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Foreign Policy

Don’t Overestimate the China-Russia Gas Deal

May 29 , 2014

On Wednesday, May 21, 2013, China’s state-owned CNPC and Russian Gazprom signed a landmark $400 billion natural gas pipeline agreement. According to the 30-year deal, Russia will send 38 billion cubic meters (bcm) a year to northeast China, starting in 2018. Russian President Vladimir Putin called the agreement an “epochal event” for Russia, for whom the energy sector represents nearly a third of GDP. Beyond the financial impact, the agreement allows Mr Putin to demonstrate that Russia, in the face of Western sanctions over the annexation of Crimea, still has allies. But, although the deal has political and commercial significance for China, it is far from being the cornerstone of a renewed Sino-Russian alliance against the United States, and does not fundamentally alter the dynamics of Asia’s gas market. 

Michal Meidan

Chronicle of a Political Deal Foretold 

After more than a decade of negotiations and false starts, China and Russia finally clinched a long-awaited gas supply deal. The two countries’ commercial interests have grown more closely aligned over the past two years, as an uncertain demand outlook from Europe prompted Gazprom to look east for new markets. The arrival of competitive suppliers, including Australian and North American liquefied natural gas (LNG) in Asia as early as next year, also contributed to a sense that Russia’s window of opportunity was closing rapidly. 

At the same time, the Chinese government is aiming to more than double gas consumption by the end of the decade – from 165 billion cubic meters (bcm) in 2013, to 400-420 bcm in 2020 – on the back of an aggressive environmental agenda. Yet since the beginning of Sino-Russian negotiations over gas supplies well over a decade ago, China’s leaders have been aggressively pursuing numerous supply options, all of which have afforded Beijing greater leverage in its pricing negotiations. 

Haggling over the contractual terms thwarted the deal time and time again. But this time around, the looming sanctions on Russia over the annexation of Crimea and Putin’s upcoming visit to Europe provided the political impetus to get the contract over the finish line. 

A Political Win for Russia, But Also for China 

While the deal was a political lifeline for Putin, it was also a welcome boost for China’s new leaders as they enter their second year in office. Simmering tensions in the East and South China Sea, irritants in China’s relationship with the US over trade and cyber-security, and concerns over the country’s economic trajectory have increased the need for a geopolitical win. Chinese President Xi Jinping can now claim success in locking in gas supplies to feed the government’s ambitious fuel-switching agenda as it ramps up efforts to tackle its “airpocalypse”. He has also managed to conclude a significant deal that his predecessor, President Hu Jintao, failed to accomplish. But while this deal has helped Putin and Xi score political points, the geopolitical and market implications of the deal should not be exaggerated. 

China and Russia: Still Number Two

The deal will catapult Russia to becoming China’s second largest gas supplier after Turkmenistan by 2020. By the same token, gas shipments to China would also represent a nearly 25% increase in Russia’s gas exports outside the former Soviet Union. But Gazprom’s 38 bcm through the “Power of Siberia” pipeline will account for 9% of China’s total gas consumption and will be a far second from Central Asia’s 80 bcm, a situation that Beijing is likely happy to maintain. For all of the rhetoric around the deal, Russia’s repeated willingness to use energy as a political tool has made Beijing wary of Moscow. Furthermore, not only is Sino-Russian bilateral trade roughly a third of Sino-American trade volumes, but Beijing still considers its ties with Washington as its most strategic bilateral relationship. 

Meanwhile, a quarter of Russian exports, 167 bcm in 2013, are destined for Europe, a fact that is unlikely to change significantly given the web of pipelines that connect the two. Moreover, the “Power of Siberia” cannot displace those links. The two fields that will largely supply China, and would otherwise remain undeveloped, are also a great distance from the drilling rigs that feed Europe. In sum, Russia will not be diverting gas from Munich or Kiev to feed Beijing’s demand any time soon. 

Enter Shale Gas 

The pipeline deal is not a game changer in terms of China’s supply dynamics. First, Russian piped gas has already been incorporated in Chinese supply assessments for the coming decade, so the agreement does not suggest a gas surplus. Second, even if Russian exports to China eventually reach 60 bcm, Beijing will still want to keep other supply options open as it seeks to mitigate the vulnerabilities associated with growing import dependency and meet the needs of different geographies and different importers. 

The “Power of Siberia” is uniquely placed to supply China’s northeastern provinces (Heilongjiang, Jilin and Liaoning), which have very few alternative sources of supply. New LNG imports are slated to reach China’s eastern provinces, the country’s largest and most affluent consumer hubs. What is more, investment and procurement choices, although highly political, are also informed by commercial calculus and internal dynamics: as CNPC invests in pipeline imports, its rival CNOOC is looking to secure and expand its share of the LNG market. 

Finally, the Chinese government is counting on an extremely ambitious domestic shale production target of 60-100 bcm to supply the bulk of its demands, for which it still needs US technological knowhow. At the same time, failure to reach its shale production goals could lead to greater demand for imported LNG. To be sure, the pricing structure of the deal highlights China’s growing leverage as a consumer and suggests greater pressure on new suppliers to match these lower prices, likely at around $10 per one million British thermal units (Mmbtu). However, given that China’s current supplies come in at prices ranging from $4/Mmbtu to $18/Mmbtu, there is still scope for North American gas to be competitive in the Asian market. 

Dr Michal Meidan is director at China Matters, an independent consultancy advising leading global investors and government departments on their China strategies, with particular emphasis on the politics and geopolitics of the Chinese energy sector. She was also a senior analyst at Eurasia Group in New York and London, prior to which she headed the Energy and Environment Program at Asia Centre at Sciences Po in Paris. Dr Meidan holds a Ph.D in Political Science and East Asian studies from Sciences Po.

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