Energy Security, Geopolitics and the China-Russia Gas Deals

During the November 2014 Asia-Pacific Economic Cooperation (APEC) summit, Beijing was not only an impressive host, but also a generous financial supporter of a number of China-centered initiatives. The largest economic package during the APEC summit went to the second China-Russia mega deal of the year: Moscow and Beijing reached a non-binding memorandum that will see top Russian gas producer Gazprom ship 30 billion cubic meters (bcm) of gas annually to China over 30 years. This is just slightly less than the $400 billion accord the two countries signed in May 2014 for Russia to supply China with 38 bcm a year by 2018. The two gas deals, sealed only six months apart, have profound implications on China’s quest for energy security, the volatile global energy market, China-Russia relations and broader geopolitical movements worldwide.

China’s Quest for Energy Security

While the world media and expert opinions have focused mainly on the significance of these deals for Russian President Vladimir Putin and his confrontation with the West over the Ukrainian crisis in recent months, Beijing sees them primarily as a part of its long-term search for energy security and diversification of supply sources. The timing simply gave China the final breakthrough.

When China became a net importer of oil in the early 1990s, it already had begun to talk to Moscow about large-scale imports of Russian oil and gas, including gas pipelines from both eastern and western Siberia (Reuters, November 10, 2014). Over the past two decades, China’s dependence on imported oil has grown to 60 percent, with suppliers mostly from the Middle East and Africa.

One of China’s key objectives for supply security in recent years has been to develop closer ties with Russia and Central Asian energy producing countries, such as Kazakhstan and Turkmenistan. Chinese national oil companies (NOCs) have invested heavily in Central Asian energy producing states, and built multiple oil and gas pipelines to the western part of China. Chinese policy makers consider these land-based supply routes less vulnerable than the sea routes through which 80 percent of its energy imports travel and where the Chinese navy does not yet have a major presence. The first China-Russia gas deal last May secured the supply pipeline from eastern Siberia while the second one in November focused on opening the western Siberian route. [1]

China has also been trying to diversify its primary energy sources from its heavy dependence on coal. Close to 70 percent of Chinese energy comes from coal, which has caused severe domestic air pollution over the past three decades of rapid economic growth. Coal use is also responsible for over 80 percent of China’s CO2 emissions, whereas natural gas represents only 6 percent of China’s energy mix, one-fifth of the global average (U.S. Energy Information Administration (EIA), 2014). Reducing coal use and increasing the shares of oil, natural gas and non-fossil fuels in China’s energy mix have become a priority for both energy and environmental concerns. The two gas agreements with Russia, if finalized and delivered, will make up 17 percent of China’s total natural gas supply by 2020 (Wall Street Journal, November 10, 2014). Yet the total Russian gas supply volume of the two deals will represent only 1.7 percent of China’s overall energy demand.

With the right government policy drivers in place, the increased use of gas and other energy sources to replace coal can potentially lead to significant reductions in the country’s CO2 emissions. One of the unintended consequences of the Chinese-Russian gas deals could be their positive contribution to the global climate change agenda. This is also good news for the U.S.-China Joint Announcement on Climate Change that President Barack Obama and President Xi Jinping signed during the APEC summit (White House, November 11, 2014).

The World Energy Market

In a rapidly changing and volatile global energy market, the two gas deals are significant for the energy industry and policy makers. The large volume movement of gas from Russia to China in the near future will have a number of impacts on global energy markets.

The first is an emerging, more integrated Euro-Asian gas distribution infrastructure. While the global transportation of crude oil is well developed via land and sea, natural gas is still constrained by the lack of delivery choices. China’s gas pipelines have increased by nearly 20 percent annually in the past decade, but its per capita length remains at one percent of the United States (Gas.in-en.com, November 24, 2014). As a byproduct of the first China-Russia agreement, a 4,000-kilometer gas pipeline from eastern Siberia to China commenced construction in September 2014, with 2018 as the completion deadline. If the two countries move ahead with planned pipelines on both eastern and western fronts, plus China’s push for the fourth gas pipeline from Central Asia, a Euro-Asian continental gas transportation infrastructure will shape future worldwide gas shipping as well as pricing.

The second related trend is the emerging shifts in regional distribution of natural gas trade. Since the Ukrainian crisis began, both European Union countries and Russia have been seeking alternatives to reduce their vulnerabilities as a gas buyer or a supplier. If the China-Russia gas deals materialize, China will overtake Germany as the largest single-country market for Russian gas exports. Russia’s western Siberian export pipeline to China draws from the same gas fields that serve Europe (Oilprice.com, November 11, 2014). [2] Gazprom, even indicated that it might shelve its Vladivostok liquefied natural gas project, designed to supply Japan, in order to focus on supplying more gas to China by pipeline (Financial Times, October 10, 2014). Thus Beijing may continue to have the upper hand in its ongoing competition with Tokyo for Russian gas supply.

Putin also recognizes the significance of the two Russia-China gas deals for Russia’s energy infrastructure development and resource diversification drive: “This will help us make yet another important step—to connect the western and eastern gas pipeline systems and have a possibility to redirect resources from East to West and from West to East when it is advantageous from the viewpoint of the world market situation” (TASS, December 18, 2014).

The third is the downturn pressure for global gas and liquid natural gas (LNG) prices due to increased competition in the Chinese and Asian markets. In recent years, China’s natural gas and LNG imports have grown rapidly. With the forecast that China will consume as much gas as EU countries combined by 2035, there is a worldwide race to export gas and LNG to China. [3] Multiple projects in North America, Australia and the Middle East have been launched, all targeting the Asian market, where the price of natural gas has been much higher than other parts of the world in recent years. Compare the recent Asian market price of $14­–16 per thousand cubic feet mcf for LNG to the North American price of $3–4 per mcf (EIA, September 27, 2013).

During the decade-long China-Russia gas price negotiations, Russians wanted a price range from China as close to its export price to the EU market as possible, whereas the Chinese wanted a reference price point around its import price from Turkmenistan. With President Putin needing a signature on the deal during his China trip last May to counter Western sanctions over Ukraine, the price of the bilateral gas deal was widely believed to have been settled more in Beijing’s favor. Chinese sources have indicated that both sides agreed on a final price between $10­–$11 per mcf. [4]

The delivery of gas from Russia to China is primarily via pipelines, but both sides have also been working on a series of LNG deals. China National Petroleum (CNPC) and China National Offshore Oil (CNOOC) have established partnerships with Novatek, Russia’s second largest gas producer, to jointly produce LNG for the Chinese market as a part of the ongoing gas trade negotiations (Moscow Times, May 20, 2014; Reuters, July 10, 2014).

The mere prospect of large volumes of Russian gas coming to China in the near future has created a more competitive environment for LNG producers from North America, Australia and the Middle East. Together with the sharp drop in global oil prices in recent months, which negatively impacted gas prices, the LNG price in Asia has already dropped to around $10 per mcf (Reuters, December 11, 2014). The latest volatility in energy prices indicates that the Russians did not obtain that bad a deal after all, assuming the Chinese side keeps its side of the bargain in the next round of negotiations.

Global Geopolitics

The two China-Russia gas agreements have geopolitical implications. Such mega deals always go beyond simple market interactions between buyers and sellers. For Russia, a country with oil and gas exports accounting for 68 percent of the country’s total export revenue in 2013, these export contracts are huge (US Energy Information Administration, Today in Energy, July 23, 2014). President Putin noted that, “This is the biggest contract in the history of the gas sector of the former USSR.” Under sanctions by Western countries over the Ukrainian crisis, Putin signed the energy deals, showing defiance to the West and demonstrating that Russia cannot be isolated economically and politically.

China is willing to express its open support for Putin’s ongoing fight with the West. Diplomatically, Beijing remains neutral in the Russian-Ukrainian confrontation, calling for a peaceful settlement of the conflict. But it is an open secret that the Chinese policy elites are sympathetic to Russia, partly due to their conceptualization that the United States, the North Atlantic Treaty Organization (NATO) and other Western countries are primarily responsible for destabilizing Ukraine in the first place. [5]

President Xi and the new leadership core came to power amid the U.S. “Pivot to Asia.” They are alarmed by what they view as a worsening international security environment. In particular, they see Japan in the East China Sea, and the Philippines and Vietnam in the South China Sea, as “challenging” China’s territorial claims with the backing of the United States (China News, January 2, 2013). Such strategic concerns prompted President’s Xi to seek closer Russian ties as a balance against Washington. Russia, as the case with his predecessors, was Xi’s first foreign visit as head of state in 2013, and called the two countries the “most important strategic partners” (BBC, March 22, 2013). Putin was visibly Beijing’s most favored guest at the Beijing APEC summit.

Facing continuous Western sanctions, the Russian ruble is rapidly declining, which raises serious questions about the Russian economy and Putin’s ability to confront Western pressure. Chinese Foreign Minister Wang Yi offered Chinese assistance to Russia to overcome its financial and economic difficulties (Xinhua, December 23, 2014). Clearly, Beijing does not want a collapsed ruble, nor a weakened Russia in its struggle with the U.S.-led Western allies over the crisis of Ukraine. Yet the gas deals with China will not fundamentally solve Russia’s weakened economy under continued Western sanctions.

It is premature to conclude that China and Russia share the same dreams in their geopolitical games against the West. Beijing does not want to return to the 1950s-style military alliance with Russia, and Moscow does not want to become too dependent on China, which is already its largest trading partner. This may explain why Putin has not yet accepted China’s offer to help even though the ruble has lost 50 percent of its value.

Furthermore, a comprehensive regional oil and gas pipeline infrastructure and stable supply of oil and gas from Russia to China in the next several decades will lessen Beijing’s energy supply concerns. For those who view Chinese behavior in East and South China Seas partly as an expression of the country’s energy insecurity, the China-Russian gas deals may provide some level of comfort and hope that Beijing will be inclined to moderate its positions for more talks of joint resource development with its neighbors while shelving or delaying sovereignty issues for future generations.

The two China-Russia gas deals are large in volume, significant for Beijing’s quest for supply security and Moscow’s quest for demand security, and they have a major impact on the global energy market and geopolitics. But like many international agreements, the devil is in the details. With the recent decline in oil prices and its impact on gas prices, the first China-Russia gas deal may now be reduced by more than 25 percent. The low oil price, if sustained for a prolonged period, may add complications to the second China-Russia gas deal negotiations as it was only signed as an accord of intent without an agreed price nor binding terms. As the first China-Russia gas deal revealed, the most difficult stumbling block to finalize the second gas deal between the two parties will be the price, and the volatile global oil and gas prices are the most difficult to predict at the moment.

Notes

1. Officially, the costs for building the pipelines are shared between China and Russia: Russia will build the section inside its boarder while China will build the portion inside China. For the Russian section, however, China is providing Russia loans to expertise to build the pipeline, since Russia lacks the necessary capital. While China’s need to provide infrastructure support to Russia is a hindrance, CNPC can successfully do this.
2. Further development of the East Siberia gas field will primarily depend on capital and a long-term buyer, which the Chinese have promised, meaning Russia does not need the West to develop the field. This extends to technical expertise, as the Russians, together with the Chinese, are quite good at handling gas exploration and development.
3. Author’s interviews, Beijing, October 21–31, 2014.
4. International Energy Agency, World Energy Outlook 2012.
5. Jin Canrong and Wang Hao, “Wukelan Weijizhong De Gefangboyi He Zhongguo Lichang,” Xushu Qianyan, April 8, 2014. Also, author’s interviews, Beijing, September–December, 2014.