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How Ukraine Is Changing Global Energy Flows

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Pacific Money

How Ukraine Is Changing Global Energy Flows

Increasingly isolated by the crisis, Russia is looking East for new energy markets.

How Ukraine Is Changing Global Energy Flows
Credit: Presidential Press and Information Office, Kremlin

On September 1, 2014, Russian President Vladimir Putin and Chinese Premier Zhang Gaoli initiated the construction of what they claim will be “the world’s largest construction project.” This 3,968 km “Power of Siberia” pipeline connecting gas fields between Russian’s Siberia and China’s Northeast region is expected deliver four trillion cubic meters of gas to China over the next thirty years. With an estimated 1.2 trillion cubic meters of gas and 93 million tons of liquid hydrocarbons stock, Chayanda fields in the Republic of Yakutia will be the chief production station conveying gas to Northeast China through the border city of Blagoveshchensk. The overall cost of this gigantic enterprise has been evaluated at more than 20 billion dollars, which covers other investments in the region totaling 7.5 billion dollars.

After more than a decade of talks, on May 21 China and Russia concluded a $400 billion deal that would run for 30 years and supply China’s northeast regions with 38 billion cubic meters of gas per year via the Eastern “Power of Siberia” pipeline. The agreement was signed between the state-owned company Gazprom and the China National Petroleum Corp during a two-day visit by Russian President Vladimir Putin to Shanghai. The main obstacle to a conclusion of the negotiations had always been the price, but the prevailing international situation gave China the upper hand. After negotiations that extended into the early hours, a deal was made. Beijing’s leverage had increased in the months leading up to the deal, since it had reduced its need for Russian gas thanks to imports from Central Asian countries and neighboring Myanmar. But although the benefits of the deal to China were obvious, Russia also struck a profitable deal, not only because of its need to find new commercial partners, but also because this was the first step to wider access to Chinese and Asian markets in general.

The signatories of the historic agreement did not have to wait long for a response from the European Union. José Manuel Barroso, president of the European Commission, sent a letter to Putin that was published on the Commission website. His letter sought to ensure that talks to grant a stable gas supply to Europe through Ukraine would not stop. It is imperative, the letter said, that all parties respect the commitments made in meetings held previously and engage in the process constructively, in particular to obtain prices consistent with market conditions. Barroso also recalled that while European companies expect Gazprom to honor previously signed contracts, it is important that an early warning system be in place and functioning. Barroso added that the European Union was willing to maintain a high level of transparency, providing data on the incoming gas flow from Ukraine.

The conclusion of the China-Russia deal comes at a turbulent time. As the BBC reported, “The deal will lessen Russia’s dependence on European buyers, who have imposed economic sanctions because of the crisis in Ukraine.” Although the West has tried to exempt the gas industry from the most targeted sectors, both EU and U.S. restrictions have compelled Russia to start exploring new alternatives. Moscow-based journalist Dmitry Babich affirmed, “The Ukrainian risks and the position of Europe make diversification a vital necessity” before adding that the China deal “has been seen as a financial lifeline for Russia as it faces growing resistance in Europe since the annexation of Crimea in March.”

This deal is a win for President Vladimir Putin, who is seeking new commercial partners in response to his increasing isolation by the EU and US. The price at which the natural gas will be sold has not been disclosed, but experts have offered estimates. If the $400 billion goes towards the actual purchase of gas, the price will be around $350 per thousand cubic meters of gas, less than the $380.50 per thousand cubic meter sold to Western Europe. However, it is likely that part of the negotiated deal will go to the costly construction of the 4,000-km long Yakutia–Khabarovsk–Vladivostok (also known as “Power of Siberia”) pipeline. Reports suggest that the gas will start flowing towards China from 2018, postponing the real impact of the deal on European countries.

Pushed by the Ukraine crisis, a growing shift might very well be taking place regarding global energy flows. While European countries have been mitigating the crisis by buoying up storage volumes (with tanks at 71 percent across the EU), Russia has been seeking other markets for its mainstay energy exports. “The new gas branch will significantly strengthen the economic cooperation with countries in the Asia Pacific region and above all – our key partner China,” Putin declared at the opening ceremony near Yakutsk. “Once we create a gas pipeline network here in the Far East and Siberia, we will be able to connect European pipeline system to the East.” That would greatly augment export opportunities through an enhanced “gasification” of Russia and would provide it with the upper hand in regulating gas flows in accordance with global markets trends.

Ukraine is a transfer country through which a significant volume of Russian gas reaches Europe. For this reason, some experts say that the energy security of EU member states is in Putin’s hands. “The prudent thing to do is to diversify the energy supply sources, especially for countries most reliant on Russian imports,” said Reuter energy columnist Clyde Russell. However, the diversification of export markets opportunities will not happen overnight. The pipeline will only be fully operational by 2019 and a transition period will be taking place with great uncertainty over Ukraine’s current events consequences. Surrounded by Vladimir Putin and Zhang Gaoli, Gazprom CEO Aleksey Miller reaffirmed that Russia’s largest state-owned company would remain a reliable supplier for its customers, a commitment that also applies to the “Power of Siberia.” According to Russell, Russia’s major companies, albeit looking for eastern opportunities, are unlikely to abandon European’s market shares and try to convince buyers of their trustworthiness. Russia and China already discussed extending their freshly concluded partnership to the oil sector, with Putin welcoming the idea of Chinese investors joining the Vankor oil and gas group. Chinese Vice Premier Zhang Gaoli expressed the hope “that oil and gas giants from China and Russia will further expand bilateral energy cooperation.” And Putin to conclude: “We generally take a very careful approach to the approval of our foreign partners, but of course, for our Chinese friends there are no restrictions.”

This landmark deal and its policy implications should be analyzed in this very peculiar context, with a rapidly changing international energy landscape. What should be noted is the greater interdependence that China and Russia have developed in the recent years. In signing this agreement, China has moved even closer to its partner, making Russia its first or second gas supplier, depending on future supplies from Turkmenistan.

For Russia, meanwhile, this deal represents a real springboard to a broader entrance into Asian gas markets. Since the deal was reached, Japan, India and South Korea have been discussing with Russia potential gas cooperation partnerships. Russia’s relative isolation following the Ukraine crisis has pushed Putin to explore new alternatives within East Asia. His success in doing so could mean that the West’s sanctions end up profoundly reshaping energy markets in the years to come.

Thomas Coibion is a Junior Researcher at the European Institute for Asian Studies, a policy think tank based in Brussels.