China, Russia Tighten Ties With Gas Pipeline – Analysis

By Michael Lelyveld

After nearly 20 years of proposals, stalled plans, and complex negotiations, Russia and China are poised to open their first natural gas pipeline connection, raising interdependence to a new level for decades to come.

Official gas deliveries from Russia’s giant Power of Siberia pipeline project are scheduled to begin on Dec. 2, crossing into northern China under a 30-year agreement between Russian monopoly Gazprom and state-owned China National Petroleum Corp. (CNPC).

The ceremonial launch is expected to open a new chapter in the energy and economic development of Russia’s sparsely settled East Siberia and China’s populous production centers that have relied heavily until now on high-polluting coal.

“The strategic significance of the completion of the Power of Siberia pipeline lies in opening a new corridor for China to import gas by land routes rather than by sea with LNG (liquefied natural gas),” said Edward Chow, senior fellow for energy and national security at the Center for Strategic and International Studies in Washington.

Like the East Siberia-Pacific Ocean (ESPO) pipeline that began pumping Russian oil into China in 2011, the 3,000-kilometer (1,864-mile) Power of Siberia project promises to bind the two countries together with mutual energy, income and investment ties.

“The initial volumes are very small compared to China’s rapidly increasing gas import requirements. However, its eventual success may lead to additional pipeline routes from Russia to China,” said Chow.

“For Russia, the project is also important for the domestic need to build infrastructure for integrating East Siberia and the Russian Far East,” he said.

Over the next year, Russian inflows of 5 billion cubic meters (176.5 billion cubic feet) are likely to serve only China’s hard-pressed industrialized northern provinces and the smog-bound Beijing-Tianjin-Hebei region.

On China’s side of the border, only the northern pipeline section from Heihe in Heilongjiang province to Changling in Jilin province has been completed so far.

But the first line in China is part of a 5,111-kilometer (3,175-mile) three-stage project planned to reach Shanghai, Yicai Global news service said. Russian gas volumes are projected to rise to 10 billion cubic meters (bcm) in 2021, 32 bcm in 2022-2023 and a peak of 38 bcm per year sometime after that, CEEMarketWatch reported.

Delayed for years

While the project, also known as Russia’s “eastern route,” may supply only 7.5 percent of China’s gas demand in 2030, it has already earned a place in the modern record of relations between the two countries.

A gas deal with China was one of the top priorities for a newly-inaugurated President Vladimir Putin in 2000, Reuters reported at the time. But the project was delayed for years by Russia’s insistence on building a western line first to channel existing gas resources through the Altai Mountains to Xinjiang, already a primary source of Chinese gas.

Behind-the-scenes wrangling over Moscow’s route preference and gas pricing demands delayed the Power of Siberia project by several years and may have cost Russia billions of dollars. In the meantime, China built pipelines across Central Asia and invested heavily in Turkmenistan.

In the end, the attraction of China’s growing gas market gave it the upper hand in an eastern route contract with Russia in 2014 for new and more costly supplies from Siberia’s Chayandinskoye gas field.

Putin has recently shifted Russia’s push for a western route to a plan for a line through Mongolia, apparently putting the Altai option aside.

The history of the Power of Siberia planning and Russian attempts to spur competition with Europe is strikingly similar to its strategies in developing the ESPO project to play China’s oil interests against those of Japan.

Years were lost in Russia’s internal debates over both projects while development costs rose and energy prices softened, undercutting profitability and the benefits of closer ties.

Little has been made public about the precise terms of the Gazprom-CNPC gas contract, although Gazprom claimed in a 2014 press release that it included favorable conditions for Russia, including a take-or-pay provision and a pricing formula tied to a basket of oil products.

At the time, Gazprom CEO Alexei MIller cited the value of the contract as U.S. $400 billion (2.8 trillion yuan currently).

But China fought off Russian pressure for a U.S. $25-billion (175-billion yuan) prepayment to help finance the project, essentially duplicating Chinese credits for the ESPO pipeline construction costs. Chinese financing for the Power of Siberia project never materialized.

“Instead, it was decided to abandon the idea of a mandatory prepayment,” the official RIA Novosti news agency reported on May 21, 2014.

A pricing dispute over ESPO oil that emerged soon after that pipeline opened may have soured China on more prepayment demands, leaving Russia to shoulder huge costs for the Siberia gas route on its own.

Instead, China has invested similar levels of capital as a shareholder in Russia’s Arctic LNG projects under development by Gazprom rival and independent producer Novatek. Russian officials argue that the two gas sources will be kept from competing in China, although it is unclear how.

Gazprom has provided few updates on its costs for Power of Siberia since 2012, when Miller estimated the pipeline’s expense as 770 billion rubles (U.S. $12 billion, 84.5 billion yuan), plus 430 billion rubles (U.S. $6.7 billion, 47.2 billion yuan) for field development.

Figures cited in 2014 were much higher. Putin said Russia planned to invest U.S. $55 billion (3.5 trillion rubles, 385 billion yuan) in the project, according to RIA Novosti, potentially making it the biggest in the post-Soviet period.

The take-or-pay provision may give Russia some assurance that China will buy enough gas to cover the investment as its economic growth weakens, but the confidence is not iron-clad.

Similar contracts between Gazprom and European customers were revised when demand and prices plunged after the world financial crisis.

“The problem with politically motivated contracts is that they tend to be unstable and subject to renegotiations when market or political conditions change,” Chow said.

The cost burden of the Power of Siberia project raises questions about Russia’s return on investment, the divergent interests of the two countries, the relative health of their economies and their negotiating strengths.

The issues may come into play in the next several years as Russia’s costs continue to increase in the second stage of development with the addition of supplies from Siberia’s Kovykta gas field.

Officially, China’s economy is still growing at a six-percent rate in the third quarter while Russia’s is projected to rise by just 1.1 percent this year.

After two decades with Putin in power, Russia remains reliant on oil, gas and other resources for as much as 60 percent of its gross domestic product, according to a RBC Group estimate based on 2017 data.

China’s reliance on foreign oil and gas is a near mirror image. Last year, the country imported about 70 percent of its oil, while gas imports covered 44.5 percent of demand.

In an economic downturn, China could slow the growth of gas imports and the transition from coal, which still provides 59 percent of primary energy needs and two-thirds of the electricity supply, according to the International Energy Agency (IEA).

In 2010, Russia’s then-deputy prime minister Igor Sechin said that “the growth of gas consumption in China may be unlimited.” But signs of lower growth and slower coal-to-gas conversions have already started to emerge this year.

Economic conditions and energy markets have changed over the years that it has taken to develop the Power of Siberia project, suggesting that greater interdependence will entail risks on both sides.

“It is of great significance to deepening all-around cooperation between the two countries and advance integration of our interests,” China’s Foreign Ministry spokesman Geng Shuang said earlier this month.