China, What's Next?

China’s Challenges: Natural Gas

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China, What's Next?

China’s Challenges: Natural Gas

China has crafted a strategy for natural gas that aims to increase domestic production and secure access to gas resources in neighbouring countries.

In the space of just a couple of years, natural gas has become the ‘next big thing’ in energy circles. The recent expansion of unconventional gas production in North America has transformed the United States into the world’s top producer of the fuel. Cleaner-burning than coal, gas is expected to benefit in a carbon-constrained world as it displaces coal in the electricity-generation sector. Moreover a burgeoning interconnected global gas market, spurred by the expansion of the sea-borne liquefied natural gas (LNG) trade, is helping to increase market flexibility so that disruptions like those caused by Russia-Ukrainian disputes have less pernicious effects on downstream countries.

Hoping to take advantage of these developments, China has crafted a strategy for natural gas that aims to increase domestic production and secure access to gas resources in neighbouring countries. For Beijing, gas offers an opportunity to power its growing economy in a less polluting way than burning coal (although coal is expected to remain vital to China’s rapid economic ascent).

Natural gas may also have a role to play in the transportation sector, where Beijing is experimenting in dramatic fashion with compressed natural gas (CNG) in automobiles. Historically, oil’s prominent and essential role in the transportation sector has driven its centrality in international affairs. A transportation sector that could rely jointly on oil and natural gas would allow China to be marginally more indifferent to Middle Eastern geopolitics—in stark contrast with the US experience of the past half-century.

The BP Statistical Review of World Energy 2010 estimates that China produced approximately 85 billion cubic metres (bcm) of natural gas in 2009, while consuming 89 bcm, an import gap that’s expected to expand rapidly in the coming years as gas demand outpaces domestic supply. Indeed, the International Energy Agency (IEA) sees China’s gas demand increasing by 6 percent annually through 2035.

The reality is, though, that the country’s own conventional natural gas resources are nowhere near enough to meet this growing demand, forcing Beijing to ramp up its efforts to access gas supplies abroad—particularly in Central Asia, Russia and Burma.

It’s here that the frequent portrayal of Beijing as a cash-flush power willing to throw money around to lock up resources is misplaced. China has in fact been carefully expanding its influence in Central Asia and Russia in particular, biding its time until the right deal has come along.

Negotiations with Russia over gas supplies, for example, have been ongoing for years (much to Moscow’s consternation). The proposal on the table now would mean two pipelines entering China—one in Xinjiang from the Russian region of Altai and another in Manchuria from the Russian Far East. The former line would have a capacity of 30 bcm per year, the latter 38 bcm per year. But lack of agreement on the price Russian state gas company Gazprom will charge has stalled things.

Of course, there’s more to this than pricing. Although Moscow enjoys a privileged position in the export of Russian oil and gas for both economic and political reasons, its manipulation of energy flows to Europe has tarnished the country’s reputation as a reliable supplier of hydrocarbons. Meanwhile, investments in the gas fields that would supply China have been slow to materialize. Both points will likely have made Beijing think carefully about the implications of an inconsistent supply of Russian gas. This reticence over gas is in contrast with a deal struck over crude oil, with China having issued a $25 billion loan to Russia in February 2009 to secure a 20-year supply of crude oil. At the same time, Beijing has postponed a decision on a loan for natural gas—a conspicuous vote of no confidence in Russia’s short-term attractiveness as a gas supplier.

If the story of the Russia-China gas trade relationship is one of chess-like negotiations and Beijing’s reticence, China’s experience in Central Asia has been more straightforward. China signed an agreement to build a gas pipeline out of Turkmenistan via Uzbekistan and Kazakhstan in 2006. Backstopped with a $4 billion loan to Ashgabat and upstream contracts for China’s state-owned CNPC in Turkmenistan, the pipeline came online in December 2009—impressively swift.

However, now that it’s operational, Beijing has leveraged its position to extract concessions from the countries along the pipeline. Turkmenistan in particular is under pressure. Russia has cut its purchases of Turkmen gas by three-quarters since 2008, prompting Ashgabat to push China to buy more gas. But Beijing, keenly aware of its negotiating advantage, has held out, purchasing only 4 bcm this year.

In the case of Uzbekistan and Kazakhstan, China has spurred competition for access to the pipeline, with the two engaging in development of gas fields and infrastructure in order to access the pipeline before the other. That said, China may decide it’s in its own interests to selectively manage access to the pipeline in order to win concessions on price and upstream contracts in each country, which would provide it potent political leverage with countries that would prefer to develop robust alternatives to exporting hydrocarbons to Russia.

But can Beijing afford to play the long game with neighbouring gas suppliers given its fast-growing demand? A look at China’s alternative sources of supply, particularly domestic production and increasing volumes of LNG in the country’s gas supply mix, offer a glimpse of a possible answer.

Beijing has prioritized the development of domestic gas supply, partnering with a number of Western oil firms to develop the country’s unconventional gas resources, which are thought to be large. Washington has promoted this cooperation through the US-China Shale Gas Resource Initiative, a mechanism announced in November 2009 to share expertise and technology for unconventional gas production. In addition, LNG spot prices are currently depressed, prompting Chinese energy firms to purchase spot cargoes through the country’s three LNG import terminals. Sixteen more LNG import terminals are under consideration. Such trends point to a relative decline in the importance of Russian and Central Asian gas to China’s energy security future—a narrative that Beijing’s diplomats are sure to promote in Moscow, Ashgabat, Tashkent and Astana.

Chinese national oil companies operate with the explicit backing of the Chinese state–including the state budget.In a region where governments treat their oil and gas resources as strategic commodities to be traded for political perquisites, Chinese companies therefore possess an in-built advantage. But more importantly, China’s unity of effort—political and commercial—allows Beijing to act strategically, with long time horizons, in order to secure the best deal. While China couldn’t have predicted the revolution in unconventional gas production or the global recession, its patience has strengthened its bargaining position vis-à-vis Russia and the Central Asian states.

Beijing’s engagement also has the tacit consent of Washington. Western policy in the post-Soviet period has been designed to reinforce Central Asian sovereignty by developing export corridors for oil and gas that avoid Russian (and Iranian) territory. While the United States and Europe have had some success on the western edge of the Caspian Sea by constructing the Baku-Tbilisi-Ceyhan oil pipeline and the Baku-Tbilisi-Erzurum gas pipeline, large-volume trans-Caspian projects for Kazakh and Turkmen oil and gas have been delayed for commercial and geopolitical reasons. In this regard, China has developed a non-Russian, non-Iranian export corridor for Turkmen, Uzbek, and Kazakh gas where the West couldn’t (there’s also a Kazakhstan-China oil pipeline in operation). In a sense, this should provide greater stability in an important and strategic part of the world. And China, meanwhile, appears to have not yet attempted to translate its newfound economic heft into political influence to the West’s detriment: Beijing has so far avoided pushing for the curtailment of the Western military presence in Central Asia despite ongoing worries about ‘encirclement.’

China’s energy trade relationships with Russia and Central Asia should also make the Middle Kingdom feel more assured about its energy security future. Much of China’s naval build-up and assertive behaviour, especially in the South China Sea, in recent years is motivated by concerns about the security of China’s sea-borne energy imports from the Middle East, both oil and LNG. In the post-World War II period, the US Navy has played the role of guarantor of open trade on the high seas, but Beijing appears to believe this commitment won’t continue in the event of conflict with Washington over Taiwan or North Korea. The United States’ efforts to help China expand domestic gas production and its lack of opposition to China-bound pipelines out of Central Asia and Russia should be interpreted by Beijing as indicative of the US commitment to help China grow comfortable about its place in the American-led world order.

Natural gas is clearly an important component of Beijing’s energy strategy over the next century. Thus far, China’s approach to accessing foreign and domestic sources of supply has proven collaborative, rather than confrontational, in nature. US assistance on Chinese unconventional gas production presages greater cooperation on energy matters, including in clean-tech where Beijing and Washington can best address climate-altering carbon emissions. In Russia and Central Asia, meanwhile, China has husbanded its resources and influence to achieve advantageous deals.

China’s outreach on gas to both Russia and Central Asia appears to have the tacit approval of Washington, which is perhaps not surprising for a power that wants Beijing to feel sufficiently energy secure that it doesn’t need to mount a significant challenge to US naval dominance.

Matt Stone is an energy consultant and analyst of US foreign policy with a focus on the post-Soviet region and the Middle East.