China-Russia Project Stalls as Energy Prices Plunge

An analysis by Michael Lelyveld
2016-01-25
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china-russia-01252016.jpg Gazprom CEO Alexei Miller (L), Russian President Vladimir Putin (2nd L) and Vice Premier of the People's Republic of China Zhang Gaoli (R) attend Siberian gas pipeline near Yakutsk, Sept. 1, 2014.
AFP

Russia's biggest energy deal with China faces delays as economic pressures mount in both countries, raising risks for the plan to link Siberian gas fields with China's industrial northeast.

On Dec. 29, Russia's monopoly Gazprom said it had cancelled a tender for a major portion of its mammoth Power of Siberia pipeline project after regulators objected to anti-competitive terms.

Gazprom's record tender for an 822-kilometer (510-mile) section of the pipeline was set to award 156 billion rubles (12.8 billion yuan) to "a single contractor for the entire set of works required for gas transportation" in order to "optimize costs," Interfax reported.

But on Dec. 7, Russia's Federal Antimonopoly Service (FAS) cited faulty documentation and "bidding criteria that were not measurable," the news agency said.

The regulatory roadblock came one week after Gazprom awarded 197.7 billion rubles (16.3 billion yuan) in pipeline contracts without competition to a construction firm owned by Arkady Rotenberg, a friend of President Vladimir Putin and a target of Western sanctions over Russia's conflict with Ukraine.

It was unclear whether the FAS action was meant solely to head off higher costs from limited competitive bidding. But cost is one of several problems for the gas deal that was valued at U.S. $400 billion (2.6 trillion yuan) when it was signed with China National Petroleum Corp. (CNPC) in 2014 after a decade of talks.

Technical challenges

Murky contracting, bureaucracy and technical challenges have all hindered progress on the plan to meet China's demand for cleaner-burning fuel, according to a year-end Interfax report.

"'The project is on schedule,' Gazprom officials intone.

Meanwhile, the available information suggests that although Power of Siberia may be a future hero, it is currently facing a struggle just to stand up," Interfax said.

The entire project stretches 3,968 kilometers (2,465 miles) to the Chinese border at an estimated cost of U.S. $21.3 billion (140.1 billion yuan), according to the TASS news agency. So far, 80 kilometers (50 miles) of pipeline have been completed, Interfax said.

The normally well-connected news agency voiced frustration with Gazprom over unanswered questions about the project. The company has been reorganized into numbered departments without clear responsibilities, it said.

"Thus, Power of Siberia's image is being shaped by tender flip-flops, postponements, cancelled purchases, new purchases and single-tender purchases," said the report.

Delays have caused contractors to miss much of the winter construction season in the Siberian wilderness, when the terrain is frozen and more stable. Construction costs per kilometer are several times higher than in western Russia, it said.

But external conditions facing the project may be even more challenging.

Export gas prices have plunged nearly 50 percent since the 30-year export deal was signed, making it unlikely to still be worth U.S. $400 billion. Peak volumes under the contract would reach 38 billion cubic meters (1.3 trillion cubic feet) a year.

Reports of the start-up date for deliveries have gradually slipped from 2018 to 2019 to 2021 and beyond.

Anticipated profits shrinking

While the anticipated profits for Russia are shrinking, an expected prepayment from China of U.S. $25 billion (164.5 billion yuan) never materialized. Reports suggest that Chinese banks have been wary about lending to Russia, which is bearing dual-burdens of sanctions and recession.

Russia's gross domestic product (GDP) fell 3.7 percent last year, Economic Development Minister Alexei Ulyukayev said Monday.

China's reluctance to finance the pipeline has hindered Gazprom's strategic shift to focus on Asia, which was meant to send a message to Western critics and spur competition for Russia's resources.

In early December, Interfax said Gazprom would return to its previous practice of holding its annual investment meetings in New York and London after moving them to Hong Kong and Singapore last year.

The report cited "the indecisiveness and conservativeness of Asian investors, and also the limited size of the Asian financial market."

Russia-China trade fell nearly 28 percent last year due in part to the oil slump, China's General Administration of Customs (GAC) reported. Russian exports to China were down 19 percent to U.S. $31.4 billion (206.5 billion yuan).

While conditions in Russia threaten delays, weakening economic growth in China has created little pressure for speed, despite the push to replace more high-polluting coal with cleaner gas.

The growth of China's gas consumption dropped from 17.4 percent in 2013 to 8.9 percent in 2014, according to CNPC.

Last year, the growth rate over 11 months dipped to 3.7 percent, the National Development and Reform Commission (NDRC) said.

The major market for Power of Siberia gas in China's industrial northeast has been struggling with the slowest GDP growth rates in the country and extreme production overcapacity.

Some plants that once may have been counted as potential gas consumers are now more likely to be shut down.

The combination of factors appears to be working against the gas deal on both sides.

On Jan. 16, Ulyukayev denied that terms of the deal would change due to weaker Chinese demand after Reuters quoted a Gazprom source as saying that volumes could be cut back.

Too important to abandon

Over the past year, Russian officials have periodically pushed for additional pipelines to China, including a western route through Xinjiang, but reports of progress have been few and far between.

In November, an intergovernmental commission concluded that a "new model of cooperation" would be needed to pursue the western route in light of lower energy prices, Interfax reported at the time.

In December, Gazprom and CNPC signed an agreement on design and construction of the Amur River border crossing for the Power of Siberia project, but that work could be years away.

Despite rising problems, Moscow remains committed to the costly project, which has been seen as a key to unlocking the resource wealth of Eastern Siberia and the Russian Far East, said Edward Chow, senior fellow for energy and national security at the Center for Strategic and International Studies in Washington.

"Since the agreement was signed, oil and gas prices have collapsed, projected Chinese energy demand is softer than expected, Russian country risks have gone up and its ability to finance expensive projects has deteriorated," said Chow.

"So, delay is to be expected. The question is for how long. It would not surprise me if the project does not flow significant gas volumes until 2025 or beyond," he said.

Chow sees the expected prepayment from China as an indicator of progress, and this has been missing. But the stakes may be too high to give up on the project.

"Since this is a strategically and politically important project for both Russia and China, it will not be abandoned.

There are always things that state-controlled companies can do to appear to make progress," he said.

But Russia may face even tougher challenges in developing Siberia's giant Kovykta and Chayanda gas fields that are planned to supply the pipeline.

"The pipeline itself should be the simplest part of the project," Chow said.

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