Russia Sanctions Over Ukraine Aid China Gas Plans

An analysis by Michael Lelyveld
2014-11-24
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Gazprom CEO Alexei Miller (R), President Vladimir Putin (2nd L) and Vice Premier Zhang Gaoli (L) attend the ceremony marking the welding of the first link of 'The Power of Siberia' gas pipeline outside Yakutsk, Sept. 1, 2014.
Gazprom CEO Alexei Miller (R), President Vladimir Putin (2nd L) and Vice Premier Zhang Gaoli (L) attend the ceremony marking the welding of the first link of 'The Power of Siberia' gas pipeline outside Yakutsk, Sept. 1, 2014.
AFP

China is gaining an edge in energy deals with Russia as Moscow faces sanctions pressure from the conflict in Ukraine.

The latest energy accords announced in Beijing on the sidelines of the Asia Pacific Economic Cooperation (APEC) summit suggest that China is increasing its access to Russian resources while resisting demands for more favorable financial terms.

At a signing ceremony on Nov. 9, Presidents Xi Jinping and Vladimir Putin sealed a memorandum of understanding for a second Siberian gas pipeline on a western route that Russia has promoted unsuccessfully for years.

The preliminary commitment to the project known as the Altai pipeline, named for a remote Russian border region, follows an agreement in May on an eastern Siberian gas line to supply China's coastal cities and industrial northeast.

China has previously balked at proposals for access through Xinjiang, which already provides transit for its pipelines from Central Asia.

But Beijing is seen as more amenable to Russia's push for the western route now that the eastern "Power of Siberia" project is underway, said Mikkal Herberg, energy security research director for the Seattle-based National Bureau of Asian Research.

The Altai line would add 30 billion cubic meters (1 trillion cubic feet) per year of import capacity to the 38 billion cubic meters (1.3 trillion cubic feet) of the eastern route, boosting China's plans to replace more of its high-polluting coal with cleaner fuel.

"The signing of energy agreements between China and Russia is a win-win situation for both countries," said Zhou Dadi, vice director of the China Energy Research Society, as quoted by the official Xinhua news agency.

"The western route is becoming the priority for our gas cooperation," said Alexei Miller, CEO of Russian monopoly Gazprom, according to Reuters.

Miller said the projects could make Russia's gas sales to China larger than those to Europe "in a mid-term perspective," Itar-Tass reported.

Gas is expected to start flowing on the eastern route in 2019, while Gazprom hopes to sign a contract for the western line next year and complete construction in 2020.

On Chinese terms

China has been cool to the 2,600-kilometer (1,615-mile) Altai plan since Putin first proposed it in 2006, but Russia has hotly pursued a breakthrough to offset risks in Europe as sanctions on Moscow have tightened this year.

Both sides praised the mutual benefits of the gas deals, which were among 17 documents on cooperation signed during the summit, but China appeared in the stronger position.

"The Russians are having to come to terms with their reliance on China for energy markets and investment, so it's being done mainly on Chinese terms," Herberg said.

On Monday, Russian Finance Minister Anton Siluanov acknowledged the impact that Western sanctions have had on Moscow so far.

"We're losing around U.S. $40 billion (245 billion yuan) a year because of geopolitical sanctions, and about U.S. $90-100 billion (552-614 billion yuan) from oil prices falling about 30 percent," Siluanov told a press conference, Reuters reported.

Russia's deals with China are unlikely to cover the difference with near-term cash relief.

While announcing Russia's progress on the Altai route, Miller said Gazprom had given up on its long-sought goal of getting prepayments from state-owned China National Petroleum Corp. (CNPC) for gas to help pay for the Power of Siberia project.

In May, Gazprom deputy CEO Alexander Medvedev said a prepayment of U.S. $25 billion (153 billion yuan) had been agreed "in principle" to defray Russia's pipeline and infrastructure costs that Miller had estimated at U.S. $55 billion (336 billion yuan).

Instead, at the summit, Miller argued that gas prices had already been negotiated without an upfront payment.

"But since we have agreed finally on the price, we do not consider as possible using a prepayment as a financial instrument for further lowering of the price," said Miller.

"We are not negotiating loans," Miller also said.

Cost of development

Russia's capitulation after years of seeking advance payments may leave it with high development costs at a time when oil revenues are dropping and its hard currency reserves have dwindled in defense of the plunging ruble.

Herberg cited Russian sources as saying that Chinese funds have started flowing into the country, but these appear to be commercial loans rather than the prepayments that Gazprom sought.

Total costs of the western line are unclear, although they are expected to be lower than those for the eastern route, due to Russia's existing energy development in West Siberia.

Reports in 2012 estimated the project at U.S. $14 billion (85 billion yuan), but uncertainties about crossing the Altai region could drive costs higher.

Gazprom officials have yet to explain how they will cope with the environmental challenges of the mountainous wilderness and Altai's Ukok Plateau, designated by UNESCO as a World Heritage Site.

According to engineering details published by the Russian website Regnum.ru in 2007, altitudes of the pipeline route reach as high as 2,600 meters (8,530 feet).

Tunneling through the mountains may be needed, a study for Gazprom's Department of Strategic Development said.

On the Xinjiang side, the route would cover vast undeveloped distances before joining the corridor of China's West-East Gas Pipeline system.

"Over 8,000 kilometers (4,970 miles) of pipelines will have to be built in total to reach industrially developed regions in China because the territory on the pipeline's entrance to the country resembles a desert," Mikhail Krutikhin, a partner at the RusEnergy consulting firm, told the Moscow Times.

Last week, CNPC director of foreign relations Zhang Xin told Interfax that the Altai route had been agreed despite offers of transit from third countries, apparently referring to Mongolia and Kazakhstan.

Krutikhin and other analysts believe China will have a strong hand to renegotiate gas prices because Russia will have huge investment costs and pipeline capacity to fill, with only one customer on the other end.

Herberg said Russia tried for years to avoid such a trap, arguing against single-customer pipeline projects, only to fall prey to isolation after annexing Crimea and supporting separatists in Ukraine.

Energy investment

There are also signs that Russia has thrown open its previously-barred doors to Chinese investment in its energy sector as sanctions put ventures with Western companies on hold.

At the APEC meeting, Russia's state-owned Rosneft oil company announced a framework agreement to sell a 10-percent stake in its prized Vankor oilfield to CNPC for an undisclosed price.

The field, which produces some 440,000 barrels of low-sulphur crude per day, has been the main source of Russian oil deliveries to China through the East Siberian-Pacific Ocean (ESPO) pipeline.

Such key Russian resources have long been considered off-limits to foreign investment, particularly from neighboring China, but sanctions on Rosneft have been taking their toll.

"Nobody could get access to that or any of what Russia defines as strategic oil assets before," Herberg said. "So, they're clearly moving closer together in an energy sense, but I think it's Russia basically throwing themselves into the arms of the Chinese."

Sanctions on Western technology for liquefied natural gas (LNG) production in Russia may also affect its energy exports to China.

In Beijing, Miller suggested that Gazprom may be forced to scrap ambitious plans to develop LNG for the international market in the Russian Far East with a liquefaction plant at Vladivostok and consider building a second eastern export pipeline to China instead.

"We are carefully studying the possibility of supplying pipeline gas from the Far East to China," Miller told Interfax. "Yes, this can be considered an alternative to LNG."

The narrowing of Russia's export markets for gas could give China the upper hand in setting terms.

Sanctions on LNG technology transfers are also reportedly clouding prospects for Russia's plans to develop resources on the Arctic Yamal Peninsula with foreign partners.

CNPC and France's Total each have 20-percent stakes in the U.S. $26.9-billion (164.6-billion yuan) project with Russian independent producer Novatek.

In June, a Total official voiced concern that the project would need U.S. technology that is currently banned.

But CNPC's Zhang insisted last week that sanctions would block development.

"In our opinion, there are no problems with the Yamal project," said Zhang, according to Interfax.

Earlier this month, Novatek shareholder and Putin cohort Gennady Timchenko told the Kremlin's RIA Novosti news service that Chinese banks were prepared to invest over U.S. $10 billion (61.2 billion yuan) in the Yamal project.

But he added that investors "have begun to think and decide for themselves whether they need to get involved in this story or not," the Moscow Times said.

Timchenko is subject to U.S. sanctions, while Novatek appears on both U.S. and European Union sanctions lists.

Comments (2)
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Anonymous Reader

Ecosystems and the environment certainly lose as more fossil fuel extraction takes place under Putin in Russia and Xi Jinping in China.

Nov 30, 2014 09:10 PM

Zhuubaajie

from Hong Kong

Things are at a critical juncture. Oil prices are rumored to continue to drop. If the Saudis are convinced to NOT cut production (so oil drops to $60), and the West moves to lock Russia out from SWIFT - how's that for a scenario?

Putin is an ultra-nationalist. But when pushed to the wall, he could see things differently. China has what he needs - namely lots of cash. How about US$1 Trillion in cash for 100 years of development rights on the eastern 1/3 of Siberia, including the Kuriles?

So Putin gets cash, and China gets 50 years of 10% growth. The ongoing extraction taxes (to be negotiated as part of the deal) alone would support a mid level income for ALL Russians. China would develop at least 1 million sq. km. of farmland out of that 5 million sq. km., and would be able to feed yet another China and export at will. The world gets ample low cost food. Everyone wins.

Nov 26, 2014 03:03 AM

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