Can China, Russia Close Gas Deal?

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Can China, Russia Close Gas Deal?

China is thirsty for it and Russia has plenty. So why can’t the two countries finally close a natural gas deal?

Although Russian Prime Minister Vladimir Putin undoubtedly had numerous goals in visiting Beijing last week, his most visible mission was to make progress in the protracted negotiations concerning China’s possible purchase of an enormous volume of Russian natural gas.

For years, this issue has been a prominent agenda item at Russian-Chinese leadership summits. Expectations had been rising that an agreement might be imminent, but Putin proved unable to finalize the deal, further postponing the date when the pipeline might be built.

Chinese policy makers are eager to expand their natural gas imports. China’s surging economy has meant the country has become one of the world’s largest purchasers of natural gas and other foreign energy sources. Rapid economic growth has fuelled energy demands that outstrip China’s domestic energy supplies. And, although the government has tried to improve energy conservation and expand the use of nuclear and renewable energy sources, the Chinese will still need to import enormous quantities of oil and gas for the foreseeable future. In this regard, Beijing is seeking to diversify its foreign energy sources to limit their dependence on any single exporting country or region.

In principle, Russia should find a natural place within this framework. The Russian Federation possesses the largest natural gas reserves in the world. Many of Russia’s new and untapped gas fields are in eastern Siberia and the Russian Far East. These locations lie closer to China than the older fields that now provide gas primarily to consumers in Russia and Europe.

But despite these natural advantages, and their mutual interests in increasing bilateral energy cooperation, the Chinese and Russian governments have made only limited progress in moving beyond rosy statements of principles and vacuous memoranda of understanding to the initiation of actual energy projects. Various technical obstacles, pricing conflicts and mutual suspicions have historically kept Chinese purchases of Russian energy at relatively low levels. Frequent delays in shipments on the part of the Russians and attempts to leverage the competing interests of the Chinese, Asian, and European markets off of each other have prevented Chinese policy makers from regarding Russia as a reliable long-term supplier.

At one point in 2007, an exasperated Zhang Guobao, China’s chief energy planner and Vice Minister for National Development and Reform, complained that: ‘The Sino-Russia pipeline question is one step forward, two steps back. Today is cloudy with a chance for sun, while tomorrow is sunny with a chance for clouds. One moment Russia is saying they have made a decision, the next saying that no decision has been made.’

Perhaps the most serious impediment to large deliveries of Russian natural gas to China is the underdeveloped transportation infrastructure connecting the two countries. During most of the Cold War, the border between China and the Soviet republics was sealed and heavily militarized. In addition, the USSR’s energy pipeline network flowed from east to west since Europeans were the main foreign purchasers of the oil and gas produced in Russia, Azerbaijan, and Central Asia. It has only been in the past decade that Russian energy planners have made a comprehensive effort to send their oil and gas eastward toward the expanding markets of East Asia.

Russian energy giant Gazprom and the Chinese National Petroleum Corporation (CNPC) have been negotiating possible deals since 2004, when they established a strategic partnership agreement. During Putin’s March 2006 trip to Beijing, Gazprom and the CNPC signed a memorandum of understanding about constructing a 6,700-kilometre Altai pipeline to deliver Russian natural gas to China. The current talks envisage a 30-year contract in which Russia would supply some 68 billion cubic metres of gas annually.

But Gazprom has repeatedly delayed starting construction of new gas pipelines because, despite years of negotiations, Chinese and Russian negotiators have proved unable to agree on a price formula for the gas deliveries. Without an agreed delivery price, Gazprom is unwilling to construct an enormously expensive pipeline which, in the worst case of continued deadlock in the Russia-China negotiations, would remain idle.

According to press reports, China is offering about $250 per 1,000 cubic metres of gas, whereas Russian negotiators are demanding approximately $350. In essence, Russian negotiators want Beijing to pay world market prices, whereas the Chinese insist on receiving a discount. Given the large volumes at issue, in which even a single dollar difference could amount to billions of dollars over the life of the contract, each side is naturally fighting hard for its positions.

To support their arguments, Russian negotiators point out that their natural gas could flow westward to Europe as well as eastward to other Asian countries besides China. They also note that Russia’s natural gas supplies, while enormous, aren’t unlimited, with the implication that Beijing needs to compromise or risk losing out.

Chinese negotiators parry by observing that the emergence of international markets for liquefied natural gas (LNG) and shale gas make other sources of gas potentially available to Chinese consumers. In addition, China has begun receiving large-scale deliveries of natural gas from Central Asia after China financed construction of the first east-west energy pipeline in Central Asian history. This pipeline should deliver as much as 40 billion cubic metres of natural gas annually from Turkmenistan alone. Turkmenistan has offered China more gas than the Russians have ever considered providing China.

After it became apparent that no gas breakthrough would occur, China’s Foreign Ministry stated that Gazprom and the CNPC would continue to negotiate on the basis of the principles of ‘fairness, friendliness and mutual accommodation.’ Putin in turn stressed the importance of broadening the Russian-Chinese partnership beyond gas, stressing the need in particular to prioritize hi-tech cooperation in such industries as biotechnology, nanotechnology and aircraft manufacturing.

Putin is correct that the Sino-Russian economic partnership needs to extend beyond energy, but the parties should also consider following the precedent they established by their April 2009 oil-for-loans deal. According to its provisions, the Development Bank of China lent Russia’s state-run energy companies the money they needed to build and operate a 67-kilometre branch pipeline off the East Siberia Pacific Ocean (ESPO) oil pipeline to the Russian-Chinese border town of Xing’an. The CNPC then built a 1,000-kilometre pipeline from there to oil refineries in Daqing.

If Russian and Chinese negotiators agreed on a similar gas arrangement, China would lend Gazprom the money required to construct the Altai pipeline in return for guaranteed shipments of natural gas to China. Looked at from a different perspective, this deal would involve China’s purchasing the gas from Gazprom in return for Russia’s committing to use some or all of this money to construct the pipeline to ship the gas to China.  

In the absence of this or another creative financing arrangement, we could see many more Chinese-Russian energy meetings fail to consummate what should be a natural gas partnership between Asia’s thirstiest nation and its leading gas supplier.