability.” Will this happen again? Altai has the potential to come online faster than other proposed pipeline projects coming from eastern Siberia due to already-existing infrastructure in western Siberia. But a lot depends on gas demand in China and infrastructure development in both countries. Gazprom projects Chinese gas demand to reach 300 to 400 bcm annually by 2020, but Beijing already has access to cheap Central Asian gas and is now trying to jump-start its own shale gas revolution.

The issue of geography should not be understated in this context. China’s industrially-developed southeastern provinces, where demand for gas is highest and supply is struggling to keep up, is far from both western and eastern Siberian oil and gas fields. The high level of capital expenditures needed for infrastructure development to bridge these distances will ultimately increase the price of gas deliveries from Russia, if gas were to be piped into China, according to Kevin Rosner in a report for the Journal of Energy Security in late 2010. This complicates the business dynamic of realizing gas infrastructure projects in Russia’s Far East.

Russia could perhaps stand to benefit from greater flexibility by increasing its LNG capacity. Gazprom, in fact, just completed the world’s first LNG shipment to Japan through the Northern Sea Route via the Arctic. But, as mentioned in last week’s post, Russian LNG will still be competing with (currently) cheaper Australian and Qatari LNG that is already supplying Asia-Pacific markets. On a related side note, just this week Shell announced that it is planning to shift it’s gas business to Singapore in light of projected future demand growth in Asia, signaling the growing interest among global gas producers to increase downstream activities in the Asia-Pacific region.

“We see the major gas trading, the growth of the gas market, the growth of the integrated gas business will be Asia-based,” Andy Brown, upstream director at Shell, told Bloomberg on December 5. “The LNG business is going to be in the Far East, and Singapore is a central part of the Far East trade.”

The direction of Sino-Russian energy relations is uncertain, but China will no doubt play a leading role in the Russian gas industry’s calculations as the Eastern Gas Program materializes. It is curious to see the Altai pipeline project as the headliner from Gazprom’s meeting with CNPC on Thursday. Is there a political motive behind this? Today, by the way, Gazprom officially began construction of its flagship 63 bcm per year South Stream pipeline through Europe’s Southern Corridor, the company’s latest project to strengthen it’s status as a major gas supplier to EU countries.

Ben Priddy
Central Asian Analyst