The 2009 Sino-Russian Gas Deals: Cementing a Strategic Partnership?

February 2010 Vol. 237 No. 2

The pressures of the financial and economic crisis have lead to a slump in Europe’s natural gas demand. This has caused a sizeable reduction in Russian gas imports – up to 50 billion cubic meters (bcm) in Western Europe alone – with Germany’s and Italy’s purchase reduction rates (44% and 34% respectively) being responsible for nearly half that drop. The loss in exports is significantly affecting Gazprom’s balance sheet and in conjunction with reduced Russian domestic consumption leading to excess capacity, forcing the gas major to reconsider its export dependency on the European gas market.

Unsurprisingly, the Russian gas monopoly has lately turned its attention towards the major emerging natural gas consumer China, as Prime Minister Putin’s 2008 visit to Beijing brought forth another round of negotiations on a long-awaited gas deal. Besides the conclusion of numerous commercial deals worth up to $3.5 billion signed between Russian and Chinese companies, Gazprom and China National Petroleum Corporation (CNPC) agreed to a strategic framework agreement on gas supplies, which would open the way for Russia to supply up to 70 bcm per annum by 2014-2015 through two new pipelines.

The first, known as the Altai pipeline, would cost roughly $10 billion and provide up to 30 bcm of Yamal gas running 6,700 km from Russia’s Altai region to Xinjiang where it would connect to China’s West-East pipeline. The second, using gas from Sakhalin or the Kovykta field would have a capacity of 40 bcm and would run from Eastern Siberia to Beijing.

This gas agreement would cement an increasingly important relationship between Russia, the largest energy exporter, and China, the largest energy consumer behind the United States. With the Russian Federation being as abundant in natural resources as the People’s Republic in cheap labor and manufacturing, there is indeed a vast complementary between both actors.

However, despite the actual benefits a closer Russian-China energy relationship might bring as well as the positive rhetoric surrounding the latest framework agreement signed on 13 October 2009, one should treat this so-called protocol of intentions with some skepticism as it represents a mere continuation of a discussion that has been running since early 2004. Commercial negotiations were already supposed to finish back in 2005 with deliveries destined to reach China in 2008 but disagreements on pricing, with China insisting on $70 per thousand cubic meters (mcm) and drawing comparisons to the discount prices offered by Russia to post-Soviet states such as Ukraine and Belarus, broke down efforts to clinch a deal. In March 2006 another preliminary agreement was drafted – this time for 68 bcm by 2011 – which faced similar obstacles as China obstinately refused to pay more than $100/mcm.

Consequently, the numerous memoranda of understanding and framework agreements have so far struggled to turn themselves into viable commercial contracts. While Moscow wishes to set the export price in accordance with the European pricing formula, which is linked to the oil price, Beijing insists that the gas price should be either fixed or linked to the local price for coal since Russian natural gas supplies would substitute coal in power generation.

The current economic dynamics, particularly in the oil and natural gas markets, are however increasing the chances of Moscow and Beijing actually striking an agreement. This is due to four fundamental factors.

First and foremost, lower oil prices are facilitating a deal as the corresponding gas prices are closer to China’s level of expectation. The current oil price of roughly $80 per barrel is therefore a good starting point for both actors. This is confirmed by Putin’s statement that a preliminary agreement has been reached to connect gas prices to an ‘Asian oil basket’.

Second, a LNG supply glut is depressing natural gas prices on the spot market. Back in August, for example, the forward gas price in the United Kingdom for delivery in winter was around 40 pence ($0.66) a therm, down from more than 100 pence ($1.64) in June 2008. This is putting pressure on the Russian Federation to stay within an acceptable price for Beijing.

Third, opening up the Chinese gas market would allow Moscow greater flexibility in exports, particularly with regards to offloading some of its potential excess supply, which has arisen due to the reduction in European gas imports from Russia. In addition, such access would considerably strengthen the case for developing Russia’s virgin resource base in Eastern Siberian, which exceeds 65 trillion cubic meters. This is particularly relevant in light of the fact that Russia’s new draft energy strategy until 2030 calls for a significant increase in oil and gas production in East Siberia and the Far East.

Fourth, a solid gas agreement between Russia and China could provide the former with the necessary capital to invest in its natural resources sector particularly given the fact that the credit crunch has raised the cost of borrowing and significantly reduced Russia’s investment potential. Such a development is already taking place in the oil sector with China National Petroleum Corporation and China’s Development Bank having agreed to a $25 billion loan to Russia’s Transneft and Rosneft back in February as part of an agreement to supply 15 million tons of oil annually over the next 20 years. This oil-for-loan credit, with an estimated interest rate of only 5.7%, will finance such ventures as new oil fields and pipelines in Eastern Siberia for China.

For Beijing, on the other hand, a solid gas agreement would lock-in gas supplies in the context of a steadily rising demand and potential future supply gap, which has been identified by several analysts, as a number of coal-fired power stations are replaced with natural gas, amongst others, due to concerns surrounding climate change.

The Great Recession and its economic conditions are therefore aligning interests between the Russian Federation and the People’s Republic of China. This promotes the closing of a gas deal and a settlement on prices, which according to Deputy Prime Minister Igor Sechin, might already be concluded in 2010. But as always the devil is in the details, and both sides still have some tough negotiations ahead of them concerning the exact formula on how to determine prices and what currency, or basket of currencies, to use. An agreement could also still be undermined by a drastic change in oil prices and the economic climate.

Last but not least, the negotiations are complicated by the fact that both parties do not entirely trust each other and therefore maintain a lot of room for maneuver. Parallel to its negotiations with Beijing, Moscow is in an open dialogue with Tokyo, which has consistently courted Russia for its natural gas supplies. Russia is also keen to develop its liquefied natural gas (LNG) capacities with exports to the United States. China, on the other hand, is dramatically increasing its presence in Central Asia. Having recently provided Turkmenistan with a loan for the development of the potential world-class South Yolotan gas field, Beijing has completed the first stage of the Turkmenistan-China pipeline in late 2009, which will ultimately provide up to 30 bcm per annum.

Analysts believe that, in a bid to decrease its dependence on Russia, Turkmenistan has agreed to a price that is roughly 50% lower than European prices. In addition, China wants to increase its imports from Myanmar as well as its domestic production, with Sinopec having recently discovered a huge gas field near Chongqing. Beijing is also expanding its LNG capacities in a coastal network that could handle up to 50 bcm by 2010.

In conclusion, despite all the ‘strategic partnership’ rhetoric, the Sino-Russian relationship is primarily a pragmatic relationship of convenience, which is currently being advanced by an economic climate that aligns both Moscow’s and Beijing’s interests. China is Russia’s fall-back option when the gas situation is unfavourable in Europe while Russia is yet another possible resource appendage for China if the price is right. This makes a gas deal hostage to circumstances and increases chances of such a deal falling through should the present economic conditions change.

Roderick Kefferpütz is a Brussels-based political advisor specializing in Eurasian political and energy affairs. He holds an MPhil with distinction in Russian and Eastern European Studies from the University of Oxford and is a regular commentator on energy security and Russian affairs in the international and German media.

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